The Senate has approved a bipartisan IRS reform bill, which now heads to President Trump’s desk. Trump is expected to sign the bill into law.

The Senate has approved a bipartisan IRS reform bill, which now heads to President Trump’s desk. Trump is expected to sign the bill into law.

The reworked Taxpayer First Act ( HR 3151) cleared the Senate on the evening of June 13. The revamped measure had been approved unanimously in the House on June 10.

"After years of good-faith, bipartisan work, our IRS reforms are finally going to become law," House Ways and Means Committee Chairman Richard Neal, D-Mass., and ranking member Kevin Brady, R-Tex., said in a joint statement. "In this historic legislation, we focused on putting taxpayers first."

Likewise, Senate Finance Committee (SFC) Chairman Chuck Grassley, R-Iowa, praised the passage of the bipartisan, bicameral IRS reform bill. "It’s a big first step toward strengthening taxpayer protections and turning the IRS into the customer service organization it ought to be," Grassley said in a statement. "I look forward to President Trump signing it into law so the IRS can begin implementing long overdue reforms that will put taxpayers first," he added.

Reworked Bill

The reworked IRS reform bill, originally introduced in the last Congress, was revised earlier in June after the House passed a prior version in April. However, the original House-approved Taxpayer First bill (HR 1957) was deemed doomed in the Senate by May because of recent controversy surrounding the IRS’s Free File program. Thus, the provision codifying the Free File program was stripped from the original bill; the measure was reintroduced as HR 3151. It then quickly cleared each chamber.

Service Improvements

Generally, the Taxpayer First Act aims to reform the IRS for the first time in 20 years to better meet the needs of taxpayers. It requires the IRS to develop a comprehensive customer service strategy, as well as a plan to redesign its structure, modernize its technology, and enhance its cyber security. In addition, the new law will:

• waive the application fee for an offer in compromise (OIC) by a low-income taxpayer;

• clarify information available about low-income taxpayer clinics (LITCs);

• codify the Volunteer Income Tax Assistance (VITA) Program;

• require notice regarding the closure of taxpayer assistance centers (TACs);

• improve the IRS whistleblower program; and

• modify the private debt collection program.

Identity Protection

The legislation includes a number of provisions to help protect taxpayers from tax ID theft and improve taxpayer interaction with the IRS should they become a victim. For example, the IRS must provide a single point of contact for victims of identity theft, notification of suspected identity theft, and guidelines for stolen identity refund fraud cases.

The IRS is required to expand its current program that allows victims of tax ID theft to obtain a personalized PIN. Any individual must be allowed to request an identity protection personal identification number (IP PIN) to confirm a taxpayer’s identity on tax returns.

Electronic Filing

The IRS reform bill directly impacts taxpayers and other persons by reducing the threshold for filing electronically from 250 or more returns during the year. The threshold is 100 or more returns for 2021, and 10 or more return after 2021. The IRS can waive the e-file requirement for tax return preparers in areas with limited internet access.

E-filing requirements are also extended to all tax-exempt organizations that file returns or statements, regardless of amount of assets, gross receipts, or number of returns to be filed. In addition, the IRS is directed to develop an internet portal to allow taxpayers to file series Form 1099, similar to the portal used to file series Form W-2 with the Social Security Administration.

Other Electronic Services

To help increase the use of electronic services, the IRS must publish within six months uniform standards for accepting electronic signatures on requests for disclosure of taxpayer information (Forms 2848, 4506-T, and 8821). It must also limit the redisclosure of return information by a designee to only those expressly consented to by the taxpayer.

The new law increases the penalty for improper disclosure or use of information by return preparers. It also puts new limits on access to returns and return information by non-IRS employees.

Overall, the IRS must develop procedures to authenticate users of its suite of electronic services, to prevent tax refund fraud. Included in these services, the IRS must develop an automated version of its Income Verification Express Service (IVES) for third-parties.

Planning Note: The legislation also allows the IRS to accept credit and debit card payments for the payment of taxes directly, as opposed to through a third party. In addition, the IRS must establish procedures for taxpayers to report misdirected deposits of refunds.

Other Changes

Additional changes made by the Taxpayer First Act include:

• clarifying procedures for equitable relief from joint liability;

• establish new safeguards on the seizure of funds believed to be structured to avoid the $10,000 financial reporting requirement; and

• modify procedures for the issuance of summons and notice of third party contacts by the IRS.

To help pay for these changes, the minimum penalty for failure to file returns is increased after 2019 to the lesser of $330 (indexed for inflation) or 100 percent of the amount required to be shown on the return.

Taxpayers may rely on two new pieces of IRS guidance for applying the Code Sec. 199A deduction to cooperatives and their patrons:

Taxpayers may rely on two new pieces of IRS guidance for applying the Code Sec. 199A deduction to cooperatives and their patrons:

• Proposed regulations provide detailed rules for coop patrons and specified cooperatives to calculate the deduction.

• A proposed revenue procedure provides three methods for specified cooperatives to calculate W-2 wages.

199A Deduction for Cooperatives and Patrons

The 199A deduction, also known as the pass-through deduction or the QBI deduction, generally allows individuals, estates and trusts to deduct up to 20 percent of their qualified business income (QBI) from sole proprietorships and pass-through entities. Since most coops are C corporations, they cannot claim the deduction. However, their members may receive patronage dividends that are included in QBI.

Despite these general rules, certain agricultural or horticultural coops, known as "specified cooperatives," can claim their own version of the a deduction under Code Sec. 199A(g). A specified coop can also pass through any portion of this deduction by making qualified payments to its patrons. The patrons must reduce their own QBI accordingly.

For specified coops, the 199A(g) deduction retains many of the rules that governed the Code Sec. 199 domestic production activities deduction before it was repealed at the end of 2017. For example, the 199A(g) deduction is based on the specified coop’s domestic production gross receipts (DPGR) and qualified production activities income (QPAI), rather than its QBI.

Sec. 199A Deduction for Coop Patrons in General

Under the proposed regulations, any coop patron’s QBI may include patronage dividends and an exempt coop’s non-patronage dividends that:

• are related to the patron’s trade or business,

• are qualified items of income, gain, deduction or loss at the coop level,

• are not from a specified service trade or business (SSTB), and

• are properly reported to the patron.

The proposed regulations provide detailed rules for how coops must report the required information to their patrons. However, the coop does not report any W-2 wages or unadjusted basis in qualified property immediately after acquisition (UBIA). The W-2/UBIA limit that can reduce QBI for higher-income taxpayers is calculated only at the patron level.

Sec. 199A(g) Deduction for Specified Cooperatives

Code Sec. 199A(g) allows specified coops to claim a 199A deduction and pass through any portion of it by making qualified payments to its members. However, as mentioned above, a specified coop’s deduction is largely based on the pre-2018 domestic production activities deduction (DPAD). This means that the 199A(g) deduction for specified coops is effectively separate from the general Code Sec. 199A(a) deduction for other taxpayers.

Since specified coop patrons might be able to claim both the general 199A(a) deduction and the passed-through portion of the coop’s 199A(a) deduction, they must reduce their 199A(a)deduction by nine percent of QBI (or if less, 50 percent of W-2 wages) that is allocable to the qualified payments from the specified coop.

The proposed regulations offer a safe harbor that patrons can use to calculate this reduction. The patron allocates aggregate business expenses and W-2 wages between qualified payments and other gross receipts by ratably apportioning them based on the ratio of qualified payments to total gross receipts in QBI.

The proposed regulations also define several terms that are relevant to the 199A(g) deduction for specified coops, including:

• Patron,

• Specified cooperative,

• Agricultural or horticultural products (though the IRS is also considering broader definitions), and

• In whole or significant part.

Sec. 199A(g) Deduction and DPAD

The proposed regulations also provide four steps to determine the amount of a specified coop’s 199A(g) deduction. A specified coop that is not tax-exempt must:

• separate patronage and non-patronage gross receipts and related deductions;

• identify patronage gross receipts that qualify as DPGR,

• use the patronage DPGR from step (3) to calculate QPAI, and

• calculate the 199A(g) deduction, which is generally nine percent of the lesser of QPAI from step (4), or taxable income

These last three steps are virtually identical to the pre-2018 DPAD rules.

A tax-exempt specified coop calculates two separate 199A(g) deductions: one based on gross receipts and related deductions from patronage sources, and one based on those items from non-patronage sources.

The proposed regulations also apply DPAD-types rules to:

• determine the coop’s DPGR,

• reduce a specified coop’s 199A(g) deduction to reflect oil-related QPAI, and

• pass through the deduction to patrons.

In addition, the proposed regulations provide special rules for partnerships and expanded affiliated groups (EAGs).

Specified Coops and W-2 Wages

Although the proposed regulations treat the 199A(g) deduction as largely independent from the general 199A(a) deduction, both deductions generally use the same rules for W-2 wages. However, under the proposed regulations, W-2 wages for the 199A(g) deduction cannot include wages paid with respect to employment in Puerto Rico.

As mentioned above, a wages/UBIA limit may reduce the 199A deduction for higher-income taxpayers. A proposed revenue procedure provides three methods for calculating W-2 wages for purposes of the 199A(g) deduction:

• unmodified Box method

• modified Box 1 method

• tracking wages method.

These methods are largely identical to the methods provided in Rev. Proc. 2019-11, but are intended to better reflect changes that may be made in the underlying Form W-2, Wage and Tax Statement.

Effective Dates for 199A Proposed Regulations and Revenue Procedure

The regulations are proposed to apply to tax years beginning after the date they are published as final. However, taxpayers may apply them in their entirely before that date.

The notice of the proposed revenue procedure is effective on June 18, 2019. Specified cooperatives may rely on the proposed procedure before it is published in its final form.

IRS Invites Comments on Proposed Rules for Sec. 199A

The IRS requests comments on the proposed regulations and the proposed revenue procedure. In particular, the IRS invites comments on the following elements:

• A coop’s reporting of W-2 wages and UBIA,

• The safe harbor for coop patrons,

• Definitions,

• A specified coop’s separation of patronage and non-patronage income,

• DPGR treatment of minor assembly and contract work, and

• W-2 wages and Puerto Rico.

Comments are due by August 19, 2019. They may be mailed or hand-delivered to the IRS, or submitted electronically via the Federal eRulemaking Portal at www.regulations.gov. Comments on the proposed regs should reference "IRS REG-118425-18" and comments on the proposed revenue procedure should reference "Notice 2019-27".

The IRS has issued final regulations that require taxpayers to reduce the amount any charitable contribution deduction by the amount of any state and local tax (SALT) credit they receive or expect to receive in return. The rules are aimed at preventing taxpayers from getting around the SALT deduction limits. A safe harbor has also been provided to certain individuals to treat any disallowed charitable contribution deduction under this rule as a deductible payment of taxes under Code Sec. 164. The final regulations and the safe harbor apply to charitable contribution payments made after August 27, 2018.

The IRS has issued final regulations that require taxpayers to reduce the amount any charitable contribution deduction by the amount of any state and local tax (SALT) credit they receive or expect to receive in return. The rules are aimed at preventing taxpayers from getting around the SALT deduction limits. A safe harbor has also been provided to certain individuals to treat any disallowed charitable contribution deduction under this rule as a deductible payment of taxes under Code Sec. 164. The final regulations and the safe harbor apply to charitable contribution payments made after August 27, 2018.

SALT Limit

An individual’s itemized deduction of SALT taxes is limited to $10,000 ($5,000 if married filing separately) for tax years beginning after 2017. Some states and local governments have adopted laws that allowed individuals to receive a state tax credit for contributions to certain charitable funds. These laws are aimed at getting around the SALT deduction limit by creating a charitable deduction for federal income tax purposes. Regardless of state and local law, however, federal law controls when determining charitable deductions for federal income tax purposes.

Return Benefit

The final regulations generally adopt the rule in proposal regulations ( NPRM REG-112176-18) that the receipt of a SALT credit for a charitable contribution is the receipt of a return benefit (quid pro quo benefit). If a taxpayer makes a payment or transfers property to Code Sec. 170(c) entity, he or she must reduce any charitable contribution deduction for federal income tax purposes if he or she receives or expects to receive a SALT credit in return. A taxpayer is generally is not required to reduce the charitable deduction on account of its receipt of state or local tax deductions. However, the taxpayer must reduce its charitable deduction if it receives or expects to receive state or local tax deductions in excess of the taxpayer’s payment or the fair market value of property transferred.

De Minimis Exception

The final regulations retain the de minimis exception that a taxpayer’s charitable deduction is not reduced if the SALT credits received as a return benefit do not exceed 15 percent of the taxpayer’s charitable payment. The 15-percent exception applies only if the sum of the taxpayer SALT credit received or excepted to receive does not exceed 15 percent of the taxpayer’s payment or of the fair market value of the property transferred.

Safe Harbor

The IRS has also issued Notice 2019-12 providing a safe harbor for certain individuals if any portion of a charitable contribution deduction disallowed due to the receipt of a SALT credit. Under the safe harbor, any disallowed portion of the charitable deduction may be treated as the payment of SALT taxes for the purposes of deducting taxes under Code Sec. 164.

Eligible taxpayers can use the safe harbor to determine their SALT deduction on their tax-year 2018 return. Those who have already filed may be able to claim a greater SALT deduction by filing an amended return if they have not already claimed the $10,000 maximum amount ($5,000 if married filing separately).

Final regulations address the global intangible low-taxed income (GILTI) provisions of Code Sec. 951A. The final regulations retain the basic approach and structure of the proposed regulations published on October 10, 2018. The final regulations address open questions and comments received on the proposed regulations.

Final regulations address the global intangible low-taxed income (GILTI) provisions of Code Sec. 951A. The final regulations retain the basic approach and structure of the proposed regulations published on October 10, 2018. The final regulations address open questions and comments received on the proposed regulations.

Final regulations on the foreign tax credit also adopt proposed regulations published December 7, 2018. These rules were issued to ensure that the applicability dates coincide with the applicability dates of the Code sections to which they relate. The final foreign tax credit regulations also retain the basic structure and approach of the proposed regulations.

Also, a number of provisions were substantially revised.

Domestic Partnerships

The final regulations treat a domestic partnership as an entity for purposes of determining whether a U.S. person is a U.S. shareholder and whether a foreign corporation is a controlled foreign corporation (CFC). But the final rules treat a domestic partnership as an aggregate for purposes of determining whether and to what extent a partner of a domestic partnership has a GILTI inclusion.

Transfers During Qualified Period

The final regulations allow taxpayers to make an election that eliminates disqualified basis in property, by reducing a commensurate amount of adjusted basis in the property for all purposes of the Code.

Specified Tangible Property

A CFC may elect to use its non-ADS depreciation method for property acquired before enactment of the GILTI rules. A special rule requires depreciation of the salvage value: the portion of the basis in the property that would not be fully depreciated under the non-ADS depreciation method.

Anti-Abuse Rule

Under a "per se" rule in the proposed regulations, property was deemed to be held for the principal purpose of reducing a GILTI inclusion if held by the CFC for less than a 12-month period. The final regulations convert the per se rule to a rebuttable presumption. Under a second presumption, property held for more than 36 months is not subject to the rule. A safe harbor applies for certain transfers.

Foreign Tax Credit

The foreign tax credit proposed regulations contained a rule for determining the adjusted basis of the stock of the foreign corporation for purposes of allocating expenses to stock of certain foreign corporations. The final regulations provide that a taxpayer should not have an adjusted basis below zero in stock of a foreign corporation. A taxpayer’s adjusted basis may be reduced below zero as a result of an adjustment for earnings and profits deficits, as long as the adjustment for earnings and profits increased the adjusted basis of the foreign corporation above zero.

Applicability of Final Regs

The final GILTI regulations generally apply to tax years of foreign corporations beginning after December 31, 2017, and to tax years of U.S. shareholders in which or with which such tax years of foreign corporations end.

Proposed Regulations

The Treasury Department and the IRS also issued proposed regulations on the treatment of domestic partnerships for determining amounts included in their partners' gross incomes under Code Sec. 951 with respect to CFCs owned by the partnership, and the GILTI treatment of gross income that is subject to a high rate of foreign tax under Code Sec. 951A.

The proposed regulations would affect U.S. persons that own stock of foreign corporations through domestic partnerships and U.S. shareholders of foreign corporations. The Treasury Department and the IRS request timely comments on all aspects of the proposed rules. A public hearing will be scheduled if requested in writing by any person that timely submits written comments.

Aggregate Treatment Adopted

To be consistent with the treatment of domestic partnerships under Code Sec. 951A, Treasury and the IRS determined that a domestic partnership should also generally be treated as an aggregate of its partners in determining stock owned under Code Sec. 958(a) for Code Sec. 951 purposes.

Expansion to Exclude Other High-Taxed Income

Treasury and the IRS also determined that the GILTI high tax exclusion should be expanded (on an elective basis) to include certain high-taxed income even if that income would not otherwise be foreign base company income (FBCI) or insurance income. Further, taxpayers should be allowed to elect to apply the Code Sec. 954(b)(4) exception (the "GILTI high tax exclusion") for certain classes of income that are subject to high foreign taxes.

Newly issued temporary regulations limit the application of the Code Sec. 245A participation dividends received deduction (the participation DRD) and the Code Sec. 954(c)(6) exception in certain situations that present an opportunity for tax avoidance. The temporary regulations also provide related information reporting rules under Code Sec. 6038.

Newly issued temporary regulations limit the application of the Code Sec. 245A participation dividends received deduction (the participation DRD) and the Code Sec. 954(c)(6) exception in certain situations that present an opportunity for tax avoidance. The temporary regulations also provide related information reporting rules under Code Sec. 6038.

Participation Exemption Regime

The transition to the participation exemption system introduced by the Tax Cuts and Jobs Act, P.L. 115-97 (the Act) is effected through several interlocking provisions – Code Secs. 245A, 951A, and 965. All three provisions have different effective dates so there are periods in which some but not all of them apply. The participation exemption system operates alongside the subpart F regime.

Code Sec. 245A generally allows a domestic corporation a 100-percent dividends received deduction (a participation DRD) for the foreign-source portion of a dividend received after December 31, 2017, from a specified 10 percent-owned foreign corporation (an SFC). Generally, only earnings that are not taxed under the subpart F or the global intangible low-taxed income (GILTI) regime can, upon distribution, give rise to a dividend eligible for the participation DRD. Distribution of earnings and profits that is taxed under the subpart F or GILTI regime is a distribution of previously taxed earnings and profits (PTEP) that is not treated as a dividend and cannot qualify for the participation DRD. The participation DRD applies to distributions made after December 31, 2017.

The participation DRD does not apply to untaxed earnings of U.S. shareholders as of December 31, 2017. Instead, such earnings are subject to a transition tax under Code Sec. 965. For fiscal year CFCs, there is a gap period during which certain of their earnings may escape taxation.

Code Sec. 951A (the GILTI regime) taxes a U.S. shareholder on its global intangible low-taxed income, or GILTI, with respect to its CFCs at a reduced rate. The GILTI regime applies in the first tax year of a CFC beginning after December 31, 2017.

Code Sec. 954 generally provides that a dividend received by a CFC is included in the CFC’s foreign personal holding company income (FPHCI). Under Code Sec. 954(c)(6), however, a dividend received by a CFC from a related CFC is not included in the CFC’s FPHCI if certain requirements are satisfied (the section 954(c)(6) exception).

Scope of the Temporary Regulations

The temporary regulations limit the availability of the participation DRD and the section 954(c)(6) exception in specific and narrow cases where the deduction or exception, respectively, effectively eliminates subpart F income or GILTI from the U.S. tax system. Specifically, the temporary regulations address transactions that have the effect of avoiding tax under Code Sec. 965, 951A, or 951by inappropriately converting income that should have been subject to U.S. tax into nontaxed income. The temporary regulations also include information reporting rules under Code Sec. 6038 to facilitate administration of certain rules in the temporary regulations. The temporary regulations do not include general rules relating to dividends eligible for the participation DRD since those rules will be included in separate guidance.

Overview of the Temporary Regulations

Code Secs. 245A, 951A, and 965 generally act to tax foreign source income equivalently across taxpayers and sources so long as a U.S. shareholder owns the same amount of stock of a calendar year CFC throughout the CFC’s entire tax year. However, deviations from this condition potentially allow taxpayers to avoid tax by claiming a participation DRD in situations where otherwise identical income would be subject to U.S. tax. The following two situations may present such an opportunity for tax avoidance: (1) a U.S. corporation is the shareholder of a fiscal year CFC during 2018, or (2) a CFC pays a dividend and experiences a direct or indirect change in ownership during a tax year. The temporary regulations limit the application of the participation DRD in these situations.

With respect to the first situation, described above, as a result of a gap in the effective dates of these related international tax provisions, the difference between calendar year and fiscal year CFCs is significant and presents the potential for substantial tax avoidance when utilized to artificially generate earnings and profits in non-ordinary course transactions between related parties.

The temporary regulations refer to the portion of a dividend attributable to earnings and profits arising from such a transaction during this period as an "extraordinary disposition amount." An extraordinary disposition amount consists of certain earnings and profits resulting from transactions between related parties during the disqualified period. Although the period during which extraordinary dispositions may have occurred has passed, the regulations will potentially apply to any distributions of the associated earnings and profits after 2017.

In the second situation, described above, the participation DRD could facilitate the avoidance of the subpart F and GILTI regimes by allowing a U.S. shareholder to transfer, before the end of a CFC’s tax year, stock of the CFC to a new shareholder who will not be taxed on the CFC’s subpart F income or tested income.

The earnings and profits representing the portion of a dividend of a CFC attributable to subpart F income or tested income that, absent a transfer of the CFC stock pursuant to an extraordinary reduction, would have been subject to the subpart F or GILTI regimes are referred to as an "extraordinary reduction amount" in the temporary regulations. An extraordinary reduction amount consists of certain earnings and profits generated during a CFC’s tax year beginning after 2017 in which a domestic corporate U.S. shareholder reduces its ownership of the CFC by certain threshold amounts (e.g., a decrease in ownership of more than 10 percent). For this purpose, "certain earnings and profits" refers to income generally subject to inclusion under the subpart F or GILTI regimes.

Results similar to the ones described in the context of extraordinary disposition amounts and extraordinary reduction amounts can be achieved using the exemption from subpart F income under Code Sec. 954(c)(6) and lower-tier CFC dividends to upper-tier CFCs. Thus, the temporary regulations limit the application of the section 954(c)(6) exception in order to prevent similar results in circumstances in which a lower-tier CFC pays a dividend to another CFC, instead of directly to a U.S. shareholder.

Operation of the Temporary Rules

The temporary regulations do not permit the participation DRD for the portions of dividends made by CFCs that are attributable to ineligible amounts, which comprise extraordinary reduction amounts and 50 percent of any extraordinary disposition amounts.

To accomplish this, the temporary regulations disallow a deduction for transactions that have the effect of avoiding tax under Code Sec. 965, 951A, or 951. The extraordinary disposition rules accomplish this by denying the participation DRD for a narrowly and objectively defined class of earnings and profits generated by transactions undertaken in the disqualified period in circumstances that raise abuse concerns.

The extraordinary reduction rules accomplish this by denying the participation DRD for certain earnings distributed in the same year as reductions in ownership of CFC stock by a controlling Code Sec. 245A shareholder. The temporary regulations contain similar rules with respect to the section 954(c)(6) exception.

Information Reporting under Code Sec. 6038

Ineligible amounts, tiered extraordinary disposition amounts, and tiered extraordinary reduction amounts must be reported on the appropriate information reporting form in accordance with Code Sec. 6038. A transition rule mandates that taxpayers report the required information on the first return filed following the issuance of revised forms, instructions, or other guidance with respect to reporting such information. The transition rule also requires a corporation to report the information with respect to a predecessor corporation.

Applicability Dates

The rules in the temporary regulations relating to eligibility of distributions for the participation DRD apply to distributions occurring after December 31, 2017. The rules in the temporary regulations relating to the eligibility of dividends for the section 954(c)(6) exception also apply to distributions occurring after December 31, 2017, subject to a transition rule.

Final regulations reduce the Code Sec. 956 amount for certain domestic corporations that own stock in controlled foreign corporations (CFCs). The regulations are intended to ensure that Code Sec. 956 is applied consistently with the participation exemption system under Code Sec. 245A.

Final regulations reduce the Code Sec. 956 amount for certain domestic corporations that own stock in controlled foreign corporations (CFCs). The regulations are intended to ensure that Code Sec. 956 is applied consistently with the participation exemption system under Code Sec. 245A.

Subpart F Rules

Under the subpart F rules, U.S. shareholders of a CFC are currently taxed on their pro rata shares of the CFC’s subpart F income without regard to whether the income is distributed to the shareholders ( Code Sec. 951(a)). Subpart F income generally includes passive income and other income that is readily movable from one taxing jurisdiction to another ( Code Sec. 952). A U.S. shareholder is a U.S. person (e.g., individual citizen, domestic corporation, etc.) that owns or is treated as owning 10 percent or more of the voting power or value of a foreign corporation ( Code Sec. 951(b)).

The U.S. shareholders of a CFC are taxed on their pro rata share of the CFC’s earnings that are invested in U.S. property during the tax year and not distributed or otherwise taxed (the "section 956 amount"). U.S. shareholders are effectively taxed on foreign source earnings brought back into the United States, on the theory that the returned earnings are substantially the same as a dividend. This rule is intended to create symmetry by taxing effective repatriations of earnings in the same manner as actual repatriations of earnings are taxed.

Participation DRD

The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) added Code Sec. 245A, which allows a 100-percent participation exemption deduction—a participation dividends-received deduction (DRD)—for the foreign-source portion of dividends received from a specified 10-percent owned foreign corporation by a domestic corporation that is a U.S. shareholder of the foreign corporation. A specified 10-percent owned foreign corporation is any foreign corporation (other than certain passive foreign investment companies) in which a domestic corporation is a U.S. shareholder.

However, a domestic corporation cannot claim a participation DRD for a dividend on any share of the foreign corporation’s stock:

• that the domestic corporation holds for 365 days or less during the 731-day period that begins on the date that is 365 days before the date when the share becomes ex-dividend with respect to the dividend; or

• to the extent the domestic corporation is obligated to make related payments on positions in substantially similar or related property ( Code Sec. 246(c)).

Under the TCJA, a Code Sec. 956 inclusion is not eligible for the DRD because it is not a dividend.

Tax Treatment Symmetry

The participation exemption system has made the current broad application of Code Sec. 956 to corporate U.S. shareholders inconsistent with the Code section’s purposes and the scope of the transactions it is meant to address. In response, the regulations:

• exclude corporate U.S. shareholders from the application of Code Sec. 956 to the extent necessary to maintain symmetry between the taxation of actual repatriations and the taxation of effective repatriations, so that neither an actual dividend to a corporate U.S. shareholder nor the shareholder’s Code Sec. 956 amount will result in additional U.S. tax; and

• reduce the Code Sec. 956 amount otherwise determined regarding a U.S. shareholder for a CFC’s tax year ( "tentative Section 956 amount") to the extent that the shareholder would be allowed a participation DRD had the shareholder received a distribution from the CFC equal to the tentative Code Sec. 956 amount (the "hypothetical distribution").

The regulations include an ordering rule to address the previously taxed earnings and profits (PTEP) rules in Code Sec. 959. Under the ordering rule, the hypothetical distribution is treated as:

• first attributable to earnings and profits (E&P) described in Code Sec. 959(c)(2) (amounts attributable to subpart F inclusions); and

• then attributable to E&P described in Code Sec. 959(c)(3) (all other E&P).

The regulations also address the tentative section 956 amount with respect to domestic partnerships. The regulations provide that the tentative section 956 amount with respect to a domestic partnership is reduced to the extent that one or more of the domestic corporate partners would be entitled to a participation DRD if:

• the partnership received the amount as a distribution; and

• the remaining amount of the inclusion under Code Sec. 956 is allocated to the partners in the same proportion as net income would result to partners upon a hypothetical distribution.

Applicability Date

The regulations will apply to tax years of CFCs beginning on or after July 22, 2019, and to tax years of U.S. shareholders in which or with which such tax years of CFCs end.

The regulations may be applied to tax years of CFCs beginning after December 31, 2017, and to tax years of U.S. shareholders in which or with which such tax years of CFCs end, provided the rules are applied consistently by the taxpayer and U.S. related persons.

Final rules allow employers to use health reimbursement arrangements (HRAs) to reimburse employees for the purchase individual insurance coverage, including coverage on an Affordable Care Act Exchange. The rules also allow "excepted benefit HRAs," which would not have to be integrated with any coverage. The rules generally apply for plan years starting on or after January 1, 2020.

Final rules allow employers to use health reimbursement arrangements (HRAs) to reimburse employees for the purchase individual insurance coverage, including coverage on an Affordable Care Act Exchange. The rules also allow "excepted benefit HRAs," which would not have to be integrated with any coverage. The rules generally apply for plan years starting on or after January 1, 2020.

HRA Use Expanded

The final rules expand the use of HRAs by:

• allowing integration of an HRA with individual health insurance coverage and thereby satisfy the Affordable Care Act’s annual dollar limit and preventive care cost sharing requirements;

• creating "excepted benefit HRAs" limited in amount and to the types of coverage for which premiums may be reimbursed;

• providing new premium tax credit eligibility rules for individuals who are offered an HRA integrated with individual health insurance coverage;

• clarifying that individual health insurance coverage, the premiums of which are reimbursed by an HRA or qualified small employer HRA (QSEHRA), does not become part of an ERISA plan when certain conditions are met; and

• adding new special enrollment for the individual market for individuals who gain access to HRAs integrated with individual health insurance coverage or who are provided a QSEHRA.

The final regulations add conditions on individual coverage HRAs intended to prevent a negative impact on the individual market.

Integration With Individual Coverage

Almost any employer can satisfy Affordable Care Act reimbursement requirements by having employees buy their own individual coverage. An employers may integrate an HRA with individual health coverage only if:

• participants and dependents are actually enrolled in individual health insurance coverage (though not coverage that consists solely of excepted benefits) for each month they are covered by the HRA;

• coverage is offered to a class of employees to whom a traditional group health plan is not offered;

• coverage is offered on the same terms in amount and conditions to all employees within each class (though certain variations based on age are allowed);

• an opt out option is provided for individuals who prefer Affordable Care Act Exchange coverage, but would not be eligible for the premium tax credit if enrolled in an employer health plan such as an HRA; and

• substantiation and notice requirements are met.

To guard against adverse selection, the final rules add a minimum class size requirement that will apply to certain classes of employees in certain instances. Classes of employees may include full-time employees; part-time employees; seasonal employees; employees who are included in a unit of employees covered by a collective bargaining agreement in which the plan sponsor participates; employees who have not satisfied a waiting period for coverage; employees who have not attained age 25 prior to the beginning of the plan year; nonresident aliens with no U.S.-based income; employees whose primary site of employment is in the same rating area; and groups combining any of these classes of employee.

Excepted Benefit HRAs

An employer that wants to offer an HRA that is not integrated with non-HRA group coverage, Medicare, TRICARE, or individual health insurance coverage may do so as an excepted benefit. As excepted benefits, these HRAs would not be subject to the employer group plan rules, including the market reforms under the Affordable Care Act. An excepted benefit HRA:

• must not be an integral part of the plan;

• must provide benefits that are limited in amount ($1,800 per year, adjusted for inflation after 2020);

• cannot provide reimbursement for premiums for certain health insurance coverage; and

• must be made available under the same terms to all similarly situated individuals.

Final regulations provide requirements that a person must satisfy to become and remain a certified professional employer organization (CPEO), as well as the CPEO’s federal employment tax liabilities and other obligations.

Final regulations provide requirements that a person must satisfy to become and remain a certified professional employer organization (CPEO), as well as the CPEO’s federal employment tax liabilities and other obligations.

CPEOs

Some employers contract with PEOs to complete and file tax returns, pay and withhold employment taxes on wages paid to employees, or provide other employee benefits. Code Sec. 3511 and Code Sec. 7705 provide certification requirements for PEOs, and codify the employment tax consequences of being CPEO.

For federal employment tax purposes, a CPEO is generally treated as the employer of any individual who is:

• performing services for a customer of the CPEO; and

• covered by a contract between the CPEO and the customer.

Employer treatment applies only to remuneration paid to the covered employee by the CPEO. If an individual covered by a CPEO contract performs services for a customer at a work site that meets certain coverage requirements, only the CPEO is treated as the employer for federal employment tax purposes for remuneration its pays to that work site employee.

A person must apply to the IRS to become a CPEO, and the IRS must certify that the person meets certain requirements. A CPEO must:

• meet tax status and background requirements;

• meet bond, financial review, and quarterly reporting requirements; and

• notify the IRS of any change that materially affects the continuing accuracy of information it has provided to the IRS.

The Treasury Secretary can suspend or revoke CPEO certification if the person does not satisfy certain agreements or applicable requirements.

Final Regs

The final regulations adopt and amend proposed regulations published in 2016 ( NPRM REG-127561-15), and reflect and address certain interim guidance ( Rev. Proc. 2016-33, 2016-25 I.R.B. 1034; Notice 2016-49, 2016-34 I.R.B. 265; Rev. Proc. 2017-14, 2017-3 I.R.B. 426). In finalizing the regulations, the IRS reviewed and analyzed a variety of issues affecting CPEOs, including:

• maintaining a separate annual FICA tax and FUTA tax wage base and withholding threshold for each customer for which a covered employee performs services during a calendar year;

• the treatment of tax credits, including the addition of the employer credit for paid family and medical leave and certain employee retention credits to the list of specified credits that apply to the CPEO customer and not the CPEO;

• the treatment of self-employed individuals under the CPEO rules;

• CPEO reporting to the IRS, such as reporting the commencement or termination of CPEO contracts and service agreements;

• the meaning of key terms such as "responsible individuals" (certain owners, officers, and other persons of the CPEO), "work site," and "work site employee";

• the CPEO application process, including when an applicant may reapply for certification;

• CPEO "suitability" requirements, including domestic disregarded entity and sole proprietorship certification, fingerprint cards and background checks, and the waiver of confidentiality and privilege;

• working capital requirements, including a limited exception to the positive working capital requirement;

• bond requirements, including a provision that the IRS Commissioner may provide exceptions to the rule that a CPEO must meet the bond requirements without posting collateral; and

• maintaining employee records.

Applicability

The final regulations are effective on May 28, 2019.

House and Senate lawmakers have started their August recess, leaving pending tax legislation for after Labor Day. In past years, September has been a busy month for tax legislation and this year is likely to be the same. Before leaving Capitol Hill, lawmakers took actions in several areas related to tax reform.

House and Senate lawmakers have started their August recess, leaving pending tax legislation for after Labor Day. In past years, September has been a busy month for tax legislation and this year is likely to be the same. Before leaving Capitol Hill, lawmakers took actions in several areas related to tax reform.

House action

In the House, the  Budget Committee approved along party lines a fiscal year (FY) 2018 budget resolution. The resolution calls for:

• Simplifying the tax code to promote fairness for American families and businesses;
• Lowering tax rates for individuals and consolidating the seven tax brackets into fewer brackets;
• Repealing the alternative minimum tax (AMT); and
• Reducing the corporate tax rate.

The budget resolution does not set out specific tax changes or include legislative language. Rather, according to GOP leaders in the House, the budget resolution will serve as the vehicle for tax legislation at a future date.  House Budget Committee Chair Diane Black, R-Tennessee, predicted that tax reform will be "deficit neutral" and will "reduce tax rates and simplify the tax code." Budget Committee Ranking Member John Yarmuth, D-Kentucky, said that the resolution "adopts the worst extremes of the President's proposals by cutting taxes for millionaires and billionaires at the expense of everyone else."

Administration discussions

Since May, White House and Treasury Department officials have been meeting with business leaders, representatives of business and taxpayer groups, and other stakeholders in "listening sessions" about changes to the tax code. In July, Treasury Secretary Steven Mnuchin, after meeting with representatives from the agriculture sector, predicted that tax reform "would be done this year." Mnuchin said that "tax reform is one of our most important areas of focus.”

Bipartisan bills

Meanwhile, some stand-along tax bills have either passed committee or have been introduced. In July, the House Ways and Means Committee approved bipartisan legislation to overhaul the IRS's forfeiture authority. The Clyde-Hirsch-Sowers RESPECT Bill (HR 1843) was sponsored by Ways and Means Tax Policy Subcommittee Chair Peter Roskam, R-Illinois, and Democratic Caucus Chair Joe Crowley, D-New York. The RESPECT Act generally prohibits the IRS from seizing funds relating to a structuring transaction unless the  property to be seized is from an illegal source.

In the Senate, the Senate Finance Committee may take up a bipartisan bill to encourage retirement savings by enhancing growth of S corporations owned by employee stock ownership plans (ESOPs). The Promotion and Expansion of Private Employee Ownership Bill was introduced by Sen. Ben Cardin, D-Maryland, and Sen. Pat Roberts, R-Kansas. The lawmakers explained that their bill would amend the tax code to eliminate barriers that business owners face in establishing or expanding S corporation ESOPs. Similar bipartisan legislation is pending in the House.

Other pending tax bills include:

• HR 3068, which would enhance the research tax credit for domestic manufacturers.
• HR 3126, which would provide a tax credit to individuals for legal expenses paid  to establish guardianship of a family member with disabilities.
• HR 3138, which would generally treat Native American governments in the same manner as state governments for certain federal tax purposes.

Treasury tax position

The Treasury Department's top tax professional is the assistant secretary for tax policy. That position has been vacant since January 20. In July, the Senate Finance Committee unanimously approved President Trump’s nomination of David Kautter to serve as Treasury assistant secretary for tax policy. "This position is particularly important in the current environment as the administration is engaging with Congress on comprehensive tax reform," SFC Chair Orrin Hatch, R-Utah, said. Ranking member Ron Wyden, D-Oregon, said "it’s my hope that Mr. Kautter can help to bring Democrats and Republicans together." Kautter has worked at several major accounting firms over the past 30 years.

Please contact our office if you have any questions about tax legislation.

Taxpayers that plan to operate a business have a variety of choices. A single individual can operate as a C corporation, an S corporation, a limited liability company (LLC), or a sole proprietorship. Two or more individuals can form a partnership, a corporation (C or S), or an LLC.

Taxpayers that plan to operate a business have a variety of choices. A single individual can operate as a C corporation, an S corporation, a limited liability company (LLC), or a sole proprietorship. Two or more individuals can form a partnership, a corporation (C or S), or an LLC.

Nontax considerations

State law and nontax considerations are an important consideration in choosing the form of the business and may play a decisive role. A general partner of a partnership has unlimited liability for the debts of the business. This can be modified by using a limited partnership (LP), which must have at least one general partner and at least one limited partner. The general partner still have unlimited liability, but a limited partner's liability is limited to its contribution to the partnership. A corporation has limited liability; shareholders generally are not responsible for the liabilities of the corporation beyond their contributions to the entity.

Federal tax considerations

At the same time, it is crucial to consider federal tax requirements and consequences when choosing the form of business entity. A primary federal tax consideration is avoiding a double layer of tax on business income. This can be accomplished by operating as a passthrough entity, such as a partnership or S corporation. Income is not taxed at the entity level. It passes through to partners and shareholders and is taxed at their rates.

In contrast, C corporations are taxable entities. Furthermore, when a C corporation pays a dividend to its shareholders, this generally is taxable to the shareholder. It must be noted that income of a passthrough entity is allocable and taxable to its owners, whether or not the income is actually distributed to the partner or shareholder. Dividends are not taxed unless there is an actual distribution.

While a partnership is organized under state law, an S corporation is a creature of the federal tax system. The S corporation is a regular corporation for state law purposes.

Advantages of partnerships

Unlike an S corporation shareholder, anyone or any entity can be a partner. S corporations are limited to 100 shareholders; only certain individuals, estates and trusts are eligible to be shareholders. C corporations and nonresident aliens cannot be shareholders of an S corporation.

S corporations are limited to a single class of stock; income and losses must be allocated on the same basis to each shareholder. Having only one class of stock may affect the corporation's ability to raise capital. A partnership can have different classes of partners and has more flexibility for allocating income and losses to different types of partners.

Partnership liabilities can increase a partner's basis in the partnership, offsetting distributions of cash and reducing their taxation. The increased basis allowed partners to use losses generated by the partnership. Liabilities of an S corporation do not create stock basis; separate bases in stock and debt must be calculated. This lack of basis may limit the use of losses generated by the S corporation.

Contributions of appreciated property by a partner to the partnership generally are not taxable, even if the partner is not part of a group controlling the partnership. Contributions by a shareholder to a corporation are tax-free only if the shareholders are part of a group controlling 80 percent of the corporation after the contribution. However, a partnership must follow special allocation rules for handling built-in gain on contributed property, whereas S corporations do not have special allocation rules in this circumstance.

Conclusion

In general, a partnership offers more flexibility than an S corporation in the treatment of taxes. However, S corporation shareholders do have limited legal liability, while general partners are not insulated from the partnership's debts and liabilities.

Since 2009, the IRS has operated an Offshore Voluntary Disclosure Program (OVDP) for U.S. taxpayers who have failed to disclose foreign assets or report foreign income from those assets to the IRS or Treasury. The program provides reduced penalties and other benefits, thus giving taxpayers an opportunity to address their past noncompliance and "become right" with the government.

Since 2009, the IRS has operated an Offshore Voluntary Disclosure Program (OVDP) for U.S. taxpayers who have failed to disclose foreign assets or report foreign income from those assets to the IRS or Treasury. The program provides reduced penalties and other benefits, thus giving taxpayers an opportunity to address their past noncompliance and "become right" with the government.

The IRS reports that 45,000 taxpayers have made voluntary disclosures since 2009 and have paid $6.5 billion in back taxes, interest, and penalties. In 2014, the IRS made important changes to the OVDP, with the expectation that the revised program will lead to a significant increase in the number of U.S. taxpayers who participate in the OVDP and report their undisclosed foreign assets.

Reporting obligations

U.S. taxpayers, including U.S. citizens living abroad, must report and pay taxes on their worldwide income, including income from foreign assets. Taxpayers must report foreign accounts on Form 1040, Schedule B; if their value exceeds certain thresholds, they must report on Form 8938, Statement of Foreign Financial Accounts. Taxpayers with accounts worth more than $10,000 must report the accounts on the Report of Foreign Bank and Financial Accounts (FBAR), which is filed with Treasury (not the IRS).

The IRS provided temporary OVDPs in 2009 and 2011. In 2012, it opened another OVDP that it continues to offer. Under the 2012 program, taxpayers must enter into a closing agreement with the IRS, provide updated returns for the prior eight years, and pay a penalty as high as 27.5 percent. In return, the IRS agrees not to pursue criminal penalties against taxpayers who may have willfully failed to report their foreign assets and/or income. In 2012, the IRS also unveiled a "streamlined procedures" program, with lighter penalties for U.S. taxpayers residing abroad who were nonwillful evaders.

2014 revisions

The revised streamlined procedures program has been expanded to taxpayers living in the United States. Participants are no longer required to have an unpaid tax balance of $1,500 or less per year. Participants self-certify that their noncompliance was not willful; the IRS will review their circumstances. Taxpayers must pay taxes on any unreported income from the past three years and must file required FBAR reports for the previous six years. Participants living abroad pay no penalty, while U.S. residents pay a miscellaneous offshore penalty of five percent.

The OVDP program for potentially willful evaders has been tightened. Taxpayers must provide increased information and must pay the 27.5 percent penalty at the time of application. In light of the expanded streamlined program, the IRS eliminated reduced penalties (five and 12.5 percent) that had been offered to nonwillful OVDP participants. To increase the pressure on nonfilers, the IRS increased the penalty from 27.5 percent to 50 percent for taxpayers who used a foreign financial institution or a facilitator that the IRS or Justice Department publicly acknowledges to be under investigation.

Taxpayers are advised to consult with their tax adviser about these programs and choose carefully. A taxpayer cannot participate in both the streamlined and the OVDP programs; it is an either/or proposition. If a taxpayer is confident that his or her noncompliance was not willful, the streamlined program is a reasonable choice. However, this program provides no protection from criminal prosecution, further audits, or proposed tax increases, if the IRS decides that the taxpayer acted willfully.

In 2012, many taxpayers will have additional considerations when analyzing whether to sell investments before the end of the year or retain them in 2013. First, the Bush-era tax cuts are scheduled to expire at the end of 2012. This affects ordinary income rates, as well as rates on capital gains and dividends. Second, under the health care law, a new 3.8 percent Medicare tax on unearned income, including interest, dividends and capital gains, will take effect in 2013. Together, these real and potential changes may add up to hefty new taxes in 2013, unless Congress takes action otherwise.

In 2012, many taxpayers will have additional considerations when analyzing whether to sell investments before the end of the year or retain them in 2013. First, the Bush-era tax cuts are scheduled to expire at the end of 2012. This affects ordinary income rates, as well as rates on capital gains and dividends. Second, under the health care law, a new 3.8 percent Medicare tax on unearned income, including interest, dividends and capital gains, will take effect in 2013. Together, these real and potential changes may add up to hefty new taxes in 2013, unless Congress takes action otherwise.

Income tax rates

Current income tax rates continue through the end of 2012.  These include the overall individual income tax rates, currently at 10, 15, 25, 28, 33 and 35 percent. If Congress does not take any action, these rates revert to the higher rates that used to apply: 15, 28, 31, 36, and 39.6 percent. Republicans favor retaining all of the Bush-era rates. President Obama and many Democrats support retaining the 10, 15, 25, and 28 percent rates for lower- and middle-income taxpayers, while reinstating the 36 and 39.6 percent rates for taxpayers with income over $200,000 (single taxpayers) or $250,000 for joint filers.

Additionally, there are calls for tax reform and for an overall lowering of income tax rates, in exchange for ending unspecified tax deductions and benefits. For example, House Republicans have called for replacing current income tax rates with two brackets, of 10 and 25 percent.

Capital gains and dividends

Current income tax rates that extend through the end of 2012 also include the 15 percent rate on capital gains and qualified dividends for qualified taxpayers. If Congress does not act, these rates revert to much higher ordinary income rates, in the case of dividends, and to the 20 percent rate that formerly applied to capital gains. Again, the President and the Republicans would both extend the current rates, but disagree on whether to apply the extensions to all taxpayers (the Republicans) or only to lower- and middle-income taxpayers under the $200,000/$250,000 thresholds (the President).

3.8 percent tax

Adding to the mix is the impending 3.8 percent tax on unearned income. Under the health care law, this tax will apply to 2013 income (and beyond) of single taxpayers with income exceeding $200,000 and joint filers with income exceeding $250,000. The tax is imposed on the lesser of net investment income or the excess of adjusted gross income about the $200,000/$250,000 thresholds.

Net investment income also includes rents, royalties, gain from disposing of property used in a passive activity, and income from a trade or business that is a passive activity. The tax does not apply to distributions from retirement plans and IRAs. Taxpayers cannot necessarily avoid the tax by moving assets to a trust, because the tax will apply if trust income exceeds a threshold currently set at only $11,200.

Sell or hold

Generally, taxpayers should make investment decisions based on economics, holding on to a "good" investment and selling a "bad" investment. This involves looking at past performance and perhaps gazing into a crystal ball. Taxpayers that are debating whether to sell appreciated assets or assets that pay qualified dividends may want to act in 2012, when income tax rates are lower and before the 3.8 percent tax takes effect. Taxpayers considering the sale of declining assets may want to consider holding off until 2013, when losses can offset more highly-taxed gains and reduce the income potentially subject to the 3.8 percent tax.

Because the 3.8 percent tax does not apply to tax-free income, such as municipal bonds and distributions from a Roth IRA, taxpayers may want to shift some of their investments to yield nontaxable income. While the income from converting a traditional IRA to a Roth IRA would be included in the income calculations, qualifying distributions after the conversion would not be included.

Again, the decision must make economic sense. If the taxpayer expects an asset to continue to decline in value during 2012, he or she should sell the asset soon and not wait until 2013. Another consideration is the bunching of income. Taxpayers that sell substantial capital gains assets in 2013 may push their income up to the $200,000/$250,000 thresholds that trigger higher taxes. If the taxpayer is considering a sell-off of assets, it may make more sense to sell assets before 2013.

If a taxpayer wants to shift to more conservative investments, income yields may decline, but so will the incidence of the dividend, capital gains, and unearned income taxes described above. On the other hand, taxpayers looking at more speculative investments should understand that a successful investment may generate income taxed at higher rates in 2013.

Please contact our office if you have any questions.

Stock is a popular and valuable compensation tool for employers and employees. Employees are encouraged to stay with the company and to work harder, to enhance the value of the stock they will earn. Employers do not have to make a cash outlay to provide the compensation, yet they still are entitled to a tax deduction.

Stock is a popular and valuable compensation tool for employers and employees. Employees are encouraged to stay with the company and to work harder, to enhance the value of the stock they will earn. Employers do not have to make a cash outlay to provide the compensation, yet they still are entitled to a tax deduction.

Employers may make a direct transfer of stock to an employee as compensation for services performed. In the simplest case, the employee's rights in the stock are vested upon receipt. Under Code Sec. 83, the employee has income, equal to the fair market value of the stock, less any amount paid for the stock. The employer can take a compensation deduction under Code Sec. 162 for the amount included in the employee's income.

Risk of forfeiture

The employer may decide to impose certain conditions on the employee's right to the stock (such as a requirement that the employee continue to work for the company for two years before the stock "vests"). In this situation, the stock is subject to a substantial risk of forfeiture (or is "nonvested") until the two-year period elapses. After two years, the stock vests, and the employee recognizes income for the excess of the stock's value (at the time of vesting) over the amount paid. If the employee leaves the company within two years, the employee forfeits the stock.

An employee who receives stock subject to a substantial risk of forfeiture may anticipate that he or she will stay with the company for the required two years. The employee may also anticipate (or at least hope) that the stock will appreciate in value. Rather than wait two years and have to recognize income when the stock vests, an employee may elect under Code Sec. 83(b) to treat the property as vested upon receipt and to recognize compensation income (if any) at the time of receipt.

83(b) election

The employee may be required to pay for the stock when received. If the employee paid the fair market value of the stock, making a Code Sec. 83(b) election is particularly advantageous, because the employee will not recognize any income on the election.

Example.  Widget Corporation transfers 10 shares of its common stock to Hal, an employee, subject to a requirement that Hal work for two years before the stock vests. The stock is worth $5 a share. Hal is required to pay $5 a share upon receipt of the stock. By making a Code Sec. 83(b) election, Hal will not recognize any income, because the value and the cost of the stock are the same. If Hal did not have to pay any money for the shares, and made an election, Hal would have $50 of compensation income (10 shares times $5 a share).

After making an election, if the employee then works for two years, and the stock appreciates, the employee does not recognize any further compensation income, because the employee has already been taxed under Code Sec. 83.  By making the election, the employee is treated as owning the stock. When the employee sells the stock, the employee will recognize capital gain or loss, measured by the difference between the amount received and the value of the stock when it vested.

Election formalities

To make an election under Code Sec. 83(b), an employee must file a statement with the IRS, within 30 days of the transfer of the property to the employee. The statement must be filed with the Internal Revenue Service Center where the employee would file his or her income tax return. A copy of the statement must be provided to the employer, who is entitled to a compensation deduction when the election is made. A copy must also be attached to the employee's income tax return.

IRS regulations prescribe the requirements for an election. In Rev. Proc. 2012-29, the IRS also provided sample language for employees to use to make the election. The IRS advised that the sample language is not required. The election must identify the taxpayer, the property being transferred, the date of the transfer, the restrictions on the property, the property's value at the time of transfer (generally determined without the restrictions), the amount paid by the employee, and the amount of compensation income (the value minus the amount paid). The employee must also sign the election.

The election cannot be revoked without the IRS's consent. The IRS will not ordinarily grant consent unless there has been a mistake of fact as to the underlying transaction.

If you have any questions about making a Code Sec. 83(b) election, please contact our office.

Some individuals must pay estimated taxes or face a penalty in the form of interest on the amount underpaid. Self-employed persons, retirees, and nonworking individuals most often must pay estimated taxes to avoid the penalty. But an employee may need to pay them if the amount of tax withheld from wages is insufficient to cover the tax owed on other income. The potential tax owed on investment income also may increase the need for paying estimated tax, even among wage earners.

Some individuals must pay estimated taxes or face a penalty in the form of interest on the amount underpaid. Self-employed persons, retirees, and nonworking individuals most often must pay estimated taxes to avoid the penalty. But an employee may need to pay them if the amount of tax withheld from wages is insufficient to cover the tax owed on other income. The potential tax owed on investment income also may increase the need for paying estimated tax, even among wage earners.

The trick with estimated taxes is to pay a sufficient amount of estimated tax to avoid a penalty but not to overpay. The IRS will refund the overpayment when you file your return, but it will not pay interest on it. In other words, by overpaying tax to the IRS, you are in essence choosing to give the government an interest-free loan rather than invest your money somewhere else and make a profit.

When do I make estimated tax payments?

Individual estimated tax payments are generally made in four installments accompanying a completed Form 1040-ES, Estimated Tax for Individuals. For the typical individual who uses a calendar tax year, payments generally are due on April 15, June 15, and September 15 of the tax year, and January 15 of the following year (or the following business day when it falls on a weekend or other holiday).

Am I required to make estimated tax payments?

Generally, you must pay estimated taxes in 2012 if (1) you expect to owe at least $1,000 in tax after subtracting tax withholding (if you have any) and (2) you expect your withholding and credits to be less than the smaller of 90 percent of your 2012 taxes or 100 percent of the tax on your 2011 return.  There are special rules for higher income individuals.

Usually, there is no penalty if your estimated tax payments plus other tax payments, such as wage withholding, equal either 100 percent of your prior year's tax liability or 90 percent of your current year's tax liability. However, if your adjusted gross income for your prior year exceeded $150,000, you must pay either 110 percent of the prior year tax or 90 percent of the current year tax to avoid the estimated tax penalty. For married filing separately, the higher payments apply at $75,000.

Estimated tax is not limited to income tax. In figuring your installments, you must also take into account other taxes such as the alternative minimum tax, penalties for early withdrawals from an IRA or other retirement plan, and self-employment tax, which is the equivalent of Social Security taxes for the self-employed.

Suppose I owe only a relatively small amount of tax?

There is no penalty if the tax underpayment for the year is less than $1,000. However, once an underpayment exceeds $1,000, the penalty applies to the full amount of the underpayment.

What if I realize I have miscalculated my tax before the year ends?

An employee may be able to avoid the penalty by getting the employer to increase withholding in an amount needed to cover the shortfall. The IRS will treat the withheld tax as being paid proportionately over the course of the year, even though a greater amount was withheld at year-end. The proportionate treatment could prevent penalties on installments paid earlier in the year.

What else can I do?

If you receive income unevenly over the course of the year, you may benefit from using the annualized income installment method of paying estimated tax. Under this method, your adjusted gross income, self-employment income and alternative minimum taxable income at the end of each quarterly tax payment period are projected forward for the entire year. Estimated tax is paid based on these annualized amounts if the payment is lower than the regular estimated payment. Any decrease in the amount of an estimated tax payment caused by using the annualized installment method must be added back to the next regular estimated tax payment.

Determining estimated taxes can be complicated, but the penalty can be avoided with proper attention. This office stands ready to assist you with this determination. Please contact us if we can help you determine whether you owe estimated taxes.

On June 28, the U.S. Supreme Court issued its long-awaited landmark decision on the Patient Protection and Affordable Care Act (PPACA) and its companion law, the Health Care and Education Reconciliation Act (HCERA). In a 5 to 4 decision of historic proportions, the nation's highest court upheld the law – except for a certain Medicaid provision involving state funding.  Key to the Court's approval of President Obama's signature health care law was the finding that the linchpin individual mandate was constitutional.  The requirement under the individual mandate that individuals pay a penalty if they fail to carry minimum essential health insurance coverage was declared within the Constitution based upon Congress's power to tax.

The Supreme Court's decision preserves all of the far-reaching tax provisions and health insurance reforms that were part of the overall health care reform legislation as passed in 2010. In coming months, lawmakers and legal scholars will examine all of the nuances of the Court's highly complex decision.  More immediately, individuals and businesses are concerned about what steps they need to take next.

Role of taxes

To a large extent, the Obama administration's health care law is driven by tax provisions, to provide the carrot, the stick and adequate funding in alternating quantities. The role played by taxes in the new health care provisions is also underscored by the predominate part that the IRS will play in its administration.

Under the health care law, a number of tax provisions are scheduled to take effect in 2013 and beyond. The court's decision allows the numerous tax provisions within the health care laws to move forward on schedule. Some important provisions have already taken effect; others will take effect in 2013 and 2014. One provision, the excise tax on high-cost employer-sponsored coverage, will not take effect until 2018.

Main provisions/effective dates

PPACA and HCERA include the following tax provisions (not a complete list):

• Small employer Sec. 45R credit, effective for tax years beginning in 2010 – the government will provide a credit of 35 percent of health insurance premiums to small employers (25 percent for tax-exempt organizations. The credit expires after 2015.
• Economic substance doctrine, effective after March 30, 2010 – the economic substance test was codified as a two-prong test, requiring that the transaction change the taxpayer's economic position in a meaningful way, and that the taxpayer has a substantial business purpose for the transaction.
• Over-the-counter limitations for health accounts, effective for tax years beginning after December 31, 2010 – health accounts, such as flexible spending arrangements, health reimbursement arrangements, health savings accounts, and Archer Medical Savings Accounts, can only reimburse expenses for medicine and drugs if the item is a prescription drug (or insulin).
• Indoor tanning services excise tax, effective on or after July 1, 2010 – amounts paid for indoor tanning services are subject to a 10-percent excise tax. Tanning salons must collect the tax and pay it quarterly.
• Itemized deduction for medical expenses, effective for tax years beginning after December 31, 2012 – the threshold for deducting medical expenses as an itemized deduction is raised from 7.5 percent to 10 percent of adjusted gross income.
• Additional 0.9% Medicare tax, effective after December 31, 2012 – an additional 0.9 percent Medicare tax is imposed on wages and self-employment income of higher-income individuals: individuals – above $200,000; married filing jointly – above $250,000; married filing separately – above $125,000.
• 3.8% Medicare contribution tax, effective after December 31, 2012 – a 3.8 percent Medicare tax is imposed on unearned income for higher-income individuals, including interest, dividends, annuities, royalties, rents and other passive income.
• Medical device excise tax, effective for sales after December 31, 2012 – a 2.3 percent excise tax is imposed on sales of certain medical devices by manufacturers, producers and importers. Retail items such as eyeglasses are excluded from the tax.
• Employer shared responsibility, effective after December 31, 2013 – the "employer mandate": an applicable large employer (50 or more full-time employees) must make a payment if any full-time employee can receive the premium tax credit. The payment is required if the employer does not offer minimum essential coverage, or offers coverage that is not affordable.
• Branded prescription drug fees, effective for calendar years beginning after December 31, 2010 – an annual fee imposed on manufacturers and importers with receipts from branded prescription drug sales.
• Sec. 36B premium assistance credit, effective for tax years ending after December 31, 2013 – lower-income individuals who obtain health insurance coverage through an insurance exchange may qualify for the credit, unless they are eligible for other minimum essential coverage.
• Excise tax on high-dollar insurance, effective for tax years beginning after December 31, 2017 – employer-sponsored health coverage whose cost exceeds a threshold amount ($10,200 for self-on coverage; $27,500 for other coverage) will be subject to a 40-percent excise tax.

Looking ahead

Employers, taxpayers – indeed everyone – must prepare for sweeping changes in health care in coming years.  Many of the provisions in the PPACA have already been implemented or are in the process of being implemented.  Other provisions, as the above list indicated, are scheduled to take effect after 2012.  The Supreme Court's upholding of the PPACA clears the way for full implementation of the new law (unless a future Congress votes to repeal the law, which at this point would be an uphill battle). Our office will keep you posted of developments and the steps you need to take in the coming months.

In light of the IRS’s new Voluntary Worker Classification Settlement Program (VCSP), which it announced this fall, the distinction between independent contractors and employees has become a “hot issue” for many businesses. The IRS has devoted considerable effort to rectifying worker misclassification in the past, and continues the trend with this new program.  It is available to employers that have misclassified employees as independent contractors and wish to voluntarily rectify the situation before the IRS or Department of Labor initiates an examination.

The distinction between independent contractors and employees is significant for employers, especially when they file their federal tax returns. While employers owe only the payment to independent contractors, employers owe employees a series of federal payroll taxes, including Social Security, Medicare, Unemployment, and federal tax withholding. Thus, it is often tempting for employers to avoid these taxes by classifying their workers as independent contractors rather than employees.

If, however, the IRS discovers this misclassification, the consequences might include not only the requirement that the employer pay all owed payroll taxes, but also hefty penalties. It is important that employers be aware of the risk they take by classifying a worker who should or could be an employee as an independent contractor.

“All the facts and circumstances”

The IRS considers all the facts and circumstances of the parties in determining whether a worker is an employee or an independent contractor. These are numerous and sometimes confusing, but in short summary, the IRS traditionally considers 20 factors, which can be categorized according to three aspects: (1) behavioral control; (2) financial control; (3) and the relationship of the parties.

Examples of behavioral and financial factors that tend to indicate a worker is an employee include:

• The worker is required to comply with instructions about when, where, and how to work;
• The worker is trained by an experienced employee, indicating the employer wants services performed in a particular manner;
• The worker’s hours are set by the employer;
• The worker must submit regular oral or written reports to the employer;
• The worker is paid by the hour, week, or month;
• The worker receives payment or reimbursement from the employer for his or her business and traveling expenses; and
• The worker has the right to end the employment relationship at any time without incurring liability.

In other words, any existing facts or circumstances that point to an employer’s having more behavioral and/or financial control over the worker tip the balance towards classifying that worker as an employee rather than a contractor. The IRS’s factors do not always apply, however; and if one or several factors indicate independent contractor status, but more indicate the worker is an employee, the IRS may still determine the worker is an employee.

Finally, in examining the relationship of the parties, benefits, permanency of the employment term, and issuance of a Form W-2 rather than a Form 1099 are some indicators that the relationship is that of an employer–employee.

Conclusion

Worker classification is fact-sensitive, and the IRS may see a worker you may label an independent contractor in a very different light. One key point to remember is that the IRS generally frowns on independent contractors and actively looks for factors that indicate employee status.

Please do not hesitate to call our offices if you would like a reassessment of how you are currently classifying workers in your business, as well as an evaluation of whether IRS’s new Voluntary Classification Program may be worth investigating.

Under a flexible spending arrangement (FSA), an amount is credited to an account that is used to reimburse an employee, generally, for health care or dependent care expenses. The employer must maintain the FSA. Amounts may be contributed to the account under an employee salary reduction agreement or through employer contributions.

Use-it or lose-it

The general rule is that no contribution or benefit from an FSA may be carried over to a subsequent plan year. Unused benefits or contributions remaining at the end of the plan year (or at the end of a grace period) are forfeited. This is known as the “use it or lose it” rule. The plan cannot pay the unused benefits back to the employee, and cannot carry over the unused benefits to the following calendar year.

Example. An employer maintains a cafeteria plan with a health FSA. The plan does not have a grace period. Arthur, an employee, contributes $250 a month to the FSA, or a total of $3,000 for the calendar year. At the end of the year (December 31), Arthur has incurred medical expenses of only $1,200 and makes claims for those expenses. He has $1,800 of unused benefits. Under the “use it or lose it” rule, Arthur forfeits the $1,800. 

Grace period

Because the “use it or lose it” rule seemed harsh, the IRS gave employers the option to provide a grace period at the end of the calendar year. The grace period may extend for 2½ months, but must not extend beyond the 15^th day of the third month following the end of the plan year. Medical expenses incurred during the grace period may be reimbursed using contributions from the previous year.

Example. Beulah contributes $3,000 to her health FSA for 2010. The FSA is on January 1 through December 31 calendar year.  On December 31, 2010, Beulah has $1,800 of unused contributions. Her employer provides a grace period through March 15, 2011. On January 20, 2011, Beulah incurs $1,500 of additional medical expenses. Because these expenses were incurred during the grace period, Beulah can be reimbursed the $1,500 from her 2010 contributions. On March 15, 2011, she has $300 of unused benefits from 2010 and forfeits this amount.

Exceptions

There are other exceptions to the prohibition against deferred compensation within the operation of an FSA. A cafeteria plan is permitted, but not required, to reimburse employees for orthodontia services before the services are provided, even if the services will be provided over a period of two years or longer. The employee must be required to pay in advance to receive the services. 

Another exception is provided for durable medical equipment that has a useful life extending beyond the health FSA’s period of coverage (the calendar year, plus any grace period). For example, a health FSA is permitted to reimburse the cost of a wheelchair for an employee.

If you have any questions on setting up an FSA, whether as an employer or an employee, and which benefits must be covered and which are optional, please do not hesitate to call this office.

Job-hunting expenses are generally deductible as long as you are not searching for a job in a new field. This tax benefit can be particularly useful in a tough job market. It does not matter whether your job hunt is successful, or whether you are employed or unemployed when you are looking.

Expenses directly connected with a job search are deductible as a miscellaneous itemized deduction. You can deduct job-hunting expenses if the amount of all your so-called miscellaneous itemized deductions exceeds two percent of your adjusted gross income. However, if you claim the standard deduction, you cannot deduct job-hunting expenses. Therefore, as a practical matter for many job seekers, job hunting expenses do not materialize as a tax deduction.

For those who are able to use job seeking expenses as a deduction, it can be difficult to determine what a new field is. A professional photographer who pursues a job in the retail industry clearly is searching in a new field and cannot deduct any of his or her job-hunting expenses. But there are exceptions. The IRS has allowed persons who retired from the military to search for jobs in new fields and claim their job-hunting expenses. Taking a temporary job while searching for permanent employment in your current field will not be considered a job change that disqualifies your job-hunting expenses.

Persons entering the job market for the first time, such as college students, and persons who have been out of the job market for a long period of time, such as parents of young children, cannot deduct their job-hunting expenses. However, a college student who worked in a particular field while in school may be able to deduct job-hunting expenses.

Deductible expenses include typing, printing and mailing a resume. Long-distance phone calls are also deductible. You can deduct travel costs for going on a job search or an interview, including air transportation, railroad, or car expenses. The standard rate for car expenses for business is 55 cents per mile for 2012. Amounts you pay to a job counselor, employment agency or job referral service are all deductible.

It is important to keep records of your costs. While your individual expenses may not be substantial, your total expenses can add up to a significant amount.

A limited liability company (LLC) is a business entity created under state law. Every state and the District of Columbia have LLC statutes that govern the formation and operation of LLCs.

The main advantage of an LLC is that in general its members are not personally liable for the debts of the business. Members of LLCs enjoy similar protections from personal liability for business obligations as shareholders in a corporation or limited partners in a limited partnership. Unlike the limited partnership form, which requires that there must be at least one general partner who is personally liable for all the debts of the business, no such requirement exists in an LLC.

A second significant advantage is the flexibility of an LLC to choose its federal tax treatment. Under IRS's "check-the-box rules, an LLC can be taxed as a partnership, C corporation or S corporation for federal income tax purposes. A single-member LLC may elect to be disregarded for federal income tax purposes or taxed as an association (corporation).

LLCs are typically used for entrepreneurial enterprises with small numbers of active participants, family and other closely held businesses, real estate investments, joint ventures, and investment partnerships. However, almost any business that is not contemplating an initial public offering (IPO) in the near future might consider using an LLC as its entity of choice.

Deciding to convert an LLC to a corporation later generally has no federal tax consequences. This is rarely the case when converting a corporation to an LLC. Therefore, when in doubt between forming an LLC or a corporation at the time a business in starting up, it is often wise to opt to form an LLC. As always, exceptions apply. Another alternative from the tax side of planning is electing "S Corporation" tax status under the Internal Revenue Code.

Estimated tax is used to pay tax on income that is not subject to withholding or if not enough tax is being withheld from a person's salary, pension or other income. Income not subject to withholding can include dividends, capital gains, prizes, awards, interest, self-employment income, and alimony, among other income items. Generally, individuals who do not pay at least 90 percent of their tax through withholding must estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability during the year.

Estimated tax is used to pay tax on income that is not subject to withholding or if not enough tax is being withheld from a person's salary, pension or other income. Income not subject to withholding can include dividends, capital gains, prizes, awards, interest, self-employment income, and alimony, among other income items. Generally, individuals who do not pay at least 90 percent of their tax through withholding must estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability during the year.

Basic rules

The "basic" rules governing estimated tax payments are not always synonymous with "straightforward" rules. The following addresses some basic rules regarding estimated tax payments by corporations and individuals:

Corporations. For calendar-year corporations, estimated tax installments are due on April 15, June 15, September 15, and December 15. If any due date falls on a Saturday, Sunday or legal holiday, the payment is due on the first following business day. To avoid a penalty, each installment must equal at least 25 percent of the lesser of:

• 100 percent of the tax shown on the corporation's current year's tax return (or of the actual tax, if no return is filed); or
• 100 percent of the tax shown on the corporation's return for the preceding tax year, provided a positive tax liability was shown and the preceding tax year consisted of 12 months.

A lower installment amount may be paid if it is shown that use of an annualized income method, or for corporations with seasonal incomes, an adjusted seasonal method, would result in a lower required installment.

Individuals. For individuals (including sole proprietors, partners, self-employeds, and/or S corporation shareholders who expect to owe tax of more than $1,000), quarterly estimated tax payments are due on April 15, June 15, September 15, and January 15. Individuals who do not pay at least 90 percent of their tax through withholding generally are required to estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability during the year. The required annual payment is generally the lesser of:

• 90 percent of the tax ultimately shown on your return for the 2015 tax year, or 90 percent of the tax due for the year if no return is filed;
• 100 percent of the tax shown on your return for the preceding (2014) tax year if that year was not for a short period of less than 12 months; or
• The annualized income installment.

For higher-income taxpayers whose adjusted gross income (AGI) shown on your 2014 tax return exceeds $150,000 (or $75,000 for a married individual filing separately in 2015), the required annual payment is the lesser of 90 percent of the tax for the current year, or 110 percent of the tax shown on the return for the preceding tax year.

Adjusting estimated tax payments

If you expect an uneven income stream for 2015, your required estimated tax payments may not necessarily be the same for each remaining period, requiring adjustment. The need for, and the extent of, adjustments to your estimated tax payments should be assessed at the end of each installment payment period.

For example, a change in your or your business's income, deductions, credits, and exemptions may make it necessary to refigure estimated tax payments for the remainder of the year. Likewise for individuals, changes in your exemptions, deductions, and credits may require a change in estimated tax payments. To avoid either a penalty from the IRS or overpaying the IRS interest-free, you may want to increase or decrease the amount of your remaining estimated tax payments.

Refiguring tax payments due

There are some general steps you can take to reconfigure your estimated tax payments. To change your estimated tax payments, refigure your total estimated tax payments due. Then, figure the payment due for each remaining payment period. However, be careful: if an estimated tax payment for a previous period is less than one-fourth of your amended estimated tax, you may be subject to a penalty when you file your return.

If you would like further information about changing your estimated tax payments, please contact our office.

Under the Patient Protection and Affordable Care Act (PPACA) enacted in March 2010, small employers may be eligible to claim a tax credit of 35 percent of qualified health insurance premium costs paid by a taxable employer (25 percent for tax-exempt employers). The credit is designed to encourage small employers to offer health-insurance to their employees.

Under the Patient Protection and Affordable Care Act (PPACA) enacted in March 2010, small employers may be eligible to claim a tax credit of 35 percent of qualified health insurance premium costs paid by a taxable employer (25 percent for tax-exempt employers). The credit is designed to encourage small employers to offer health-insurance to their employees.

Employees and wages

An employer can claim the maximum 35 percent credit if it has no more than 10 full-time equivalent (FTE) employees receiving average annual wages of $25,000 or less. The credit is phased out as the number of FTEs increases to 25 and as average annual wages increase to $50,000.  An employer with 25 or more employees, or paying average annual wages of $50,000 or more per employee, will not receive a credit.

In counting FTEs, the employer should not include owners and family members.  Seasonal employees are not counted unless they work at least 120 days during the year. In determining average annual wages, employers must count all wages, bonuses, commissions or other compensation, including sick leave and vacation leave.

Applicable years

The credit took effect in 2010.  It did not expire at the end of 2010 but can be claimed from year to year.  The credit applies at the 35/25 percent levels for four years, through 2013. After 2013, the maximum credit increases to 50 percent for for-profit employers and 35 percent for tax-exempt employers, but only for two years. Thus, the credit can be claimed every year for the six years from 2010 and 2015.  The credit is recalculated every year based on the total health insurance premiums paid. Only non-elective employer premiums are counted; salary reduction contributions paid through a cafeteria plan or other arrangement are not counted.

Premiums

An employer must pay at least 50 percent of the premium cost of health insurance coverage, and must pay the same uniform percentage of costs for each employee who obtains health insurance through the employer. A transition rule for 2010 treats an employer as satisfying the uniformity rule as long as the employer pays at least 50 percent of the coverage costs of each employee, based on the cost of employee-only (single) coverage, even if the employer does not pay the same percentage of costs for each employee.

The premiums must be paid for qualified health insurance, such as a hospital or medical service plan or health maintenance organization. It includes coverage for dental, vision, long-term care, nursing home care, and coverage for a specified disease or illness.  Coverage does not accident insurance, disability income insurance, and workers' compensation.

Claiming the credit

The credit is determined on Form 8941, Credit for Small Employer Health Insurance Premiums. For-profit employers report the amount of the credit on Form 3800, General Business Credit, and attach the forms to their income tax return. As a general business credit, any unused credit (in excess of taxable income) can be carried back one year (except for a credit arising in 2010, the first year) or carried forward 20 years.  For-profit employers deduct the credit from the premiums paid for health insurance, when computing the deduction for health insurance premiums.

Tax-exempt employers report the credit on Form 990-T, Exempt Organization Business Income Tax Return, regardless of whether the organization is subject to tax on unrelated business income. The credit is refundable for tax-exempt employers, provided it does not exceed the employer’s income tax withholding and Medicare taxes. The credit is not refundable if the employer does not claim the credit on Form 990-T.

The IRS is moving quickly to alert employers about a new tax credit for health insurance premiums. The recently enacted health care reform package (the Patient Protection and Affordable Care Act of 2010 and the Health Care and Education Reconciliation Act of 2010) created the small employer health insurance tax credit. The temporary credit is targeted to small employers that offer or will offer health insurance coverage to their employees. The credit, like so many federal tax incentives, has certain qualifications. Please contact our office and we can arrange to review in detail how the credit may cut the cost of your business's health insurance premiums. The dollar benefits of the credit are substantial and they apply immediately to 2010 premium costs.

Outreach

The IRS is sending postcards to more than four million small businesses in coming weeks. The postcards briefly describe the new tax credit and are just one part of the IRS's outreach campaign to educate employers about the credit. The IRS has also created a special page on its web site on the credit along with a fact sheet and frequently asked questions and answers.

Maximum credit

The new health care credit is effective immediately so employers need to plan now to take advantage of it. The credit, which is available over the next five years, also rises over time but the enhanced credit comes with some additional requirements.

For tax years beginning in 2010 through 2013, the maximum credit reaches 35 percent of qualified premium costs paid by for-profit employers. The maximum credit is 25 percent of qualified premium costs paid by tax-exempt employers.

The maximum credit climbs to 50 percent of qualified premium costs paid by for-profit employers (35 percent for tax-exempt employers) for tax years beginning in 2014 through 2015. However, Congress imposed some additional requirements. An employer may claim the credit only if it offers one or more qualified health plans through a state insurance exchange. The health care reform package requires states to create insurance exchanges by January 1, 2014.

Example. ABC Co. employs nine individuals with average annual wages of $23,000 for each employee in 2010. ABC pays $72,000 in health care premiums for its employees. This amount does not exceed the average premium for the small group market in the state in which ABC offers coverage and ABC otherwise meets the requirements for the credit. ABC's credit for 2010 is $25,200 (35 percent x $72,000).

Tax-exempt employers have additional limitations. If the amount of their credit exceeds the amount of payroll taxes of the tax-exempt employer during the calendar year in which the tax year begins, the credit is limited to the amount of payroll taxes.

FTEs

The maximum credit is available to qualified employers with no more than 10 full-time equivalent (FTE) employees paying average annual wages of $25,000 or less. The credit completely phases out if an employer has 25 or more FTEs or pays $50,000 or more in average annual wages. Effectively, a small employer can have exactly 25 FTEs or pay average annual compensation of exactly $50,000 and not receive a credit under the phase-out rules. The monetary amounts are adjusted for inflation after 2013.

The health care reform package explains how to calculate the number of FTEs. The number of an employer's FTEs is determined by dividing the total hours for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee) by 2,080. The result, if not a whole number, is rounded to the next lowest whole number. Lawmakers selected 2,080 hours because 2,080 hours comprise the number of hours in a 52-week assuming a 40-hour work week. Any hours beyond 2,080, such as overtime hours, are not taken into account when calculating FTEs.

Example. ABC Co has nine employees. ABC pays Aidan, Bonnie, Catherine, David, and Eddie wages for 2,080 hours each for 2010. ABC pays Francine, Gary and Harry wages for 1,040 hours each for 2010. ABC pays Kieran wages for 2,300 hours for 2010. The total hours not exceeding 2,080 per employee is the sum of: --10,400 hours for the five employees paid for 2,080 hours each (5 x 2,080) plus --3,120 hours for the three employees paid for 1,040 hours each (3 x 1,040) plus --2,080 hours for the one employee paid for 2,300 hours (lesser of 2,300 and 2,080), which add up to 15,600 hours.

To calculate the number of FTEs, 15,600 is divided by 2,080, which results in 7.5, rounded to the next lowest whole number.

Average annual wages

A formula is also used to calculate average annual wages. The amount of average annual wages is determined by first dividing the total wages paid by the employer to employees during the employer's tax year by the number of the employer's FTEs for the year. The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000).

Example. ABC Co. pays $224,000 in wages and has 10 FTEs. ABC's average annual wages are $224,000 divided by 10 which equals $22,400, and is rounded down to the nearest $1,000 for a final number of $22,000

Owners and family members

Some individuals are excluded from the calculation of FTEs and average annual wages. These include a sole proprietor, a partner in a partnership, a shareholder owning more than two percent of an S corporation, and any owner of more than five percent of other businesses. Certain family members of these individuals are also excluded from the calculation of FTEs and average annual wages. These include a child, a parent, a sibling, and others. This list is not exhaustive. Please contact our office for more details about who is excluded from these calculations.

Premium deduction

Employers generally may deduct the cost of health insurance premiums paid on behalf of employees. The health care reform package does not change this general rule. However, the amount of premiums that an employer may deduct is reduced by the amount of the small employer health care tax credit.

Qualifying arrangement

Only premiums paid by the employer under a qualifying arrangement are counted in calculating the credit. Under a qualifying arrangement, the employer pays premiums for each employee enrolled in health care coverage offered by the employer in an amount equal to a uniform percentage (not less than 50 percent) of the premium cost of the coverage. The IRS is developing transition relief for 2010.

Additionally, the amount of an employer's premium payments is capped in relation to the average premium for the small group market. The U.S. Department of Health and Human Services will determine the average premium for the small group market in a state.

Congress is currently reviewing the costs of premiums. The health care reform package includes a requirement, effective in 2011, that insurance companies spend at least 80 percent of premium revenue on actual health care. Additionally, the health care reform package establishes a process for the annual review of premium increases prior to their use along with public disclosure of how premium rates are determined.

Claiming the credit

Qualified for-profit employers will claim the credit on their annual income tax return. The IRS is expected to advise how tax-exempt employers will claim the credit. Our office will keep you posted of developments.

According to the U.S. Department of Health and Human Services, a qualified small business can choose to start offering health insurance coverage to employees in 2010 and be eligible for the credit. If you are considering providing insurance coverage to your employees, please contact our office. If you have already been paying premiums, don't leave maximizing the new credit to chance; we can help you navigate the many federal rules that come into play.

As always, please contact our office if you have any questions about the new small employer health insurance tax credit.

Long-term care premiums are deductible up to certain amounts as itemized medical expense deductions. The amount is based upon your age. Unfortunately, most taxpayers do not have enough other medical expense deductions to exceed the non-deductible portion equal to the first 7 1/2 percent of adjusted gross income (10 percent if you are subject to alternative minimum tax (AMT)). Furthermore, more taxpayers now take the standard deduction rather than itemize, making even those medical expenses useless as a tax deduction.

A tax bill has been before Congress for several years now to allow long-term care premiums to be deductible "above the line," that is, by anyone irrespective of whether you itemize. The impetus behind this recommendation is that encouraging individuals to fund their own eventual eldercare is preferable to having federal Medicare payments to so. So far, however, Congress has not brought the matter to a vote. Some state income tax laws already allow such an above-the-line deduction.

Long-term care premiums. Long-term care insurance premiums are deductible in figuring itemized medical expense deductions up to the following amounts:

- Age 40 or younger: $290 in 2007; $310 in 2008;

- Over 40 but not older than 50: $550 in 2007; $580 in 2008;

- Over 50 but not older than 60: $1,110 in 2007; $1,150 in 2008;

- Over 60 but not older than 70: $2,950 in 2007; $3,080 in 2008; and

- Over 70: $3,680 in 2007; $3,850 in 2008.