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Federal Business Tax Update


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An update on the most pressing Federal Tax Business issues.

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Federal Business Tax Update

  1. 1. January 2014 Federal Tax Update
  2. 2. Circular 230 Notice Any tax advice contained in this program is not intended to be used and cannot be used for the purposes of avoiding any penalties that may be imposed by the Internal Revenue Code. 2 2
  3. 3. Here’s what we’ll cover: • What To Look For In 2014 – 2014 By The Numbers – “Tax Extenders” – Serious Problems Facing the IRS in 2014 (Taxpayer Advocate Report) 3 3
  4. 4. Here’s what we’ll cover: • Regulatory & Administrative Pronouncements – New IRS Commissioner – Final Tangible Property Regulations – Final Net Investment Income Tax Regulations – Guidance on Bonus Payments (FAA 20134301F) – “Use-or-Lose” FSA Rules and Additional Rulings – International Enforcement -- John Doe Summons 4 4
  5. 5. Here’s what we’ll cover: • Cases – Glass Blocks v. Commissioner – S Corporation distributions • Legislative Updates – Tax Reform • Status • Hurdles • Baucus Proposals ( Cost Recovery, Tax Accounting, International) 5 5
  6. 6. What To Look For In 2014 6 6
  7. 7. 2014 By The Numbers • The top marginal income tax rate in 2014 (39.6 percent) will apply to the taxable income of individuals & married couples filing jointly when their income exceeds $406,750 and $457,600, respectively (up from $400,00 and $450,000 in 2013). • In 2014, the Standard Deduction increases to $6,200 (from $6,100). The personal exemption increases by $50 to $3,950. • For married couples, the phase-out of the personal exemption deduction starts with adjusted gross income of $350,050; the deduction is eliminated once AGI reaches $427,550. • The FICA wage base increases to $117,000; an increase of $3,300. 7 7
  8. 8. 2014 By The Numbers • The annual dollar limit on contributions to health care flexible spending accounts remains $2,500. • The §401(k) contribution limit remains $17,500. The $5,500 “catch-up” contribution allowance for participants older then 50 also remains unchanged. • The lifetime estate tax exclusion is increased to $5.34 million (up from $5.25 million). • Fees for installment agreement and OIC will increase in 2014: − Installment Agreement increases to $120 (and $50 for reinstatement ) − OIC increases to $186 8 8
  9. 9. “Tax Extenders” - Expiring Tax Provisions • “Tax extenders” refer to legislation to extend the package of expiring tax provisions that typically get temporarily extended by Congress. The extensions tend to be for short periods of time (e.g., one – two years). • Many feel that the extension of many of these provisions is being “tied” up by Congress as they await a more comprehensive tax reform. • Most of the expiring provisions were extended by the American Taxpayer Relief Act of 2012. 9 9
  10. 10. “Tax Extenders” - Expiring Individual Provisions • Individual tax provisions set to expire include: – Deduction for state and local sales taxes; – Above-the-line deductions for certain expenses of teachers; – Above-the-line deductions for qualified tuition and related expenses; – Deduction for mortgage insurance premiums deductible as qualified interest; – Parity for exclusion for employer-provided mass transit and parking benefits; – Exclusion of discharge of principal residence indebtedness from gross income; – Credit for health insurance costs. 10 10
  11. 11. “Tax Extenders” - Expiring Business Provisions • Business tax provisions set to expire include: – Research and experimentation credit; – Work opportunity tax credit; – Increase in expensing to $500,000/$2,000,000 and expanded definition of §179 property; – Bonus depreciation; – Exceptions under Subpart F for active financing income; – Look-through treatment of payments between controlled foreign corporations (“CFC ”); 11 11
  12. 12. “Tax Extenders” - Expiring Business Provisions • Business tax provisions set to expire (cont’d): – Special treatment of certain dividends on Regulated Investment Companies (“REIT”); – Employer wage credit for activated military reservists; – Special rules for qualified small business stock; – Reduction in S corporation recognition period for built-in gains tax; – Election to accelerate alternative minimum tax (“AMT”) credits in lieu of additional first-year depreciation; – 15-year straight line cost recovery for qualified leasehold, restaurant, and retail improvements 12 12
  13. 13. “Tax Extenders” – Tax Costs To Extend • Projected Tax Costs for extending all of the tax provisions scheduled to expire between 2013 – 2023 is $938.3 billion. • Cost for extending all temporary investment incentives (i.e., partial expensing for investment property and §179 allowances) is $346.1 billion. • Cost of expending child tax credit, earned income tax credit and American Opportunity Tax Credit (scheduled to expire in 2017) is $140.4 billion. 13 13
  14. 14. Serious Problems Facing the IRS in 2014 – Taxpayer Advocate’s Report to Congress • Sequestration has caused IRS funding to be substantially cut, translating into a reduction in taxpayer services, including: – 39%of taxpayer calls going unanswered at the IRS; – A six-fold increase in hold times before speaking to an IRS representative; – A $150m reduction in the training budget (which has lead to an increase in identity theft, decrease in customer service and inappropriate adjustments at audit). – More than 50% of taxpayer correspondence (proposing adjustments to taxpayer liabilities) going unanswered for more than 45 days (falling into the “over age” category by IRS standards) leading to an 14 unnecessary increase in penalties and interest. 14
  15. 15. Serious Problems Facing the IRS in 2014 – New Budget • House lawmakers on January 15 quickly passed a $1.012-trillion spending bill for fiscal year (FY) 2014 by a vote of 359 to 67. – 193 Democrats and 166 Republicans voted for passage • The Consolidated Appropriations Bill of 2014 (HR 3547) sets spending levels for all federal agencies, including the IRS, which will see its budget cut to $11.3 billion, or roughly $526 million below the FY 2013 level. • The bipartisan spending bill would also prohibit the IRS from targeting political groups or overspending on employee training and bonuses. 15 15
  16. 16. Regulatory & Administrative Pronouncements 16 16
  17. 17. New IRS Commissioner • John Koskinen appointed Commissioner after serving as Deputy Director of the OMB – considered “turnaround” specialist • Immediate challenges facing the new Commissioner include: • 2014 filing season – due to delays from the 2013 government shutdown, the filing season will be delayed by 10 days. • 2014 tax collection – due to a congressional budget cuts, the number of available revenue agents has been decreased. • Restoration of public confidence – after 2013 “targeting scandals”. 17 17
  18. 18. Tangible Property Regulations • Final regulations – Govern the deduction and capitalization of costs incurred to acquire, maintain or improve tangible property (personal and real property, not intangible property) – Generally effective for tax years beginning on or after January 1, 2014 – Optional early adoption for 2012 and/or 2013 tax years 18 18
  19. 19. Why is this important? • Example actions required of most taxpayers: – Review and validate current capitalization policies • Critical for de minimis safe harbor – Consider tax accounting method changes for 2013 or 2014 along with impact on taxable income – Evaluate opportunities to amend 2012 tax returns – Consider financial statement implications • Some book conformity required • Effect on deferred taxes – Review and modify fixed asset accounting systems as needed – Evaluate materials and supplies accounting – Review prior year treatment of expenditures on repairs & 19 maintenance and dispositions 19
  20. 20. Tax Accounting Considerations • For tax accounting purposes, the following items are impacted: – Materials and supplies, – Acquisitions of tangible assets, – Improvements to tangible assets, – Repairs and maintenance expenditures, and – Dispositions/retirements of tangible assets. • Many of these tax accounting changes will have an impact on the way taxpayers report these items on their books – Specific areas requiring book consistency: – De minimis safe harbor – Materials & supplies under the de minimis safe harbor – Election to capitalize repairs & maintenance 20 20
  21. 21. De minimis safe harbor • De minimis safe harbor -- an annual election that permits a taxpayer to currently deduct otherwise capital expenditures (including materials & supplies) if the taxpayer: – (1) has an “accounting policy” (at the beginning of the tax year) that requires expensing of items that cost no more than a specified dollar amount for book purposes, and – (2) consistently applies that policy for book purposes. • Critical that book and tax treatment of small dollar items be 21 understood 21
  22. 22. De minimis safe harbor • Both requirements must be satisfied to deduct amounts otherwise required to be capitalized • Ceiling for safe harbor depends on whether the taxpayer has an Applicable Financial Statement (“AFS”) – AFS is an Audited statement, or – AFS is also a financial statement required to be provided to the Federal or State government or their agencies (consider bonding agencies for contractors) 22 22
  23. 23. De minimis safe harbor • The de minimis safe harbor uses an invoice test: • Taxpayers with an AFS: A taxpayer may rely on the de minimis safe harbor only if the amount paid for property does not exceed $5,000 per invoice or per item as substantiated by the invoice; – Note accounting policy must be written • Taxpayers without an AFS: A taxpayer may rely on the de minimis safe harbor only if the amount paid for property does not exceed $500 per invoice or per item as substantiated by the invoice; 23 23 – Note accounting policy just needs to “exist”
  24. 24. De minimis safe harbor • If book policy is less than the $5,000/$500 ceiling then the lower amount is the amount allowed for tax • Since the de minimis rule requires the policy to be in existence at the beginning of the tax year, to utilize this rule the policy needs to be prepared in 2013 for 2014 tax years • Each taxpayer should be reviewing their capitalization policy NOW! 24 24
  25. 25. Other key areas of these new rules • Tax rules now allow partial disposition of assets, including building components (i.e. roof, elevators, walls and ceilings…) – Consider dispositions that occurred in prior years – IRS allows a reasonable method to extract cost of asset disposed from original cost of the building or asset – Cost segregation concepts apply – Write-offs would generate an ordinary deduction – What will be the book treatment? • Materials & supplies – if the de minimis safe harbor is elected, then materials & supplies must be considered under the de minimis rules • Election to capitalize repairs & maintenance – must also capitalize for book purposes under this election – Will this be allowed under GAAP? 25 25
  26. 26. Net Investment Income – Final Regs • The Net Investment Income (“NII”) tax is part of the PPACA and went into effect on January 1, 2013. • The NII is unlikely to apply to approximately 94% of Americans. • The NII will be levied on the lesser of the following two: – A taxpayer’s net investment income, or – The excess of the taxpayer’s “modified adjusted gross income” over taxpayer’s “applicable threshold.” The applicable threshold is dependent on filing status, and is: • Married filing jointly: $250,000 • Single/head of household: $200,000 • Married filing separate: $125,000 26 26
  27. 27. Net Investment Income – Final Regs • The final regs (found in §1.1411-1 to §1.1411-10) provide guidance on what constitutes “Net Investment Income” to which the 3.8% tax is applied and they involve issues that include: – – – – – Portfolio income Ordinary trade or business Trade or business for rental real estate Net gain calculations Real estate professionals. • Note that an additional .09% Medicare tax on wages has also been implemented as part of the same regulations. 27 27
  28. 28. Net Investment Income – Changes in the Regs • Portfolio income. The IRS rejected the suggestion that the definition of portfolio income (for purposes of NII) adopts the concepts used under §469. The final NII regulations observe that the interaction of §1411 with §469 is generally limited to the determination of whether those items are attributable to a passive activity within the meaning of §1411(c)(2)(A). • Ordinary course of trade or business. Similar to the preamble in the proposed regulations, the final regulations defer to case law and administrative guidance applicable to §162 in defining a trade or business. 28 28
  29. 29. Net Investment Income – Changes in the Regs • Trade or business for rental real estate. The IRS acknowledged that "in certain circumstances" the rental of a single property may require regular and continuous involvement such that the rental activity is a trade or business under §162 (and, therefore, is a trade or business under §1411 by adoption). However, the IRS refused to provide a bright-line test to determine when a rental activity rises to the level of a trade or business "due to the large number of factual combinations that exist." • Net gain calculation. The final regulations retained the rule that net gain within Category (iii) (under §1411(c)(1)(a)(iii)) cannot be less than zero. However, they allow losses under §1211(b) as offsets while applying a specific ordering rule designed to prevent a double deduction of the same loss twice. 29 29
  30. 30. Net Investment Income – Changes in the Regs • Real estate professionals. The IRS rejected suggestions that if a real estate professional materially participates in real estate activities, the rental income should be excluded from NII. Instead, the final regulations provide a safe harbor test for a real estate professional (within the meaning of §469(c)(7)) who participates in rental real estate activities for more than 500 hours per year. The rental income associated with that activity will be deemed to be derived in the ordinary course of a trade or business. 30 30
  31. 31. Net Investment Income – Changes in the Regs • Regrouping. The 2012 NII proposed reliance regulations provided taxpayers with the opportunity to regroup their activities in the first tax year beginning after December 31, 2012. The IRS retained the regrouping provision in the final regulations. The IRS rejected calls for a "fresh start" for all individuals (and estates and trusts) regardless of whether they have NII income or modified adjusted gross income above the applicable thresholds. • NOTE - The IRS has not yet published final Form 8960, Net Investment Income Tax, and Instructions for the 2013 tax year. Form 8960 must accompany Form 1040 or 1041. 31 31
  32. 32. New IRS Guidance On Bonus Payments (FAA 20134301F) • IRS Chief Counsel issued advice stating an accrual-basis taxpayer cannot deduct bonuses until the year paid where the taxpayer retained the unilateral right to modify or eliminate the bonuses before payment, thereby failing to satisfy the all-events test. • In this instance, the taxpayer had more than a dozen bonus plans. Under the plans, employee bonuses would be calculated using formulas that use various measurements. Though performance targets were set by the board of directors early in the fiscal year, the bonuses were not paid until the committee approved the settlement and payment of the bonuses after the end of the fiscal year. All of the bonuses were paid after the end of the year, but within 2 ½ months following the end of the year. 32 32
  33. 33. FSAs, Retirement Plans and Fringe Benefits • Healthcare Flexible Spending Accounts – The “use-or-lose” rule has been amended allowing up to $500 to be carried over annually (See Notice 2013-71). • §401(k) safe harbor for plan sponsors (TD 9641) – Employers facing economic difficulties may reduce or suspend nonelective contributions to §401(k) plans if the employer is operating at an economic loss. • Updated Auto fringe rules – The cents-per-mile valuation rule is $16,000 for a car and $17,300 for a truck or van. – The per diem rate is $251 in high-cost areas and $170 in low-cost areas. 33 33
  34. 34. International Compliance – John Doe & OVDI • Judges in the Northern District of California recently authorized the IRS to issue John Doe summons on Wells Fargo Bank in an effort to gain information about U.S. taxpayers with offshore accounts at First Caribbean International Bank. – While First Caribbean does not maintain a U.S. branch, it does access the U.S. banking system through a Wells Fargo correspondence account. – The information provided in support of the John Doe summonses were derived through the offshore voluntary disclosure initiative (“OVDI”). 34 34
  35. 35. International Compliance – John Doe & OVDI • A number of U.S. taxpayers who were accepted into the OVDI program were subsequently disqualified from participation. The overwhelming majority of those taxpayers disqualified from the OVDI maintained bank accounts with Bank Leumi – an Israeli bank. • The OVDI has seen more than 38,000 participants enrolled, generating more than $5 billion in back taxes and penalties. • A number of participants in the OVDI have pled guilty to criminal tax evasion with the most common sentence totaling three year’s probation. In some cases, those seeking to evade U.S. tax (or assist those in evading U.S. tax) by maintaining numbered Swiss bank accounts have actually received jail time ranging from 45 days to 40 months. 35 35
  36. 36. Cases 36 36
  37. 37. Glass Blocks Unlimited v. Comm’r T.C. Memo. 2013-180 • Petitioner was an S corporation. Petitioner had one shareholder who was also the only full-time employee. • Petitioner’s employee transferred funds to the business in order offset financial difficulties, including operating expenses. • Petitioner did not make any salary payments to its employee/shareholder in either 2007 or 2008. Instead, Petitioner made “distributions” to its employee/shareholder. • The IRS issued a notice of deficiency asserting the distributions Petitioner made to its employee should be recharacterized as wages subject to withholding. 37 37
  38. 38. Glass Blocks Unlimited v. Comm’r (contd.) T.C. Memo. 2013-180 • Petitioner’s employee was deemed to receive wages subject to Federal employment tax because: – He performed substantially all of the work necessary to operate the business – His services generated all of the S corporation’s income. 38 38
  39. 39. Glass Blocks Unlimited v. Comm’r (contd.) T.C. Memo. 2013-180 • The funds transferred by Petitioner’s employee were found to be capital contributions (and not loans), as there was no objective evidence they should be treated as a loan. – Applying the 13 Factors Test (See, §142(a); Dixie Dairies Corp v. Comm’r., 74 T.C. at 493), including whether there were: formal loan documentation; presence of a fixed maturity date; some loan repayment, etc. • Here, there was no loan agreement or promissory note, no evidence of interest accrual (or other similar obligations) indicating the contributions were equity. 39 39
  40. 40. Legislative Updates 40 40
  41. 41. Tax Reform – Status and Hurdles • Congressman Dave Camp (R-Mich) – chairman of the House Ways and Means Committee and Senator Max Baucus (D-Mont) – chairman of the Senate Finance Committee have endeavored to lead legislators to a comprehensive reform of the tax code. Both released drafts of their reform measures. • Cong. Camp’s initial proposal aimed at closing tax loopholes while cutting tax rates (a “revenue neutral” process”). A more comprehensive look at Cong. Camp’s proposals was undertaken in previous EOW. 41 41
  42. 42. Tax Reform – Status and Hurdles • It is widely believed that significant tax reform is beyond the reach of the current Congress. Some hurdles standing in the way include: – Sen. Baucus retiring and appointed Ambassador to China; – Whether the tax code should raise revenue or be revenue neutral; – Whether “extenders” will be tied to other votes (such as passing a budget or extending our country’s debt ceiling). • Senator Baucus offered a comprehensive tax reform proposal focusing on: – Simplification of tax administration; – Overhauling the way the government taxes international business; and 42 – Reforming depreciation rules. 42
  43. 43. Tax Reform – Baucus Plan • Depreciation - Replace the current rules with a system tied closer to estimates from the Congressional Budget Office. – Reduce the number of depreciation rates from 40 to 5, and eliminate the need for businesses to calculate depreciation separately for each of their assets, other than real property. • Amortization Of Intangibles - Require businesses to deduct the cost of R&D, natural resource extraction, and 50% of advertising expenses over 5 years. • Accounting - Repeal LIFO accounting and like-kind exchange rules. • Reduce Burdens For Small Businesses - Permanently increase Section 179 expensing to $1m and expand the definition of qualifying expenses. Allow all companies with gross receipts under $10m to use cash accounting and expense inventory costs. 43 43
  44. 44. Tax Reform – Baucus Plan (contd.) • International taxation: – Reduce incentives for US and foreign multinationals to invest in, or shift profits to, low-tax foreign countries. – Reduce incentives for US-based businesses to move abroad, whether by re-incorporating abroad or merging with a foreign business. – Increase the ability of US businesses to compete against foreign businesses in foreign markets. – End the "lock-out" effect by taxing the foreign income of US businesses either immediately when earned or not at all. – Simplify the international tax rules so that firms with the most sophisticated tax advisors are not advantaged. 44 44
  45. 45. For more information contact: William M. Smith, Esq. Managing Director CBIZ MHM National Tax Office (301) 951-3636 | 45 45