Individual tax provisions

General:

·      New two-percentage-point payroll tax cut for 2011

·      Extension of the lower ordinary income tax rates for all tax brackets through 2012

·      Extension of marriage penalty relief through 2012

·      Extension of the elimination of itemized deduction and personal exemption phaseouts through 2012

·      Extension of the deduction for state and local sales taxes in lieu of state and local income taxes through 2011

·      Extension of the increased alternative minimum tax (AMT) exemptions through 2011·      Extension of the ability to offset AMT liability with certain nonrefundable personal credits through 2011

Investing:

·      Extension of the lower long-term capital gains rates through 2012

·      Extension of the lower qualified dividend tax rates through 2012

·      Extension of the 100% gain exclusion on certain qualified small business stock to stock acquired through 2011

Children and education:

·      Extension of the $1,000 child credit and other enhancements of the credit through 2012

·      Extension of the higher adoption credit and income exclusion for employer-provided adoption assistance through 2012

·      Extension of the higher dependent care credit through 2012

·      Extension of the American Opportunity education credit through 2012

·      Extension of the above-the-line tuition and fees deduction through 2011

·      Extension of the income exclusion for employer-provided education assistance through 2012

·      Extension of the enhancements to the student loan interest deduction through 2012

·      Extension of the $2,000 Coverdell Education Savings Account contribution limit and other enhancements through 2012

Charitable giving:

·      Extension of the ability to exclude from income direct contributions from IRAs to qualified charities (up to $100,000 annually) through 2011

·      Extension of the ability to take a larger deduction for donations of long-term capital gains real property for conservation purposes through 2011

Estate planning:

·      Reinstatement of the estate tax for 2010 with a top rate of 35% and a $5 million exemption (compared to 45% and $3.5 million for 2009)

·      Option for estates of taxpayers who died in 2010 to elect to follow the pre–Tax Relief act regime — no estate tax but limits on step-up in basis for transferred assets

·      Reinstatement of the generation-skipping transfer (GST) tax for 2010 at a 0% rate with a $5 million exemption (compared to 45% and $3.5 million for 2009)

·      Decrease in the top estate and gift tax rates and the GST tax rate to 35% for 2011 and 2012

·      Increase in the estate, GST and gift tax exemptions to $5 million for 2011, indexed for inflation in 2012

·      Ability of the estate of a taxpayer who dies in 2011 or 2012 to elect to allow the surviving spouse to use the deceased’s unused estate tax exemption

Business tax provisions

Investment incentives:

·      Increase in bonus depreciation to 100%, generally for assets placed in service after Sept. 8, 2010, and before Jan. 1, 2012

·      Extension of 50% bonus depreciation, generally for assets placed in service Jan. 1, 2012, through Dec. 31, 2012

·      Increase in the Sec. 179 expensing limit to $125,000 (indexed for inflation) for 2012

·      Increase in the Sec. 179 expensing phaseout threshold to $500,000 (indexed for inflation) for 2012

·      Extension of accelerated depreciation for qualified leasehold-improvement, restaurant and retail-improvement property through 2011

Tax credits:

·      Extension of the research credit through 2011

·      Extension of the Work Opportunity credit through 2011

Charitable giving:

·      Extension of the enhanced deduction for food inventory donations through 2011

·      Extension of the enhanced deduction for donations of book inventory to public schools through 2011

·      Extension of the enhanced deduction for computer inventory donations for educational purposes through 2011

Just the tip of the iceberg

As you can see, the Tax Relief act includes numerous provisions, and we’ve only touched on some of them here. Many breaks are subject to a variety of rules and limitations, so it’s important to discuss them with your tax advisor to determine exactly how they’ll affect you. We’d be pleased to help.

Happy New Year,

During the first phase of the credit, (i.e., tax years beginning in 2010, 2011, 2012, or 2013), the amount of a tax-exempt employer’s credit is generally 25% of the employer’s nonelective contributions toward the employees’ health insurance premiums. In the second phase of the credit (i.e., tax years beginning after 2013), the amount of the credit is generally 35% of the nonelective contributions.

An employer qualifying for the credit (i.e., an eligible small employer or ESE) has to meet all of the following requirements:

(1) The employer can’t have more than 25 full-time equivalent (FTE) employees for the tax year. An employer’s FTE employees are determined by dividing the total hours worked by all employees during the year by 2,080 (rounded down to the nearest whole number).

(2) The average annual wages of the employees can’t exceed $50,000 (for tax years beginning after 2013, the dollar amount is indexed for inflation) for the tax year. The average annual wages are determined by dividing the total wages the employer pays by the number of its FTE employees and then rounding that number down to the nearest $1,000.

(3) The employer has to contribute at least 50% of the premiums for the employees’ health insurance coverage on a uniform basis. However, for tax years beginning in 2010 only, an employer can meet this requirement even if it pays differing percentages of different employees’ premiums as long as all employer payments are at least 50% of each employee’s premium based on single (employee only) coverage.

In addition to satisfying the three requirements listed above, a tax-exempt ESE has to be an organization described in Code Sec. 501(c) (such as a charitable organization under Code Sec. 501(c)(3) ) that is exempt from taxation under Code Sec. 501(a) .

The amount of the credit gradually phases out if the number of an ESE’s FTE employees exceeds ten or if the average annual wages of the employees exceed $25,000. Under the phaseout, the full amount of the credit is available only to an employer with ten or fewer FTE employees and whose employees have average annual wages of less than $25,000. However, an employer with exactly 25 FTE employees or average annual wages exactly equal to $50,000 is not in fact eligible for the credit. Since the eligibility rules are based in part on the number of FTE employees, not the number of employees, in certain circumstances, an organization that uses part-time help can qualify for the credit even if they employ more than 25 individuals.

A tax-exempt ESE’s credit is limited to the amount of its payroll taxes during the calendar year in which the tax year begins. For this purpose, payroll taxes are amounts required to be withheld from the wages of the employees of the tax-exempt ESE as income tax withholding, amounts required to be withheld from the wages of the employees as Medicare taxes, and amounts of the taxes imposed on the tax-exempt ESE as the employer portion of Medicare taxes.

For the first phase of the credit, an ESE can claim the credit on qualifying health insurance purchased from an insurance company licensed under state law. If an employer pays only a portion of the premiums for the coverage provided to employees under the arrangement (with employees paying the rest), only the portion paid by the employer is taken into account. For example, if an employer pays 80% of the premiums for employees’ coverage (with employees paying the other 20%), the 80% premium amount paid by the employer counts in calculating the amount of the credit.

For the second phase of the credit, the credit is only available if the ESE purchases health insurance coverage for its employees through a state exchange. Also, during the second phase, the credit is only available for a maximum coverage period of two consecutive tax years beginning with the first year in which the employer or any predecessor first offers one or more qualified plans to its employees through an exchange. The maximum two-year coverage period does not take into account any tax years beginning before 2014. Thus, an ESE can potentially qualify for the credit for six tax years, four years under the first phase and two years under the second phase.

Please contact us if you have any questions concerning the credit or if we can assist you in determining whether your business can benefit from claiming the credit.

During the first phase of the credit (i.e., tax years beginning in 2010, 2011, 2012, or 2013), the amount of the credit is generally 35% of the employer’s nonelective contributions toward the employees’ health insurance premiums. In the second phase of the credit (i.e., tax years beginning after 2013), the amount of the credit is generally 50% of the employer’s nonelective contributions. The amount of the credit is subject to a phaseout (described below).

An employer qualifying for the credit (i.e., an eligible small employer or ESE) has to meet all of the following requirements:

(1) The employer can’t have more than 25 full-time equivalent (FTE) employees for the tax year. An employer’s FTE employees are determined by dividing the total hours worked by all employees during the year by 2,080 (rounded down to the nearest whole number).

(2) The average annual wages of the employees can’t exceed $50,000 (for tax years beginning after 2013, the dollar amount is indexed for inflation) for the tax year. The average annual wages are determined by dividing the total wages the employer pays by the number of its FTE employees and then rounding that number down to the nearest $1,000.

(3) The employer has to contribute at least 50% of the premiums for the employees’ health insurance coverage on a uniform basis. However, for tax years beginning in 2010 only, an employer can meet this requirement even if it pays differing percentages of different employees’ premiums as long as all employer payments are at least 50% of each employee’s premium based on single (employee only) coverage.

The amount of the credit gradually phases out if the number of an ESE’s FTE employees exceeds ten or if the average annual wages of the employees exceed $25,000. Under the phaseout, the full amount of the credit is available only to an employer with ten or fewer FTE employees and whose employees have average annual wages of less than $25,000. However, an employer with exactly 25 FTE employees or average annual wages exactly equal to $50,000 is not in fact eligible for the credit. Since the eligibility rules are based in part on the number of FTE employees, not the number of employees, in certain circumstances, a business that uses part-time help can qualify for the credit even if it employs more than 25 individuals.

For purposes of determining whether an employer is an ESE and determining the amount of the credit, self-employed individuals, including partners and sole proprietors, 2% shareholders of an S corporation, and 5% owners of the employer and certain relatives of these individuals are not treated as employees for purposes of the small employer health insurance credit. There are also special rules that apply to seasonal workers, leased employees, and employees who have more than 2,080 hours of service during a tax year.

For the first phase of the credit, an ESE can claim the credit on qualifying health insurance purchased from an insurance company licensed under state law. If an employer pays only a portion of the premiums for the coverage provided to employees under the arrangement (with employees paying the rest), only the portion paid by the employer is taken into account. For example, if an employer pays 80% of the premiums for employees’ coverage (with employees paying the other 20%), the 80% premium amount paid by the employer counts in calculating the amount of the credit.

For the second phase of the credit, the credit is only available if the ESE purchases health insurance coverage for its employees through a state exchange. Also, during the second phase, the credit is only available for a maximum coverage period of two consecutive tax years beginning with the first year in which the employer or any predecessor first offers one or more qualified plans to its employees through an exchange. The maximum two-year coverage period does not take into account any tax years beginning before 2014. Thus, an ESE can potentially qualify for the credit for six tax years, four years under the first phase and two years under the second phase.

An employer is entitled to an ordinary and necessary business expense deduction equal to the amount of the employer contribution minus the dollar amount of the credit. For example, if an ESE pays 100% of the cost of its employees’ health insurance coverage and the amount of the tax credit is 50% of that cost (i.e., in tax years beginning after 2013), the employer can claim a deduction for the remaining 50% of the premium cost. Any unused credit can be carried back for one year (but not before 2010) and forward for 20 years to offset future taxes.

Please contact us if you have any questions concerning the credit or if we can assist you in determining whether your business can benefit from claiming the credit.

Payroll tax holiday and up-to-$1,000 credit for employers who hire unemployed workers. To help stimulate the hiring of workers by the private sector, the new law exempts any private-sector employer that hires a worker who had been unemployed for at least 60 days from having to pay the employer’s 6.2% share of the Social Security payroll tax on that employee for the remainder of 2010. A company could save a maximum of $6,621 if it hired an unemployed worker and paid that worker at least $106,800—the maximum amount of wages subject to Social Security taxes—by the end of the year. As an additional incentive, for any qualifying worker hired under this initiative that the employer keeps on payroll for a continuous 52 weeks, the employer is eligible for an additional non-refundable tax credit of up to $1,000 after the 52-week threshold is reached, to be taken on their 2011 tax return. In order to be eligible, the employee’s pay in the second 26-week period must be at least 80% of the pay in the first 26-week period.

Workers hired after the date of introduction of the legislation (Feb. 3, 2010) are eligible for the payroll tax forgiveness and the retention bonus, but only wages paid after the date of the new law’s enactment receive the exemption for payroll taxes.

Here are some additional features of the new hiring incentive:

• The tax benefit of the new incentive is immediate. It puts money into a business’ cash flow immediately, since the tax is simply not collected in the first place.
• The tax benefit generally applies only to private-sector employment, including nonprofit organizations—public sector jobs are generally not eligible for either benefit. However, employment by a public higher education institution would qualify.
• There is no minimum weekly number of hours that the new employee must work for the employer to be eligible, and there is no maximum on the dollar amount of payroll taxes per employer that may be forgiven.
• For workers that would otherwise be eligible for the “Work Opportunity Tax Credit,” the employer must select one benefit or the other for 2010—no double dipping.
• An employer can’t claim the new tax breaks for hiring family members.
• A worker who replaces another employee who performed the same job for the employer is not eligible for the benefit, unless the prior employee left the job voluntarily or for cause.
• For the hiring to qualify, the new hire must sign an affidavit, under penalties of perjury, stating that he or she has not been employed for more than 40 hours during the 60-day period ending on the date the employment begins.
• The incentive is not biased towards either low-wage or high-wage workers. Under the measure, a business saves 6.2% on both a $40,000 worker and a $90,000 worker.
• The payroll tax holiday does not apply with respect to wages paid during the first calendar quarter of 2010, but the amount by which the Social Security payroll tax would have been reduced under the payroll tax holiday provision during the fist calendar quarter is applied against the tax imposed on the employer for the second calendar quarter of 2010.
• The Act creates a similar new set of rules permitting a payroll tax holiday for railroad retirement tax purposes.
• The credit for retaining qualifying new hires is the lesser of $1,000 or 6.2% of the wages paid by the taxpayer to the retained worker during the 52-consecutive-week period. Thus, the credit for a retained worker will be $1,000 if, disregarding rounding, the retained worker’s wages during the 52-consecutive-week period exceed $16,129.03. However, the credit is not available for pay not treated as wages under the Code (e.g., remuneration paid to domestic workers).

Direct payment option for certain tax credit bonds. State and local governments have the ability to issue special purpose tax credit bonds for school construction, energy conservation and renewable energy. The federal government subsidizes these tax credit bonds by providing investors in these bonds with a federal tax credit in place of interest that would otherwise be payable on the bond. In lieu of providing investors with federal tax credits, the new law allows issuers of qualified school construction bonds, qualified zone academy bonds, clean renewable energy bonds, and qualified energy conservation bonds to elect to receive a direct payment from the federal government equal to the amount of the federal tax credit that would otherwise be provided for these bonds.

Revenue offsets. To pay for the tax incentives, the Act includes revenue offsets consisting of: (1) a comprehensive set of measures to reduce offshore noncompliance by giving IRS new administrative tools to detect, deter and discourage offshore tax abuses; and (2) a three-year delay (through 2020) of implementation of worldwide allocation of interest—a liberalized rule for allocating interest expense between U.S. sources and foreign sources for purposes of determining a taxpayer’s foreign tax credit limitation.

July 12:
Employees who work for tips. If you received $20 or more in tips during June, report them to your employer. You can use Form 4070.

August 10:
Employees who work for tips. If you received $20 or more in tips during July, report them to your employer. You can use Form 4070.

September 10:
Employees who work for tips. If you received $20 or more in tips during August, report them to your employer. You can use Form 4070.

September 15:

Individuals. Make a payment of your 2010 estimated tax if you are not paying your income tax for the year through withholding (or will not pay in enough tax that way). Use Form 1040-ES. This is the third installment date for estimated tax in 2010. For more information, see Publication 505.

Corporations. File a 2009 calendar year income tax return (Form 1120 or 1120-A) and pay any tax, interest, and penalties due. This due date applies only if you requested an automatic 6-month extension. Otherwise, see March 15.

S Corporations. File a 2009 calendar year income tax return (Form 1120S) and pay any tax due. This due date applies only if you timely requested an automatic 6-month extension. Otherwise, see March 15. Provide each shareholder with a copy of Schedule K-1 (Form 1120S) or a substitute Schedule K-1.

Corporations. Deposit the third installment of estimated income tax for 2010. A worksheet, Form 1120-W, is available to help you estimate your tax for the year.

Partnerships. File a 2009 calendar year return (Form 1065). This due date applies only if you were given an additional 5-month extension. Provide each partner with a copy of Schedule K-1 (Form 1065) or a substitute Schedule K-1.

A Short History of GAAP

In the 15th century, a monk named Luca Pacioli codified what we now call double-entry bookkeeping. While we accountants can be an imaginative lot, we still haven’t found a better way of setting up a general ledger than what Luca documented in 1494, and indications are that he wasn’t the first to use the concept.

Until now, the basics of the double-entry system have remained unchanged, but our global economy has altered considerably. As technology has progressed, so has the need for banks, investors, companies and governments to be able to understand one another’s economic activities in a consistent manner. As the world continues to shrink due to technology, so has humanity’s ability to think of new ways to make money and spend it. The result is a complex financial system that sometimes defies logic.

To make sense of this, the accounting profession is constantly developing new standards to keep the financial statements of public and private companies relevant to their users, including creditors, investors and taxing authorities. The problem it that there is a divergence between the needs of large public companies (with stocks traded by numerous shareholders) and the needs of privately held companies, which are owned by only a few shareholders. Because accounting standards have historically addressed the needs of the public companies, private companies have been subjected to complex standards with little relevance to their situation. Hence, the new AICPA committee was established to address this issue.

What’s Happening Now

In another article this month, we talked about the complexity of changing the nation’s financial system. Addressing what is referred to as the Big GAAP vs. Little-GAAP issue is also highly complex. As a small business owner, you might not think it’s a big deal to read a headline like that in a recent issue of the Journal of Accountancy, which reads: “Panel on Private Company Financial Reporting Narrows Down Alternative Models.” CPAs recognize that this is a huge step for an AICPA panel to take and that this bodes well for any future discussion.

If you are wondering why you should care, the fact is that if you run a small shop that requires no financing and the only users of your financial statements are you and the taxing authorities, you might not care. However, if you want to grow and need capital, you might need to go to the bank. The bank could require audited financial statements and if your CPA can’t get the loan committee to accept anything other than GAAP financial statements, you might be in for a surprise when you receive the draft of statements and/or the bill for the audit. The statements that were adequate to help you manage the business up to now might not measure up to the requirements of GAAP.

For example, in years past the basic requirement for consolidating the financial statements of two or more entities was that one had a controlling interest in the other or some upstream parent held the controlling interest. The common definition of controlling interest was ownership of a greater than 50 percent voting interest in another entity. In late 2003, the Financial Accounting Standards Board issued guidance that required some companies to provide consolidated financial statements even if the greater than 50 percent voting interest test was not met. While there is theoretical justification to the treatment required by the new standards, the cost to comply with them can be onerous and the results can be misleading to the users of private company financial statements.

If you have never sought to issue GAAP financial statements and you own companies that might fall under the new rules, chances are you have not been consolidating the financial statements of those companies. If you are required to provide audited GAAP basis statements for Company A, expect to have Company B audited as well.

This is only one of the issues that our profession faces that will have a big impact on how you report your financial results.

One prime consideration is whether to require all private companies to follow whatever standards are eventually crafted or whether to allow them the option to use public company GAAP. Requiring all private companies to use private company GAAP could cause problems for those intending to go public at some point.

Nobody Has a Crystal Ball

Private vs. public company accounting standards is an issue that has befuddled policymakers for decades. It’s not likely to be one that will be resolved easily or quickly, but at least the profession is working toward a resolution. It benefits all of us to keep an eye on what is happening and offer input to ensure your needs as a small business are met.

Have a great August.

On March 21, the United States House of Representatives passed H.R. 3590, the Patient Protection and Affordable Care Act. This bill, called the Health Care Act, was subsequently amended by H.R. 4872, the Health Care and Education Affordability Reconciliation Act of 2010. The Reconciliation Act was signed into law on March 30.

The Health Care Act is a 906-page document and The Reconciliation Act is a 2,310-page document, according to the Government Printing Office.

This information, along with all the recent press about the acts, will help you understand how massive the new law is and how complicated it will be to
implement. With that in mind, let’s discuss a few of the major tax provisions and their implications in the new law.

Higher Payroll Taxes

As with most government initiatives this size, there has to be some mechanism to pay for the plan. One of those revenue raisers is an increase in Medicare taxes on wage earners. A new 0.9 percent Medicare tax will be levied on taxpayers who file single and earn more than $200,000. The threshold for married couples filing jointly is $250,000. Presently, all taxpayers pay 1.45 percent of their earned income in Medicare taxes, which is matched dollar for dollar by their employer. Self-employed individuals pay the full 2.9 percent. Beginning in 2013, taxpayers will pay an additional 0.9 percent on amounts in excess of these base amounts. The $200,000 and $250,000 thresholds will not be indexed for inflation.

Medicare Taxes on Unearned Income

Currently, individuals pay Medicare taxes only on earned income (wages and self-employment income). Unearned income (dividends, capital gains, etc.) is not subject to Medicare tax. Beginning in 2013, this exception will disappear. For those with adjusted gross incomes in excess of $200,000 for singles and $250,000 for married couples filing jointly, a new 3.8 percent Medicare tax will be levied on net investment income in excess of those threshold amounts.

How this will affect individual taxpayers will depend on the source of their income. For example, if a married couple has $75,000 in wages and $300,000 in capital gains, the new tax would apply to net investment income of $125,000 ($75,000 + $300,000 less $250,000). The overall additional tax would be $4,750 (3.8 percent of $125,000). Let’s take a look at high wage earners. Assume our sample couple earns $300,000 and has $75,000 in capital gains. The increased Medicare tax would equal $3,300 (0.9 percent of earned income over $250,000 plus 3.8 percent of $75,000 net investment income).

Income from tax deferred retirement accounts such as a 401(k) or similar accounts will not be included in income subject to the additional tax. The tax would apply to estates and trusts. The two provisions increasing Medicare taxes are estimated to increase revenue by $210 billion over 10 years.

Deductible Medical Expenses

Presently, medical expenses in excess of 7.5 percent of adjusted gross income can be deducted as an itemized deduction. The new law increases this threshold to 10 percent for tax years after 2012. For individuals older than 65 and their spouses, the new threshold will not take effect until after 2016.

This increase in the nondeductible floor could have unintended consequences to those forced to withdraw funds from their retirement accounts to pay medical bills. Under current law, IRA withdrawals used to pay for deductible medical expenses (i.e. expenses in excess of the 7.5 percent floor), are not charged a 10 percent penalty upon early withdrawal. Increasing the floor to 10 percent will raise the portion of a withdrawal subject to penalty.

For example, assume you are 35 years old and must withdraw $25,000 from your IRA to pay a hospital bill for your child. Assume also that your adjusted gross income is $125,000 and you itemize deductions. Under current law, your itemized deduction would be $15,625 ($25,000 – [7.5 percent of $125,000]). The new law would reduce that deduction by $3,125 to $12,500. Additionally, if your withdrawal is subject to the early withdrawal penalties, you would pay a 10 percent penalty tax on the $3,125.

Since the new law does not take effect until 2013, perhaps Congress will be able to address the higher penalty tax. This change is expected to increase revenue by $15 billion over 10 years.

Individuals Without Coverage

Beginning in 2014, nonexempt U.S. citizens and legal residents will be required to maintain a minimum amount of health coverage. Individuals who fail to do so will be subject to certain penalties beginning in 2016. The penalty will be the greater of 2.5 percent of household income over the minimum income required to file a tax return or a per-person penalty rate. The rate for each adult in the household would be $695 while the rate for uninsured children under 18 years old will be half of the adult rate. The overall penalty cannot exceed 300 percent of the per-adult penalty, or $2,085.

Low Income Tax Credits

Families and individuals with income of up to 400 percent of the federal poverty level ($43,320 for an individual or $88,200 for a family of four) will be eligible for a cost sharing subsidy if they participate in a local health insurance exchange. They cannot be eligible for Medicaid, employer-sponsored insurance or other acceptable insurance.

Every Bill has its Quirks

As a side note, there are a few obscure provisions that were hardly mentioned during the debate. One of those is a tax on indoor tanning services. Beginning July 1, if you use an indoor tanning salon, expect to see your bill increase by 10 percent.

The Health Care and Reconciliation acts are complicated and will take time to sort out. There is no doubt there will be income tax implications for many Americans. Some provisions will take awhile to implement, but now is the time to begin looking at your personal finances to minimize potential negative effects of the changes in health care law.