Tax Planning and the New Tax Law 11/18/2010

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A compendium of 2010 tax law changes that primarilly affect businesses

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Tax Planning and the New Tax Law 11/18/2010

  1. 1. Tax Planning and the New Tax Law brown, kaplan + liss llp 11/18/2010
  2. 2. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 2 | P a g e CONTENTS Pages 1 – 11 Outline – Tax Planning and the New Tax Law Pages 100 – 115 Articles CIRCULAR 230 DISCLOSURE To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in or accompanying this document, unless otherwise specifically stated, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in or accompanying this document.
  3. 3. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 3 | P a g e brown, kaplan + liss llp – Tax Planning and the New Tax Law November 18, 2010 Joe M. Liss, CPA, Managing Partner Michael W. Felz, CPA, MST, Partner and Director of Taxation Kristy McElroy, CPA, Manager Scott Joschko, CPA, Manager I. New tax laws a. Small Business Jobs Act of 2010 (signed September 27, 2010) i. Tax savings provisions 1. Liberalized “cost recovery” rules a. Section 179 [see article at page 100]- Up to $500,000 of equipment, furniture and certain other capitalized asset purchases can be deducted in each of 2010 and 2011. b. The reduction in this $500,000 limitation does not take effect until $2,000,000 of property is place in service in either tax year. c. Taxpayers can elect to include in qualified asset purchases up to $250,000 of certain real property – i.e. qualified leasehold improvements, restaurant property, and retail improvement property. i. This doesn’t include air conditioning or heating units, or property used for lodging (except transient accommodations in hotels and motels), property used outside the U.S., and property used by governmental units, foreign persons or entities, and tax-exempt entities.
  4. 4. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 4 | P a g e ii. Qualified leasehold improvements are improvements to the interior of a nonresidential property, made pursuant to a lease, in a portion to be occupied by the lessee, and the improvement is placed in service more than 3 years after the date the building was first placed in service by any person. d. 50% bonus depreciation [see article at page 100] – most new items of personal property, computer software and certain leasehold improvements placed in service before Jan. 1, 2011, qualify for 50% bonus depreciation in the year placed in service. e. Passenger automobiles – first year depreciation on qualified business autos placed in service on or before Dec. 31, 2010, is increased by $8,000 over the “luxury” auto limit of $3,060. Qualified business autos are allowed up to $11,060 of depreciation in the year placed in service, reduced proportionately for non-business use. f. Cell phones [see article at Page 101] – Cell phones are removed from “listed property” treatment. i. Strict substantiation requirements and additional limits placed on depreciation are removed. ii. This provision enables the fair market value of personal use of a cell phone or similar device provided to an employee predominantly for business purposes to be excluded from gross income. 2. Incentives for investment in businesses a. Start-up costs [see article at Page 102] – taxpayers can deduct up to $10,000 of start-up expenses incurred in 2010, with limitations if total start-up expenses exceed $60,000. The limit returns to $5,000 for expenses after 2010. b. Small business stock gain exclusion [see article at Page 103] – gain realized on the sale of “qualified small business stock” acquired after Sept. 27, 2010 and before Jan. 1,
  5. 5. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 5 | P a g e 2011, held for more than 5 years, subject to certain limitations, is excluded from regular tax and AMT. c. Unused “Eligible Small Business Credits” are allowed 5-year carryback – Credits earned in a taxpayer’s first tax year beginning in 2010, but are unused in 2010, can be carried back five tax years and forward 20 tax years. i. “Eligible Small Businesses” are businesses that 1. Are either corporations the stock of which isn’t publicly traded, partnerships or sole proprietorships, and 2. Have average annual gross receipts for the three-year period preceding the tax year of no more than $50 million. d. Shortened S Corporation built-in gain holding period extended for 2011 – No tax is imposed on the net unrecognized built-in gain of an S corporation if the fifth year in the recognition period preceded 2011. Thus, a five year period applies for 2011 (a seven year period applies for 2010). 3. AMT liberalization a. “Eligible Small Businesses” can offset AMT liability with 2010 general business credits – Credits earned in the taxpayer’s first tax year beginning in 2010 can be used to offset AMT and regular tax except for 5% of regular tax in excess of $25,000. i. Where credits are limited to taxes attributable to income from an activity (i.e. research and development credits), those limits still apply. 4. Fringe benefits a. Cell phones (see item 1.f. above)
  6. 6. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 6 | P a g e b. Health insurance for self-employed individuals [see article on Page 104] – For 2010, in addition to the income tax deduction previously allowed, self-employed individuals are also allowed to deduct the cost of health insurance in calculating net earnings from self-employment for purposes of the self-employment tax. 5. Qualified and Nonqualified Retirement Plans a. Retirement plan distributions may be rolled over to a designated Roth account [see article on Page 105] – Prior to this law, rollovers of distributions from a qualified plan to a designated Roth account could be made only from another designated Roth account. i. Now, eligible rollover distributions from qualified plans may be directly rolled over into a Roth IRA. ii. Plans may need to be amended to allow for such rollovers. iii. Rollovers to a designated Roth account are taxable 1. 10% early withdrawal penalty doesn’t apply 2. The taxable income is included ratably in the individual’s gross income over the two- year period beginning in 2011, though the individual may elect not to have this two- year deferral apply. 6. Information Reporting and Related Penalties [see article on Page 106] a. Rental Properties required to issue 1099s – A person receiving rental income from real estate will be considered to be engaged in a trade or business for information reporting purposes. i. Payments of $600 or more to a service provider (i.e. plumber, painter, or accountant) in the course of earning rental income will require an information
  7. 7. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 7 | P a g e return (typically Form 1099-MISC) to the IRS and service provider. ii. Exception – any individual who receives rental income of not more than the minimal amount, as determined under IRS regulations (yet to be issued), and military members or intelligence employees if the rental income is from their principal residence. iii. Backup withholding – The backup withholding rules continue to apply. If reportable payments are made to a service provider who has not provided a taxpayer identification number to the payer, the payer is required to withhold 28% of the payment and submit it to the IRS. Form W-9 is used to obtain the payee’s taxpayer identification number. b. Penalties i. In addition to the backup withholding, penalties for failure to file information returns increase from $100 to $250 per return for intentional disregard of the rules. The penalties for failure to furnish information returns to payees also increase from $100 to $250 per return. 1. Example – if you should have filed and provided 10 Form 1099-MISC, but failed to do so, your penalties total $5,000 (10 failure to file penalties at $250 each, and 10 failure to furnish penalties at $250 each), plus you would be required to submit 28% of the gross payments as backup withholding if you didn’t obtain taxpayer identification numbers. ii. The various late filing penalties increase from $15 to $30 (“first tier” penalty for failures corrected within 30 days), from $30 to $60 (“second tier” penalty for failures corrected after 30 days but before August 1st of each year), and from $50 to $100 (third tier penalty for failures corrected after August 1). The penalties for failure to furnish
  8. 8. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 8 | P a g e information returns to payees have been changed to match these late filing penalties. iii. The maximum penalties increase to $250,000 (first tier), $500,000 (second tier) and $1,500,000 (third tier). Small business (businesses with average annual gross receipts for the prior 3 years that don’t exceed $5 million) have smaller limits: $75,000 (first tier), $200,000 (second tier) and $500,000 (third tier). II. Other year-end business tax planning a. Illinois i. EDGE Tax Credit – Economic Development for a Growing Economy 1. Credit equal to amount of state income taxes withheld from the wages or salaries of employees in newly created jobs or retained jobs attributable to a particular project 2. Administered by the Department of Commerce and Economic Opportunity (DCEO) 3. See: http://www.commerce.state.il.us/dceo/Bureaus/Business_Develop ment/Tax+Assistance/ ii. Illinois Research & Development Credit – the R&D credit has been extended for tax years ending prior to January 1, 2011. The credit is equal to 6.5% of eligible expenditures for increasing R&D in Illinois. iii. Small Business Job Creation Tax Credit-for businesses with no more than 50 full-time employees 1. $2,500 credit per new employee hired and is applied towards payment of Illinois withholding taxes. 2. New, full-time employees must be hired during the 12 month period beginning July 1, 2010. a. Only new Illinois employees qualify
  9. 9. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 9 | P a g e i. A full-time employee first employed within the incentive period (7/1/2010 – 6/30/2011) ii. Whose hire results in a net increase in the applicant’s full-time Illinois employees, and iii. Who is receiving a basic wage as compensation (no less than $13.75 per hour or the equivalent salary for a new employee) b. The law limits the total monetary amount of credits awarded to no more than $50 million, and credits shall be allowed on first-come, first-served basis. c. See: http://jobstaxcredit.illinois.gov/ iv. Angel Investment Credit [see Press Release on Page 107] – for taxable years beginning after 12/31/10 and ending on or before 12/31/16, eligible taxpayers may claim a nonrefundable income tax credit in the amount of 25% of the claimant’s investment made directly in a qualified new business venture. 1. A “qualified new business venture” means a business that is registered with the DCEO, and 2. A business must submit an application in each taxable year for which the business desires registration. 3. See the DCEO website for qualifications – not yet available b. Federal i. Expiring provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 1. Top rates increase from 35.0% to 39.6% 2. Long-term capital gain rates increase from 15% to 20% 3. Qualified dividend income rates increase from 15% to 39.6% ii. Health Care and Education Reconciliation Act of 2010 1. In 2013, additional medicare taxes-
  10. 10. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 10 | P a g e a. Hospital Insurance tax rate of .9% on earned income in excess of $200,000 ($250,000 MFJ) b. 3.8% unearned income Medicare contributions tax on the lessor of “net investment income” or the excess of modified adjusted gross income over $200,000 ($250,000 MFJ, $125,000 MFS). 2. Expanded information reporting a. In 2012, 1099-MISC requirements expand to corporate providers and providers of property in addition to services b. In 2011, employer-provided health insurance costs to be reported on Form W-2 (reported only, not subject to tax) (IRS Notice 2010-69 made this disclosure optional for 2011). c. In 2010, Form 3921 is to be filed with IRS if stock is transferred in connection with exercise of incentive stock options. d. In 2010, Form 3922 is required if stock is transferred under an Employee Stock Purchase Plan. 3. “Economic Substance” Doctrine is codified – a transaction has economic substance only if the taxpayer’s economic position (other than its Federal tax position) is changed in a meaningful way and the taxpayer had a substantial purpose (other than a Federal tax purpose) for engaging in the transaction. 4. In 2018, a 40% nondeductible excise tax on insurance companies or plan administrators for any health insurance plan with an annual premium in excess of $10,200 for individuals ($27,500 for families), with the premium amounts to be adjusted for inflation. iii. Hiring Incentives to Restore Employment (HIRE) Act 1. A Qualified Employer’s 6.2% OASDI Social Security tax is forgiven for wages paid on previously unemployed new hires for any 2010 period starting after 3/18/2010 through 12/31/2010.
  11. 11. brown, kaplan + liss llp Tax Planning and the New Tax Law November 18, 2010 11 | P a g e 2. A Qualified Employee must start work anytime after 2/3/2010 and before 1/1/2011, and generally must have been unemployed for at least 60 days before his/her start date. 3. Employers that hire new workers who qualify for payroll tax forgiveness and keep them on the payroll for at least 52 consecutive weeks may be eligible for an up to $1,000 tax credit (if lesser, 6.2% of wages). iv. The Domestic Production Activity Deduction (DPAD, Sec. 199) increases to 9% from 6% of domestic production activity income in 2010.
  12. 12. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 99 | P a g e Contents Page 100 Expensing and bonus depreciation provisions in the 2010 Small Business Jobs Act 101 Simplified business cell phone deduction rules in the 2010 Small Business Jobs Act 102 Increased deduction for start-up expenditures in the 2010 Small Business Jobs Act 103 100% exclusion of gain from the sale of certain small business stock in the 2010 Small Business Jobs Act 104 Deductibility of health insurance for purposes of calculating self- employment tax in the 2010 Small Business Jobs Act 105 Retirement plan and annuity changes in the 2010 Small Business Jobs Act 106 Information reporting changes in the 2010 Small Business Jobs Act 107 Illinois Press Release – Angel Investment Tax Credit 109 Federal gift tax: liability based on lifetime gifts 110 Tax strategies for business people stepping up to a new car 112 S corporation as choice of entity 113 C corporation as choice of entity 115 Limited liability company as choice of entity
  13. 13. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 100 | P a g e Expensing and bonus depreciation provisions in the 2010 Small Business Jobs Act The recently enacted Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting business. Two of the most significant changes allow for faster cost recovery of business property. Here are the details. Enhanced small business expensing (Section 179 expensing). In order to help small businesses quickly recover the cost of certain capital expenses, small business taxpayers can elect to write off the cost of these expenses in the year of acquisition in lieu of recovering these costs over time through depreciation. Under pre-2010 Small Business Act law, taxpayers could expense up to $250,000 for qualifying property—generally, machinery, equipment and certain software—placed in service in tax years beginning in 2010. This annual expensing limit was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 exceeded $800,000 (the investment ceiling). Under the new law, for tax years beginning in 2010 and 2011, the $250,000 limit is increased to $500,000 and the investment ceiling to $2,000,000. The new law also makes certain real property eligible for expensing. For property placed in service in any tax year beginning in 2010 or 2011, the up-to-$500,000 of property that can be expensed can include up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property). Extension of 50% bonus first-year depreciation. Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008 or 2009 (2010 for certain property), by permitting the first-year write-off of 50% of the cost. The new law extends the first-year 50% write-off to apply to qualifying property placed in service in 2010 (2011 for certain property). We hope this information is helpful. If you would like more details about any aspect of the new legislation, please do not hesitate to call.
  14. 14. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 101 | P a g e Simplified business cell phone deduction rules in the 2010 Small Business Jobs Act For an example of genuine tax simplification, it would be hard to beat a provision in the recently enacted 2010 Small Business Jobs Act. For the last several years, just about everyone, it seems, even the IRS, has complained about the archaic rules governing the tax treatment of employer-provided cell phones. Since 1989 (shortly after the first cell phones were introduced), employers and employees have been required to keep a detailed log of business and personal use on employer-provided cellular telephones and similar mobile communication devices to substantiate costs that were allowable as business expenses. In tax parlance, cell phones were included in the category of “listed property” (i.e., items obtained for use in a business but which lend themselves easily to personal use) and thus were subjected to strict substantiation rules. Employers who failed to meet the substantiation requirements couldn't deduct the costs of the cell phones, and employees who failed to meet the substantiation rules saw the amount that represented personal use of the cell phone counted as taxable wages (instead of a tax-free working condition fringe). Why the strict rules for cell phones? Back in 1989, cell phones were considered an expensive luxury item only used by executives, and Congress believed that an employee's use of an employer-provided cell phone to make personal calls should be treated as a taxable fringe benefit, similar to an employee's personal use of an employer- provided automobile. Needless to say, times have changed. No longer considered a luxury item, cell phones and other mobile communication devices are now part of daily business practices at all levels, and the deduction limitations and documentation requirements no longer make sense. Today, cell phones are more akin to a land line phone which for years an employee may have occasionally used to make a personal call without tax consequence. Detailed documentation is not required for use by an employee of his office phone, and there is no reason that cell phones should be subject to stricter substantiation requirements. You may have read in the news that the IRS Commissioner and Treasury Secretary joined in a statement urging Congress to repeal the law. “The passage of time, advances in technology and the nature of communication in the modern workplace,” the Commissioner said, “have rendered this law obsolete. [We] ask that Congress act to make clear that there will be no tax consequence to employers or employees for personal use of work-related devices such as cell phones provided by employers.” And lo and behold, that is precisely what Congress has done. The new legislation removes cell phones and similar telecommunications equipment (including PDAs and Blackberry devices) from the “listed property” rules. This makes it easier for employers that provide cell phones to employees, as well as for employee who use their own cell phones. As with other business property, taxpayers must still be able to demonstrate the business use of the cell phone.
  15. 15. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 102 | P a g e Increased deduction for start-up expenditures in the 2010 Small Business Jobs Act If you've recently started a business, or if you're in the process of starting one now, you should be aware of a recent tax law change that could make a big difference in your tax bill. The recently enacted 2010 Small Business Jobs Act doubles the amount of start-up expenses that someone starting a business in 2010 can write off this year. Here are the details. Generally, expenses incurred before a business begins don't generate any deductions or other current tax benefits. However, under pre-2010 Small Business Jobs Act law, taxpayers, whether they were individuals, corporations or partnerships, were permitted to elect to write off up to $5,000 of “start-up expenses” in the year business began, and the rest could be deducted over a period of 180 months. The $5,000 figure was reduced by the excess of total start-up costs over $50,000. You were deemed to have made this election unless you opted out. The new law doubles the amount that can be written off for 2010 to $10,000 and increases the phaseout threshold from $50,000 to $60,000. It is important to note that this increased deduction is temporary, and only applies to tax years beginning in 2010. Start-up expenses include, with a few exceptions, all expenses incurred to investigate the creation or acquisition of a business, to actually create the business, or to engage in a for- profit activity in anticipation of that activity becoming an active business. To be eligible for the election, an expense also must be one that would be deductible if it were incurred after the business actually began. An example of a startup expense is the cost of analyzing the potential market for a new product. As you can see, it's important to keep a record of these start-up expenses, and to make the appropriate decision regarding the write-off election. As mentioned above, if you opt out of the election, there is no current tax benefit derived for the eligible expenses covered by the election. Also, you should be aware that an election either to deduct or to amortize start-up expenditures, once made, is irrevocable. We hope this information is helpful. If you would like more details about any aspect of the new legislation, please do not hesitate to call.
  16. 16. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 103 | P a g e 100% exclusion of gain from the sale of certain small business stock in the 2010 Small Business Jobs Act The recently enacted 2010 Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting small business. One of the changes could help those who are starting a business this year. It provides a 100% exclusion of gain from the sale of small business stock, with certain limitations. Here are the details. Before the 2009 Recovery Act, individuals could exclude 50% of their gain on the sale of qualified small business stock (QSBS) held for at least five years (60% for certain empowerment zone businesses). To qualify, QSBS must meet a number of conditions (e.g., it must be stock of a corporation that has gross assets that don't exceed $50 million and that meets active business requirements). Under the 2009 Recovery Act, the percentage exclusion for gain on QSBS sold by an individual was increased to 75% for stock acquired after Feb. 17, 2009 and before Jan. 1, 2011. Under the new law, the amount of the exclusion is temporarily increased yet again, to 100% of the gain from the sale of qualifying small business stock that is acquired in 2010 after Sept. 27, 2010 and held for more than five years. In addition, the new law eliminates the AMT preference item attributable for that sale. If you are considering investing in a small business, I would be happy to work with you to determine whether the new total exclusion for QSBS would work to your advantage. However, it should be noted that while the new provision for QSBS is ostensibly intended to encourage investment in small businesses, it may be less effective in that regard than desired, due to the restrictions on obtaining the total exclusion, specifically: (1) the narrow window within which the small business stock must be purchased (i.e., between Sept. 27, 2010 and the end of 2010); (2) the long holding period requirement for QSBS (the stock must he held for at least five years); and, most importantly, (3) the fact that the tax break only applies to investments in C corporations, a form of business organization that is not often used by small businesses, which, for tax purposes, are typically operated as S corporations, partnerships, limited liability companies or sole proprietorships. We hope this information is helpful. If you would like more details about any aspect of the new legislation, please do not hesitate to call.
  17. 17. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 104 | P a g e Deductibility of health insurance for purposes of calculating self-employment tax in the 2010 Small Business Jobs Act The recently enacted Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting small business. One provision that could be valuable to business owners this year concerns the calculation of self-employment tax. Generally, business owners can't deduct the cost of health insurance for themselves and their family members for purposes of calculating self-employment tax. The new law allows business owners to deduct health insurance costs incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax. At issue is the 15.3% tax that self-employed individuals pay on their net earnings, commonly referred to as self-employment tax. The self-employment tax rate is the sum of 12.4% for Social Security (old age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance). The Social Security tax applies to the first $106,800 of net earnings in 2010; there is no ceiling on the Medicare tax. Back in 2003, small-business advocates won the first battle in this area by achieving legislation allowing self-employed individuals to deduct the cost of health insurance for income tax purposes. While this change enabled small-business owners to deduct the cost of health care from their income, that income already had been exposed to self- employment tax. Thus, the self-employed effectively paid self-employment tax on income used to purchase health care. According to a report by the Kaiser Family Foundation, employers paid an average health insurance premium of $13,770 for family coverage in 2010. The 15.3% self-employment tax on earnings used to pay this average premium would be $2,107. Arguing that this was money that could be used to reinvest in and grow the business, small-business advocates have pushed for legislation that would allow the self-employed to deduct their health insurance premiums on their self-employment tax as well as their income tax. The new legislation does precisely that. For now, however, the change is limited to the 2010 tax year. We hope this information is helpful. If you would like more details about this or any other aspect of the new legislation, please do not hesitate to call.
  18. 18. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 105 | P a g e Retirement plan and annuity changes in the 2010 Small Business Jobs Act The recently enacted 2010 Small Business Jobs Act includes a wide-ranging assortment of tax breaks and incentives for small business. Paying for the tax breaks, in large part, are new provisions allowing taxpayers to convert 401(k) and government retirement accounts into Roth accounts, in which they pay taxes up front on the money they contribute, enabling them to withdraw it tax-free after they retire. Advocates of the new provisions argued that the changes would increase flexibility in retirement preparation, while generating immediate revenue for the government. There is also a provision permitting partial annuitization of nonqualified annuity contracts. Here are the details. Participants in governmental 457 plans allowed to treat elective deferrals as designated Roth contributions. For tax years beginning after Dec. 31, 2010, the new law will allow retirement savings plans sponsored by state and local governments (governmental 457(b) plans) to include designated Roth accounts. Contributions to Roth accounts are made on an after-tax basis, but distributions of both principal and earnings are generally tax-free. Distributions from elective deferral plans may be rolled over to designated Roth accounts. The new law allows 401(k), 403(b), and governmental 457(b) plans to permit participants to roll over their pre-tax account balances into a designated Roth account. The amount of the rollover will be includible in taxable income except to the extent it is the return of after-tax contributions. If the rollover is made in 2010, the participant can elect to pay the tax in 2011 and 2012. Plans will be able to allow these rollovers immediately upon the Act's enactment. Nonqualified annuity contracts. The new law permits holders of nonqualified annuities (annuity contracts held outside of a qualified retirement plan or IRA) to elect to receive part of the contract in the form of a stream of annuity payments, leaving the remainder of the contract to accumulate income on a tax-deferred basis. The annuity payments must be for a period of 10 years or more, or during one or more lives. We hope this information is helpful. If you would like more details about any aspect of the new legislation, please do not hesitate to call.
  19. 19. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 106 | P a g e Information reporting changes in the 2010 Small Business Jobs Act The recently enacted Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting small business. To offset a portion of the cost of the various tax breaks and incentives in the Act, Congress beefed up certain reporting requirements and penalties, in the hope that the added requirements will generate revenue and lead to more effective tax collection. Here are the details of the new reporting requirements. Information reporting required for rental property expense payments. For payments made after Dec. 31, 2010, the new law requires persons receiving rental income from real property to file information returns with IRS and service providers reporting payments of $600 or more during the year for rental property expenses. Exceptions are provided for individuals renting their principal residences (including active members of the military), taxpayers whose rental income doesn't exceed an IRS-determined minimal amount, and those for whom the reporting requirement would create a hardship (under IRS regs). Increased information return penalties. For information returns required to be filed after December 31, 2010, the penalties in the tax code for failure to timely file information returns to IRS will be increased. For example, the first-tier penalty will be increased from $15 to $30, and the calendar year maximum will be increased from $75,000 to $250,000. For small filers, the calendar year maximum will be increased from $25,000 to $75,000 for the first-tier penalty. The minimum penalty for each failure due to intentional disregard will be increased from $100 to $250. The penalties for failure to furnish information returns to payees will be similarly increased. We hope this information is helpful. If you would like more details about any aspect of the new legislation, please do not hesitate to call.
  20. 20. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 107 | P a g e FOR IMMEDIATE RELEASE June 24, 2010 Governor Quinn Signs Major Legislation to Improve State’s Economy, Create Jobs New Law Creates Angel Investment Tax Credit, Doubles New Markets Tax Credit, Launches Economic Development Pilot Program for Southern Illinois MARION – June 24, 2010. Governor Pat Quinn today signed a bill into law that will encourage investment into Illinois’ businesses and support Southern Illinois’ economy. Senate Bill 2093 will create the Angel Investment Tax Credit to support direct investment by Illinois entrepreneurs and start-up companies and will double the state’s existing New Markets Tax Credit for new investment into small businesses in underserved communities. In addition, it creates a pilot program – Sales Tax and (STAR) bonds – to help develop a major retail and entertainment complex near Marion in Southern Illinois. “Illinois has created more jobs this year than any other state in the Midwest. We must continue to work day and night to ensure residents across the state have access to a good paying job and direct investment into Illinois’ businesses and entrepreneurs is one of the best ways to do that,” said Governor Quinn. “This new law will bring investment, spur economic development and create jobs across Illinois.” Governor Quinn first announced the Angel Investment Tax Credit in a speech he gave in December as part of his Illinois Economic Recovery Plan. The new tax credit encourages investment into innovative Illinois businesses that are working to get off the ground. Under the new law, investors may claim 25 percent of an investment into a qualified Illinois business venture - up to $2 million in investment for a $500,000 credit. The program is capped at $10 million in tax credits, which will drive $40 million in investment. “Governor Quinn and the General Assembly should be congratulated for enacting the Angel Tax Credit,” said David Miller, CEO of the Illinois Biotechnology Industry Organization (known as iBIO®). “Passage of this measure sends a strong signal that Illinois – always among the best in research – will take its rightful place as among the best in generating and attracting high-paying technology jobs.” The new law doubles the cap on Illinois’ existing New Markets Tax Credit program - from $10 million to $20 million. The program provides tax credits for new investment into small businesses in low-income communities. The increased cap could generate $125 million in private investment into Illinois businesses. Illinois began its New Markets Tax Credit last year and exhausted the $10 million cap within six months.
  21. 21. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 108 | P a g e Senate Bill 2093 also creates the STAR bonds pilot program to allow a portion of the sales tax revenues generated by a major retail and entertainment complex near Marion to repay its development and construction costs. The proposed 400 acre shopping and entertainment complex will be near Interstate 57 north of Illinois 13. The STAR bonds would help finance the cost of building the $378 million project. The legislation calls for the creation of at least 500 jobs during the first five years of the pilot program. Governor Quinn is focused on economic development and job creation in Southern Illinois, which has seen unemployment range from 12 to 15 percent during 2010, among the highest rates in the state. State sales taxes may only be used to finance up to 50 percent of the development costs. Senate Bill 2093 was sponsored by Senator Gary Forby (D-Benton) and Representative John Bradley (D-Marion). The law takes effect immediately except for certain provisions that take effect on July 1 or January 1, 2011. "Most importantly, this bill will put people back to work in Southern Illinois," said Sen. Forby. "It has the potential to get more foot traffic through the doors of other surrounding shops and the tax incentive will attract businesses that would have otherwise developed in another state." “Thank you, Governor Quinn for giving us an opportunity we have never had in Southern Illinois,” said Rep. Bradley. “This has the potential to be the largest economic development project in the history of our region. This fulfills Governor Quinn’s priority of creating jobs throughout Illinois.”
  22. 22. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 109 | P a g e Federal gift tax: liability based on lifetime gifts You recently asked how the federal gift tax liability is determined. (Although the estate tax has been repealed for 2010, the gift tax continues to apply.) Unlike the income tax which is based on taxable income for each year, the gift tax rate is based on the cumulative amounts of taxable gifts you make over the course of your life. Thus, as you make more and more taxable gifts, your gift tax bracket increases. First, because of the annual exclusion, only gifts in excess of $13,000 to each donee are “taxable” in 2010. Next, the gift tax on the first $1 million of taxable gifts you make during your life is covered by a gift tax credit. This credit wipes out the first $330,800 of gift tax liability. This is the liability that would arise from $1 million of taxable gifts. Accordingly, only after the taxable gifts you make during your life reach $1 million will any gift tax apply. The tax on gifts made in the current year is the tax on total lifetime gifts minus the tax on gifts made before the current year. In 2010, the taxpayer makes an additional $250,000 in potentially taxable gifts. This brings lifetime gifts up to $1 million. Before application of the gift tax credit, the gift tax on $1 million of gifts would be $330,800: a $243,300 gift tax liability on the 2001 gifts, plus $87,500 on the 2010 gift of $250,000, taxed at a marginal bracket of 35%. The actual 2010 gift tax bill is zero, because the gift tax credit of $330,800 that applies in 2010 effectively exempts $1 million of gifts. Because the taxpayer has used up his lifetime gift exemption, any otherwise taxable gifts he makes in later years will not be exempted from tax by the gift tax credit. The gift tax does not apply to certain medical and educational expenses. Transfers to qualifying educational institutions for tuition are not subject to the gift tax. The exclusion applies to tuition for full or part-time students paid directly to the educational institution. Amounts paid for books, room, board, other supplies, or entertainment are not eligible for the exclusion. Amounts paid directly to the person or organization providing the medical service for medical expenses are also excluded from the gift tax. The medical expenses must meet certain requirements for deductibility and generally include expenses paid for diagnosis, cure, mitigation, treatment, or prevention of disease. Amounts paid for medical insurance are also eligible. If you would like to discuss the role lifetime gifts can play in your overall estate plan or have any additional questions, please call.
  23. 23. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 110 | P a g e Tax strategies for business people stepping up to a new car The decision of whether to trade in an old business car or try to sell it for cash generally should be based on factors such as the amount you can get on a sale versus a trade-in, and the time and bother a sale will entail. However, important tax factors also may affect your decision-making process. Here's an overview of the complex rules that apply to what appears to be a simple transaction, and some pointers on how to achieve the best tax results. In general, the sale of a business asset yields a gain or loss depending on the net amount you receive from the sale and your basis for it. “Basis” is your cost for tax purposes and, if you bought the asset, usually equals your cost less the depreciation deductions you claim for the asset over the years. Under the tax-free swap rules, trading in an old business asset for a new, like-kind asset doesn't result in a current gain or loss, and the new asset's basis will equal the old asset's remaining basis plus any cash you paid to trade up. The rules generally are the same for business cars, with a couple of extra twists. Here are some pointers. As a general rule, you should trade in your old business car if you used it exclusively for business driving, and its basis has been depreciated down to zero, or is very low. The trade-in often avoids a current tax. For example, if you sell your business car for $9,000, and your basis in it is only $7,000, you will have a $2,000 taxable gain, but if you trade it in, a current tax is avoided. True, your basis in the new car will be lower than it would be if you bought it without a trade-in, but that doesn't necessarily mean lower depreciation deductions on the new car. Because of the so-called “luxury auto” annual depreciation dollar caps, your annual depreciation deductions on the new car may be the same whether you sold the old car or traded it in. However, you should consider selling your old business car for cash rather than trading it in if you used it exclusively for business driving and depreciation on the old car was limited by the annual depreciation dollar caps. In this situation, your basis in the old car may exceed its value. If you sell the old car, you will recognize a loss for tax purposes. However, if you trade it in, you will not recognize the loss. By way of a simplified example, let's assume a business person bought a $30,000 car several years back and used it 100% for business driving. Because of the annual depreciation dollar caps, she still has a $16,000 basis in the car, which has a current value of $14,500. Now, she wants to buy another $30,000 car. If the old car is sold, a $1,500 loss will be recognized ($16,000 basis less $14,500 sale price). If the old car is traded in for a new one, there will be no current loss. Of course, if the old car's value exceeds its basis, the tax-smart move is to trade it in and thereby avoid a gain.
  24. 24. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 111 | P a g e You also may be better off selling your old business car for cash rather than trading it in, if you used the standard mileage allowance to deduct car-related expenses. For 2010, the allowance is 50 cents per business mile driven. For 2009, the allowance was 55 cents per business mile driven. The standard mileage allowance has a built-in allowance for depreciation, which must be reflected in the basis of the car. The deemed depreciation is 23 cents for every business mile traveled during 2010, 21 cents for every business mile traveled during 2008 and 2009, 19 cents for every business mile traveled during 2007, 17 cents for every business mile traveled during 2006 and 2005, and 16 cents for every business mile traveled during 2004 and 2003. When it's time to dispose of a car, the depreciation allowance may leave you with a higher remaining basis than the car's value. Under these circumstances, the car should be sold in order to recognize the loss. Did you use your car partially for business, partially for personal use? The rules are more complicated in this situation, which can occur if you are self-employed, or an employee required to supply a car for business use. • If you sell the part-business, part-personal-use car, cost and depreciation must be allocated between the business and personal portions. Gain or loss on the business part is recognized; gain, but not loss, is recognized on the personal part. • If you trade in the part-business, part-personal-use car, a special basis rule applies for depreciation purposes only: The basis of the new car as computed under the normal trade-in rules is reduced by any difference between (1) the depreciation that would have been allowable had the old car been used 100% for business driving, and (2) the depreciation claimed for its actual business use. Are you thinking of leasing a business car? The complex rules that apply to purchased business autos are one reason many businesses are leasing vehicles instead of buying them. You simply deduct the business/investment use portion of annual lease costs, and, if the vehicle is a “luxury” model, you add back to income during each lease year an income inclusion amount derived from an IRS table. For auto leases that begin during 2010, the auto is a “luxury” if the auto's fair market value exceeds $16,700 ($17,000 for certain trucks and vans treated as autos for purposes of the “luxury” auto rules). There are, however, a few special angles you should be aware of: • If you pay an additional sum up-front, it should be amortized over the life of the lease. • Any refundable deposit required as part of the lease deal can't be deducted at all. All of this sounds very complicated, and it is. Before you sell or trade in your business car or lease a new one, please give us a call and we'll set up a meeting to discuss your options.
  25. 25. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 112 | P a g e S corporation as choice of entity One of the biggest advantages of an S corporation over a partnership is that as S corporation shareholders you would not be personally liable for corporate debts. In order to receive this protection, it is important that the corporation be adequately financed, that various formalities required by our state be observed (e.g., filing articles of incorporation, adopting by-laws, electing a board of directors, and holding organizational meetings), and that the existence of the corporation as a separate entity be maintained. Because you expect that the business will incur losses in its early years, an S corporation is preferable to a C corporation from a tax standpoint. Shareholders in a C corporation generally get no tax benefit from such losses. In contrast, as S corporation shareholders, each of you can deduct your percentage share of these losses on your personal tax return to the extent of your basis in the stock and in any loans you make to the entity. Losses that cannot be deducted because they exceed your basis are carried forward and can be deducted by you when there is sufficient basis. Once the corporation begins to earn profits, the income will be taxed directly to you whether or not it is distributed. It will be reported on your individual tax return and be aggregated with income from other sources. Your share of the S corporation's income will not be subject to self-employment tax, but your wages will be subject to social security taxes. Are you planning to provide fringe benefits such as health and life insurance? You should be aware that the costs of providing such benefits to a 2% or more shareholder are deductible by the entity but are taxable to the recipient. This treatment will apply to you since each of you will own more than 2% of the entity. As I mentioned, the S corporation could inadvertently lose its S status if either of you transfers stock to an ineligible shareholder such as another corporation, a partnership, or a nonresident alien. If the S election were terminated, the corporation would become a taxable entity. You would not be able to deduct any losses and earnings could be subject to double taxation—once at the corporate level and again when distributed to you. In order to protect you against this risk, it is recommend that each of the shareholders sign an agreement promising not to make any transfers that would endanger the S election.
  26. 26. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 113 | P a g e C corporation as choice of entity Below is a summary of the major advantages and disadvantages of doing business as a C corporation. A C corporation allows the business to be treated and taxed as a separate entity from you as the principal owner. A properly structured corporation can protect you from the debts of the business yet enable you to control both day-to-day operations and organic corporate acts such as redemptions, acquisitions, and even liquidations. In order to ensure that the corporation is treated as a separate entity, it is important to observe various formalities required by our state. These include filing articles of incorporation, adopting by-laws, electing a board of directors, appointing a resident agent, holding organizational meetings and keeping minutes thereof. Complying with these requirements and maintaining an adequate capital structure will ensure that you do not inadvertently risk personal liability for the debt's of the business. Since the corporation is taxed as a separate entity, all items of income, credit, loss, and deduction are computed at the entity level in arriving at corporate taxable income or loss. One potential disadvantage to a C corporation for a new business is that losses are trapped at the entity level and thus generally cannot be deducted by the owners. However, since you expect to generate profits in year one, this might not be a problem. Another potential drawback to a C corporation is that its earnings can be subject to double tax—once at the corporate level and again when distributed to you. However, since most of the corporate earnings will be attributable to your efforts as an employee, the risk of double taxation is minimal since the corporation can deduct all reasonable salary that it pays to you. A C corporation can also be used to provide fringe benefits and fund qualified pension plans on a tax-favored basis. Subject to certain limits, the corporation can deduct the cost of a variety of benefits such as health insurance and group life insurance without adverse tax consequences to you. Similarly, contributions to qualified pension plans are usually deductible but are not currently taxable to you. A C corporation also gives you considerable flexibility in raising capital from outside investors. A C corporation can have multiple classes of stock—each with different rights and preferences that can be tailored to fit your needs and those of potential investors. Also, if you decide to raise capital through debt, interest paid by the corporation is deductible. Although the C corporation form of business seems appropriate for you at this time, you may in the future be able to change the corporation from a C corporation to an S
  27. 27. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 114 | P a g e corporation, if the S corporation form is more appropriate at that time. This change will ordinarily be tax free, except that built-in gain on the corporate assets may be subject to tax if the assets are disposed of by the corporation within ten years of the change.
  28. 28. brown, kaplan & liss llp Tax Planning and the New Tax Law November 18, 2010 115 | P a g e Limited liability company as choice of entity A limited liability company (LLC) is somewhat of a hybrid entity in that it can be structured to resemble a corporation for owner liability purposes and a partnership for federal tax purposes. This duality can provide the owners with the best of both worlds. Like the shareholders of a corporation, the owners of an LLC (called “members” rather than shareholders or partners) are generally not liable for the debts of the business except to the extent of their investment. Thus, the owners can operate the business with the security of knowing that their personal assets are protected from the entity's creditors. This protection is far greater than that afforded by partnerships. In a partnership, the general partners are personally liable for the debts of the business. Even limited partners, if they actively participate in managing the business, can have personal liability. Unlike a regular or “C” corporation, an LLC can be structured to be treated as a partnership for federal tax purposes. This can provide a number of important benefits to the owners. For example, partnership earnings are not subject to an entity-level tax; instead, they “flow-through” to the owners, in proportion to the owners' respective interests in profits, and are reported on the owners' individual returns. Thus, earnings are taxed only once. In addition, since you are actively managing the business, you can deduct on your individual tax return your ratable shares of any losses the business generates. This, in effect, allows you to shelter other income that you and your spouse may have. An LLC that is taxable as a partnership can provide special allocations of tax benefits to specific partners. This can be an important reason for using an LLC over an S corporation (a form of business that provides tax treatment that is similar to a partnership). Another reason for using an LLC over an S corporation is that LLCs are not subject to the restrictions the Internal Revenue Code imposes on S corporations regarding the number of owners and the types of ownership interests that may be issued. In summary, an LLC would give you corporate-like protection from creditors while providing you with the benefits of taxation as a partnership.

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