Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), enacted at the end of 2017, created the new Section 199A QBI deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, under current law the QBI deduction will sunset after 2025. In addition to the QBI deduction’s impermanence, its complexity and ambiguous statutory language have created many questions for taxpayers and practitioners.

The IRS first released much-anticipated proposed regulations for the new QBI deduction, REG-107892-18, on August 8, 2018. The proposed regulations were published in the Federal Register on August 16, 2018. The IRS released the final regulations and notice of additional proposed rulemaking on January 18, 2019, followed by a revised version of the final regulations on February 1, 2019. Additionally, Rev. Proc. 2019-11 was issued concurrently to provide further guidance on the definition of wages. Also, a proposed revenue procedure, Notice 2019-7, was issued concurrently to provide a safe harbor under which certain rental real estate enterprises may be treated as a trade or business for purposes of Section 199A.

Wolters Kluwer recently interviewed Tom West, a principal in the passthroughs group of the Washington National Tax practice of KPMG LLP, about the Section 199A QBI deduction regulations. Notably, West formerly served as tax legislative counsel at the U.S. Department of the Treasury’s Office of Tax Policy. This article represents the views of the author only and does not necessarily represent the views or professional advice of KPMG LLP.

Wolters Kluwer: What is your general overview of the revised, final regulations for the Section 199A Qualified Business Income (QBI) or "pass-through" deduction?

Tom West: I think it is admirable that Treasury and IRS were able to publish these final regulations so quickly and address so many of the comments and questions that the proposed regulations generated. I think they realized how important this particular package was to so many taxpayers for the 2018 filing season and, while questions obviously remain, having these rules out in time to inform decisions for this year’s tax returns is helpful. In particular, the liberalized aggregation rules and the additional examples regarding certain specified service trades or businesses (SSTBs) are the most consequential in my mind.

Wolters Kluwer: What should taxpayers and practitioners keep in mind in consideration of relying on either the proposed or final regulations for the 2018 tax year?

Tom West: I have to imagine that when choosing between the two, for most taxpayers the final regulations will ultimately provide the better result. The ability to aggregate at the entity level, which was only provided in the final regulations, may be a key consideration for those taxpayers with more complicated or tiered structures. That said, I do think taxpayers need to be careful in their aggregation modeling because you are going to be stuck with your aggregation once you’ve filed. It may be that some taxpayers wait on getting locked into a particular aggregation and continue to study the new rules—and even wait on additional guidance that may be coming. However, it may be important to note that the final regulations provide that if an individual fails to aggregate, the individual may not aggregate trades or businesses on an amended return—other than for the 2018 tax year.

Wolters Kluwer: How is the removal of the proposed 80 percent rule regarding specified service trades or businesses (SSTBs) from the final regulations likely to impact certain taxpayers?

Tom West: First of all, I think the removal of this rule is a demonstration of two important dynamics. One, the critical importance of the engagement of taxpayers in the comment process, and, two, the government’s willingness to listen and adapt in their rule-making. I don’t know if there are particular industries or taxpayers who will be impacted, but I do know that the change is a very logical and appropriate one, and logic doesn’t always prevail in these processes, so I’m happy to give the regulators credit when it does.

Wolters Kluwer: Which industries may have been helped or hindered by the final regulations with respect to SSTB rules?

Tom West: I’m not sure specific industries were helped, but the biggest positive in terms of the SSTB final rules is the carryover from the proposed regulations of the treatment of the skill or reputation provision. Had Treasury and the IRS gone in a different direction, there was a risk of that provision swallowing the rest of the 199A regime—not to mention how much more subjective the already sometimes difficult SSTB determinations would have become.

Wolters Kluwer: Are there any lingering, unanswered questions among taxpayers or practitioners that particularly stand out when determining what constitutes SSTB income?

Tom West: I think many taxpayers who have both SSTB and non-SSTB activities were hoping for more clarity, either in rules or examples, on how to acceptably segregate business lines or on when (or if) certain activities are inextricably tied together. There are also still lingering questions regarding when a trade or business is an SSTB—particularly in the field of health.

Wolters Kluwer: Were there any surprises in the final regulations?

Tom West: I don’t know if I’m surprised, knowing the concerns that led them to the decisions they made, but the fact that Treasury and IRS held the line on some of the SSTB-related rules is notable. I’m thinking specifically of the so-called "cliff" effect of the de minimis rule and the fact that owners of certain kinds of SSTB businesses, e.g., sports teams, are not allowed to benefit from the Section 199A deduction.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), enacted at the end of 2017, created the new Section 199A QBI deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, under current law the QBI deduction will sunset after 2025. In addition to the QBI deduction’s impermanence, its complexity and ambiguous statutory language have created many questions for taxpayers and practitioners.

The IRS first released much-anticipated proposed regulations for the new QBI deduction, REG-107892-18, on August 8, 2018. The proposed regulations were published in the Federal Register on August 16, 2018. The IRS released the final regulations and notice of additional proposed rulemaking on January 18, 2019, followed by a revised version of the final regulations on February 1, 2019. Additionally, Rev. Proc. 2019-11, I.R.B. 2019-9, 742, was issued concurrently to provide further guidance on the definition of wages. Also, a proposed Revenue Procedure, Notice 2019-7, I.R.B. 2019-9, 740, was issued, concurrently providing a safe harbor under which certain rental real estate enterprises may be treated as a trade or business for purposes of Section 199A.

Wolters Kluwer recently interviewed Tom West, a principal in the passthroughs group of the Washington National Tax practice of KPMG LLP, about the Section 199A QBI deduction regulations. Notably, West formerly served as tax legislative counsel at the U.S. Department of the Treasury’s Office of Tax Policy. This article represents the views of the author only and does not necessarily represent the views or professional advice of KPMG LLP.

Wolters Kluwer: Neither the proposed nor final regulations for Section 199A give guidance as to when rental real estate activity constitutes a Section 162 trade or business. How might the application of the safe harbor provided for in IRS Notice 2019-7 offer taxpayers clarity? And how might failure to qualify for the safe harbor impact the determination of whether the rental activity is a trade or business under Section 199A?

Tom West: The safe harbor is helpful but it appears to be intended for relatively smaller taxpayers who may have had questions about their activities rising to the level of a trade or business. I don’t think falling outside of the safe harbor is dispositive—especially in light of the recent policy statement from Treasury regarding sub-regulatory guidance.

Wolters Kluwer: Can you speak to the some of the complexity that may be involved in tax planning with respect to achieving the right balance between adequate W-2 wages and QBI?

Tom West: Other than for small taxpayers, there is only a benefit under Section 199A if the limitations are met. It does not do any good to have QBI but then have insufficient W-2 wages and qualified property to meet the limitations. So when taxpayers are evaluating what constitutes a qualified trade or business (or whether to aggregate qualified trades or businesses) they will need to determine the amount of W-2 wages with respect to each QTB. Aligning the W-2 wages with the QTB will be important—but the salary expense will also result in a reduction in the amount of QBI and therefore the amount of any Section 199A benefit—so modeling becomes critical. Consideration should also be given to any collateral consequences—for instance the impact of the alignment on allocation and apportionment for state taxes.

Wolters Kluwer: According to a March 18, 2019, Treasury Inspector General for Tax Administration (TIGTA) report, Reference Number: 2019-44-022, IRS management indicated that the timeline related to the issuance of Section 199A guidance did not provide enough time for the IRS to develop a QBI deduction tax form. Although the IRS did create a worksheet, do you have a prediction on what key elements may be included on the new form once released?

Tom West: I do think that worksheets could be developed that would facilitate the reporting of Section 199A information—particularly through tiered structures—so as to ease the reporting burden and enhance compliance.

Wolters Kluwer: The IRS has estimated that nearly 23.7 million taxpayers may be eligible to claim the Section 199A deduction and that more than 22.2 million (94 percent) of those eligible taxpayers will not require a complex calculation for the deduction. What notable differences do you expect there are between "complex" and the majority of calculations?

Tom West: For taxpayers under the Section 199A income thresholds ($157.5K single, $315K joint), the deduction is very easy to calculate and claim. Those taxpayers don’t need to worry about being in an SSTB, how much wages they paid, or the basis of their property. Once those taxpayers hit those income thresholds though, even in the phase-out range, things very quickly get complex—and that’s as a consequence of the statute; it is not something that the regulators can change.

Wolters Kluwer: Do you anticipate the IRS will issue further guidance on the Section 199A deduction?

Tom West: I do. As I said at the top, I think part of the government’s motivation in finalizing these regulations so quickly was providing guidance to taxpayers ahead of the tax-filing season. And while for the majority of taxpayers who are below the 199A cap there is probably now sufficient guidance, I think there are still a lot of questions for those with more complex situations. Given the number of taxpayers who are eligible for this deduction, and the importance of Section 199A as the big benefit to non-corporate businesses in what the Administration views as a signature legislative achievement, I have to believe that the government will be responsive to taxpayers’ requests for additional help on this provision. However, given that the provision is due to sunset, it will be important that any guidance is forthcoming in fairly short order to be of any usefulness to taxpayers.

Wolters Kluwer: At this time, do you have any recommendations for taxpayers and practitioners moving forward?

Tom West: As people are going through their tax filings this year, I’d keep a list of issues, questions, and areas where additional guidance would be helpful. It often happens that problems with new legislation or regulations don’t reveal themselves until taxpayers have to put pencil to paper and track their real-world numbers through returns. We’ll all have that experience this year and, with those lists of issues and questions in hand, there may be an opportunity to approach the IRS and Treasury in the hopes of getting resolution going forward. Keeping that list could also help identify areas for tax planning and perhaps ease the complexity of filing for 2019.

A bipartisan House bill has been introduced that would fix a GOP tax law drafting error known as the "retail glitch." The House bill, having over a dozen co-sponsors, is a companion measure to a bipartisan Senate bill introduced in March.

A bipartisan House bill has been introduced that would fix a GOP tax law drafting error known as the "retail glitch." The House bill, having over a dozen co-sponsors, is a companion measure to a bipartisan Senate bill introduced in March.

Immediate Expensing

The Restoring Investment in Improvements Act (HR 1869), sponsored by House tax writers Reps. Jimmy Panetta, D-Calif., and Jackie Walorski, R-Ind., would allow restaurants, retailers, and other leaseholders to immediately write off the cost of certain improvements. The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), enacted at the end of 2017, inadvertently excludes qualified improvement property (QIP) from the new 100 percent bonus depreciation provision.

The measure is a "small but critical fix for our job creators, and technical corrections like this are a normal part of the process when Congress enacts major reforms," Walorski said in a recent press release. "This bipartisan, commonsense bill will allow restaurants, retailers, and other small businesses to unlock the full benefits of tax reform and continue driving our nation’s economic growth."

Similarly, Panetta highlighted the negative impact that the loss of immediate expensing has caused many small businesses. "Our bill will allow restaurants, retailers, and other businesses to make the improvements they need to keep their stores competitive and safe and plan for the future," he said.

Although the "retail glitch" measure has solid bipartisan support, Democrats in general have seemed hesitant to fix any errors in the GOP tax law. To that end, House Ways and Means Committee Chairman Richard Neal, D-Mass., has said he would like to hold a hearing on technical corrections for the TCJA. The committee’s March 27 hearing on the TCJA did not specifically address technical corrections.

The House on April 9 approved by voice vote a bipartisan, bicameral IRS reform bill. The IRS bill, which now heads to the Senate, would redesign the IRS for the first time in over 20 years.

The House on April 9 approved by voice vote a bipartisan, bicameral IRS reform bill. The IRS bill, which now heads to the Senate, would redesign the IRS for the first time in over 20 years.

IRS Reform

The Taxpayer First Act of 2019 (HR 1957), as amended, cleared the House Ways and Means Committee by voice on April 2. The House and Senate both introduced the bicameral, bipartisan measure on March 28. If enacted, the bill would make numerous reforms to the IRS, some of which include modernizing antiquated information technology systems and enhancing taxpayer services and identity protections.

"With a new tax code, it is time for a new tax administrator," House Ways and Means Committee ranking member Kevin Brady, R-Tex., said in an April 9 statement. "I applaud the House for passing the Taxpayer First Act—a bold step to redesign the IRS to be an agency with one singular mission: putting taxpayers first."

The IRS Reform bill has been "years in the making," Brady said on April 9, echoing a joint statement that he and Ways and Means Chairman Richard Neal, D-Mass., along with other bipartisan tax writers recently issued. "The House Ways and Means Committee and the Senate Finance Committee have carefully and thoughtfully developed this legislation over several years, after numerous hearings and roundtables, in a bipartisan, bicameral manner," the lawmakers said.

AICPA Applauds Taxpayer First Act

The American Institute of CPAs (AICPA) issued an April 9 statement commending the House for passing HR 1957. "The AICPA appreciates the bipartisan recognition by members of the U.S. House of Representatives for bringing the Internal Revenue Service into the 21st Century," Edward S. Karl, vice president of taxation, said in a statement on behalf of the AICPA. "The AICPA has long been interested in and active in working to find ways to modernize the IRS so that it can better serve the needs of taxpayers and tax practitioners."

Free File Alliance

However, the bipartisan, bicameral bill has not advanced without its share of criticism. Several Democratic lawmakers have criticized a provision within the bill that would codify the Free File Alliance, which is an agreement between the IRS and certain tax preparation companies that includes the IRS being unable to directly assist in tax return preparation.

"Again and again in my service in the Senate I have battled the tax-preparation software industry to simplify filing taxes for the typical American," Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said in an April 9 statement. "During the debate on the tax administration bill, my staff pushed back on a prohibition on the agency competing with private tax preparation services, and I will continue to push for my proposal for the pre-filed ‘simple’ return and the principle that a taxpayer should not have to use a private company to pay their taxes online," he added.

Looking Ahead

It remains unclear when the Senate will take up the Taxpayer First Act bill. However, the bill is presently expected on Capitol Hill to easily be approved in the Senate.

Proposed regulations address gains that may be deferred when taxpayers invest in a qualified opportunity fund (QOF). Taxpayers may generally rely on these new proposed regulations. The IRS has also requested comments.

Proposed regulations address gains that may be deferred when taxpayers invest in a qualified opportunity fund (QOF). Taxpayers may generally rely on these new proposed regulations. The IRS has also requested comments.

The proposed regulations also withdraw and replace placeholder provisions in an earlier set of proposed regulations ( REG-115420-18). These concern:

• the definition of "substantially all"regulations
• transactions that can trigger includible gain;
• the timing and amount of deferred gain that is included;
• treatment of leased property used in the qualified opportunity zone (QOZ) business;
• use of QOZ business property in the QOZ;
• sourcing of income to the QOZ business; and
• the reasonable period for a QOF to reinvest proceeds from the sale of qualifying assets.

In addition, within a few months the IRS expects to address administrative rules for a QOF that fails to maintain the required 90-percent investment standard, as well as information reporting requirements.

Finally, the IRS expects to revise Form 8996, Qualified Opportunity Fund, for 2019 and subsequent tax years. These revisions may require additional information, including the employer identification number (EIN) for the QOF business, and the amounts invested by QOFs and QOZ businesses located in particular QOZs.

"Substantially All" for QOZ Business

The 2018 regulations provided that a trade or business satisfies the "substantially all" test for a QOZ business if at least 70 percent of its tangible property is qualified opportunity zone business property. The new proposed regulations generally extend this 70-percent threshold to the "substantially all" tests for use. However, in the holding period context, the "substantially all" threshold is 90 percent.

Original Use of Purchased Tangible Property

The proposed regulations generally provide that the "original use" of tangible property acquired by purchase by any person starts on the date when that person or a prior person:

• first places the property in service in the qualified opportunity zone for purposes of depreciation or amortization; or
• first uses the property in the qualified opportunity zone in a manner that would allow depreciation or amortization if that person were the property’s owner.

Used tangible property will satisfy the original use requirement with respect to a QOZ so long as the property has not been previously used (that is, has not previously been used within that QOZ in a manner that would have allowed it to depreciated or amortized) by any taxpayer

In addition, a building or other structure that has been vacant for at least five years before being purchased by a QOF or QOZ business satisfies the original use requirement. Improvements made by a lessee to leased property satisfy the original use requirement and are considered purchased property for the amount of the unadjusted cost basis of the improvements.

Land can be treated as QOZ business property only if it is used in a trade or business of a QOF or QOZ business. The holding of land for investment does not give rise to a trade or business, and the land cannot be QOZ business property. Anti-abuse rules determine whether unimproved land can be qualifying property. However, other purchased real property generally must be substantially improved, determined on an asset-by-asset basis.

Leased Tangible Property in QOZ

Leased tangible property may be QOZ property if:

• the lease is entered into after 2017; and
• substantially all of the property’s use is in a QOZ during substantially all of the lease period.

However, the first-use requirement does not apply to leased tangible property. The leased property can generally also be acquired from a related person, though several conditions apply. The proposed regulations also provide methods for valuing the leased property.

QOZ Businesses

The proposed regulations:

• provide that in determining whether a substantial portion of intangible property of a QOZ is used in the active conduct of a trade or business, a substantial portion is at least 40 percent;
• address real property that straddles a QOZ;
• provide three safe harbors and a facts-and-circumstances test for determining whether a corporation or partnership derives at least 50 percent of its gross income from the active conduct of a qualified business;
• define "trade or business" by reference to Code Sec. 162, except that the ownership and operation (including leasing) of real property used in a trade or business can also be the active conduct of a trade or business; and
• provide a safe harbor for working capital.

Other Business Rules

The proposed regulations also address:

• Section 1231 gains;
• relief regarding the 90 percent asset test, including relief for newly contributed assets and QOF reinvestments;
• the amount of an investment for purposes of the deferral election;
• inclusion events, the timing on basis adjustments, includible amounts, and special rules for partnerships and S corporations;
• gifts and bequests;
• exceptions for disregarded transfers and some nonrecognition transactions;
• distributions and contributions;
• consolidated return provisions;
• holding periods and tacking rules;
• anti-abuse rules;
• special rules for Indian tribes and tribally leased property.

Comments Requested; Public Hearing Scheduled

A public hearing on the proposed regulations is scheduled for 10 am on July 9, 2019, at the New Carrollton Federal Building in Latnham, MD. Public comments may be mailed or hand-delivered to the IRS, or submitted via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-120186-18).

The IRS has provided a safe harbor for professional sports teams to avoid the recognition of gain or loss when trading players and/or draft picks. Under the safe harbor provision, the traded player’s contract or the traded draft pick would have a zero basis.

The IRS has provided a safe harbor for professional sports teams to avoid the recognition of gain or loss when trading players and/or draft picks. Under the safe harbor provision, the traded player’s contract or the traded draft pick would have a zero basis.

Value of Professional Sports Contracts

Professional sports teams enter into contracts with their personnel (e.g., managers, coaches, players, etc.). Typical personnel contracts provide an agreed-upon amount of compensation for a certain duration of service. The value of such a contract may fluctuate based on a variety of factors, including:

• player performance;
• the changing needs of the team and of other teams;
• a player’s effect on fan attendance; and
• the number of years until a player becomes a free agent and is able to sign a contract to play for any team in a league.

Other considerations affecting the value of a player contract include:

• the size of the team’s market (i.e., whether a smaller city or a major urban population);
• the cost of player development; and
• the impact of injuries and slumps on player performance.

In most cases, teams do not trade personnel contracts or draft picks unless the team thinks that it is receiving contracts of an equal or greater value. Because each party believes that they are receiving personnel contracts or draft picks of an equal or greater value, it is difficult to assign a monetary value to them. Accordingly, the IRS developed a safe harbor whereby each team is able to treat the traded contracts or draft picks as having a basis of zero, thus avoiding the recognition of gain or loss on the trade.

Safe Harbor Requirements

In order to use the safe harbor, professional sports teams must meet the following requirements:

• all teams involved in the trade must use the safe harbor;
• teams may only trade personnel contracts, draft picks, and/or cash;
• personnel contracts and/or draft picks cannot be Code Sec. 197 intangibles; and
• the financial statements of all teams involved in the trade must not reflect assets or liabilities resulting from the trade other than cash.

Application

Sports teams using the safe harbor will not recognize any gain or loss if they only trade personnel contracts or draft picks. However, teams that receive cash in a trade will recognize the amount of cash received as gain. In addition, the team providing cash to another team in the trade will receive basis in the personnel contract or draft pick equal to the amount of cash that it provided. A team providing cash to another team in a trade for two or more draft picks or personnel contracts must allocate its basis to each personnel contract or draft pick received from the other team by dividing the basis by the number of personnel contracts or draft picks received.

In certain cases, a team may have unrecovered basis in a draft pick or personnel contract under Code Sec. 167(c). In those instances, the team may recognize gain or loss based on the difference between the unrecovered basis and any cash received.

Effective Date

Teams may use the safe harbor for any trades involving personnel contracts or draft picks entered into after April 10, 2019. However, teams may choose to apply these rules in any open tax year.

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.