The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the "pass-through deduction" or the "qualified business income deduction." Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final.

The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the "pass-through deduction" or the "qualified business income deduction." Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final.

Code Sec. 199A allows business owners to deduct up to 20 percent of their qualified business income (QBI) from sole proprietorships, partnerships, trusts, and S corporations. The deduction is one of the most high-profile pieces of the Tax Cuts and Jobs Act ( P.L. 115-97).

In addition to providing general definitions and computational rules, the new guidance helps clarify several concepts that were of special interest to many taxpayers.

Trade or Business

The proposed regulations incorporate the Code Sec. 162 rules for determining what constitutes a trade or business. A taxpayer may have more than one trade or business, but a single trade or business generally cannot be conducted through more than one entity.

Taxpayers cannot use the grouping rules of the passive activity provisions of Code Sec. 469 to group multiple activities into a single business. However, a taxpayer may aggregate trades or businesses if:

• each trade or business is itself a trade or business;
• the same person or group owns a majority interest in each business to be aggregated;
• none of the aggregated trades or businesses can be a specified service trade or business; and
• the trades or businesses meet at least two of three factors which demonstrate that they are in fact part of a larger, integrated trade or business.

Specified Service Business

Income from a specified service business generally cannot be qualified business income, although this exclusion is phased in for lower-income taxpayers.

A new de minimis exception allows some business to escape being designated as a specified service trade or business (SSTB). A business qualifies for this de minimis exception if:

• gross receipts do not exceed $25 million, and less than 10 percent is attributable to services; or
• gross receipts exceed $25 million, and less than five percent is attributable to services.

The regulations largely adopt existing rules for what activities constitute a service. However, a business receives income because of an employee/owner’s reputation or skill only when the business is engaged in:

• endorsing products or services;
• licensing the use of an individual’s image, name, trademark, etc.; or
• receiving appearance fees.

In addition, the regulations try to limit attempts to spin-off parts of a service business into independent qualified businesses. Thus, a business that provides 80 percent or more of its property or services to a related service business is part of that service business. Similarly, the portion of property or services that a business provides to a related service business is treated as a service business. Businesses are related if they have at least 50-percent common ownership.

Wages/Capital Limit

A higher-income taxpayer’s qualified business income may be reduced by the wages/capital limit. This limit is based on the taxpayer’s share of the business’s:

• W-2 wages that are allocable to QBI; and
• unadjusted basis in qualified property immediately after acquisition.

The proposed regulations and Notice 2018-64, I.R.B. 2018-34, provide detailed rules for determining the business’s W-2 wages. These rules generally follow the rules that applied to the Code Sec. 199 domestic production activities deduction.

The proposed regulations also address unadjusted basis immediately after acquisition (UBIA). The regulations largely adopt the existing capitalization rules for determining unadjusted basis. However, "immediately after acquisition" is the date the business places the property in service. Thus, UBIA is generally the cost of the property as of the date the business places it in service.

Other Rules

The proposed regulations also address several other issues, including:

• definitions;
• basic computations;
• loss carryovers;
• Puerto Rico businesses;
• coordination with other Code Sections;
• penalties;
• special basis rules;
• previously suspended losses and net operating losses;
• other exclusions from qualified business income;
• allocations of items that are not attributable to a single trade or business;
• anti-abuse rules;
• application to trusts and estates; and
• special rules for the related deduction for agricultural cooperatives.

Effective Dates

Taxpayers may generally rely on the proposed regulations and Notice 2018-64 until they are issued as final. The regulations and proposed revenue procedure will be effective for tax years ending after they are published as final. However:

• several proposed anti-abuse rules are proposed to apply to tax years ending after December 22, 2017;
• anti-abuse rules that apply specifically to the use of trusts are proposed to apply to tax years ending after August 9, 2018; and
• if a qualified business’s tax year begins before January 1, 2018, and ends after December 31, 2017, the taxpayer’s items are treated as having been incurred in the taxpayer’s tax year during which business’s tax year ends.

Comments Requested

The IRS requests comments on all aspects of the proposed regulations. Comments may be mailed or hand-delivered to the IRS, or submitted electronically at www.regulations.gov (indicate IRS and REG-107892-18). Comments and requests for a public hearing must be received by September 24, 2018.

The IRS also requests comments on the proposed revenue procedure for calculating W-2 wages, especially with respect to amounts paid for services in Puerto Rico. Comments may be mailed or hand-delivered to the IRS, or submitted electronically to Notice.comments@irscounsel.treas.gov, with “ Notice 2018-64” in the subject line. These comments must also be received by September 24, 2018.

The IRS’s proposed pass-through deduction regulations are generating mixed reactions on Capitol Hill. The 184-page proposed regulations, REG-107892-18, aim to clarify certain complexities of the new, yet temporary, Code Sec. 199A deduction of up to 20 percent of income for pass-through entities. The new deduction was enacted through 2025 under the Tax Cuts and Jobs Act (TCJA), ( P.L. 115-97). The pass-through deduction has remained one of the most controversial provisions of last year’s tax reform.

The IRS’s proposed pass-through deduction regulations are generating mixed reactions on Capitol Hill. The 184-page proposed regulations, REG-107892-18, aim to clarify certain complexities of the new, yet temporary, Code Sec. 199A deduction of up to 20 percent of income for pass-through entities. The new deduction was enacted through 2025 under the Tax Cuts and Jobs Act (TCJA), ( P.L. 115-97). The pass-through deduction has remained one of the most controversial provisions of last year’s tax reform.

A legislative package that would make permanent the pass-through deduction, as well as other individual tax cuts, is expected to move though the House this fall. However, the House’s legislative efforts are not expected, at this time, to pass muster in the more narrowly GOP-controlled Senate.

Criticism

Several Democratic lawmakers and tax policy experts have already started to weigh in on the proposed regulations, which were released on August 8 while Congress remained in its annual August recess. Democrats have criticized the new deduction for primarily benefiting the wealthy. Meanwhile, several tax policy experts have taken to Twitter to note that the deduction is overly complex and administratively burdensome.

Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., has reportedly said that the proposed regulations "confirm that the fortunate few win," under the new tax law. "Tax planners are already scouring through the nearly 200 pages of regulations in search of new ways to keep wealthy clients from paying their fair share."

Compliance Burdens

The pass-through deduction could add 25 million hours to taxpayers’ annual reporting burden, according to the proposed regulations. Additionally, the IRS has estimated that gross reporting annualized costs to taxpayers will total approximately $1.3 billion over 10 years.

Furthermore, the IRS has estimated that the compliance burden will vary between taxpayers, averaging between 30 minutes and 20 hours. The administrative burden on smaller pass-through entities is anticipated to be on the lower end of the estimate, according to the IRS.

Comment. Ryan Kelly, partner at Alston & Bird LLP, told Wolters Kluwer on August 13 that the IRS’s 25 million-hour estimate, whether accurate or not, suggests that there will be a significant increase in administrative compliance costs. "There is a real cost to tax compliance in lost time and productivity for taxpayers," Kelly said. However, Kelly predicted that taxpayers’ Code Sec. 199A compliance burden will eventually decrease. "Time will reveal the extent of taxpayers’ administrative burden to comply; however, it is likely that as time goes on the taxpayers’ compliance burden will fall as taxpayers, tax practitioners, and the Service all become more familiar with section 199A and how it is intended to operate."
Meanwhile, the chairs of the House and Senate tax writing committees have both praised Treasury and the IRS for quickly releasing the much anticipated regulations. Additionally, several tax policy experts have also praised the proposed regulations for alleviating confusion, as well as taxpayer anxiety, about ambiguous provisions of the law.

"This first-ever 20 percent deduction for small businesses allows our local job creators to keep more of their money so they can hire, invest, and grow in their communities," House Ways and Means Committee Chairman Kevin Brady, R-Tex., said in a statement. "These proposed regulations are intended to provide certainty and flexibility for Main Street businesses in this historic new small business deduction."

Improvements to the proposed regulations are expected in the coming months as stakeholders submit comments. A public hearing at IRS headquarters in Washington, D.C., has been scheduled for October 16. "Evolution of tax regulations is generally never a pretty process, but it is a necessary process that in this case will hopefully happen sooner rather than later," Kelly told Wolters Kluwer.

The House’s top tax writer has unveiled Republicans’ "Tax Reform 2.0" framework. The framework outlines three key focus areas:.

The House’s top tax writer has unveiled Republicans’ "Tax Reform 2.0" framework. The framework outlines three key focus areas:

• making permanent the individual and small business tax cuts enacted under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97);
• promoting family savings by streamlining retirement savings accounts and creating a new Universal Savings Account; and
• spurring business innovation by allowing new businesses to write off more initial start-up costs.

Tax Reform 2.0

The GOP’s tax reform "phase two" framework—otherwise known as "Tax Cuts 2.0"—was released by House Ways and Means Committee Chairman Kevin Brady, R-Tex. on July 24. The outline is expected to be used for GOP "listening sessions" to be held among lawmakers.

Brady has said that making permanent the TCJA’s individual and small business tax cuts, enacted last December temporarily through 2025, will be the "centerpiece" of the next tax reform package. Further, Brady told reporters on July 24 that he anticipates Tax Reform 2.0 to move forward as three separate tax bills. A House vote on the package is expected sometime in September.

Preliminary Analysis

Republicans’ Tax Reform 2.0 framework is a "good start," according to a July 24 report released by the independent, yet widely-considered conservative-leaning, think tank Tax Foundation. The report praised the framework’s proposal to streamline retirement savings accounts and make permanent the TCJA’s individual tax cuts. Additionally, the Tax Foundation estimates that making permanent the individual tax cuts set to expire in 2026 would grow the U.S. economy by 2.2 percent while reducing federal revenue by $165 billion annually on a static basis.

Democrats Disagree

However, several Democratic lawmakers began issuing statements criticizing the Tax Reform 2.0 framework shortly after its release. Democrats have remained united in their disapproval of the TCJA, criticizing last year’s tax code overhaul for primarily benefiting the wealthy and corporations.

"Republicans’ first tax bill exposed the party’s real priorities: big corporations and people at the top," House Ways and Means Committee ranking member Richard Neal, D-Mass., said in a July 24 statement. "This new framework is more of the same – it rewards the well-off and well-connected, fails to reinstate the state and local tax deduction, and leaves the middle class behind."

Corporate Tax Cuts

The Tax Reform 2.0 framework did not include a proposal to further reduce the corporate tax rate. President Trump has called for lowering the corporate tax rate to 20 percent. The corporate tax rate was lowered from 35 to 21 percent last December under the TCJA. Brady previously told reporters that House Republicans and the White House are continuing discussions on the idea.

Tax Reform 3.0, 4.0

"Tax Reform 2.0 is a new commitment to improve the tax code each and every year for American families and local businesses," the framework says. Congress will examine the tax code each year to identify areas of needed improvement, according to the outline. Additionally, Brady has said he hopes to see a Tax Reform 3.0, 4.0, and so on.

Senate

At this time, the Tax Reform 2.0 package is not expected to clear the Senate in its entirety. It is thought on Capitol Hill that Democrats may support measures that focus on retirement and education savings and business innovation. However, several lawmakers view it as unlikely that Democrats would support a bill that makes permanent the individual tax cuts under the TCJA.

Brady has reportedly said that extending TCJA’s individual provisions would increase the deficit by $600 billion over 10 years but would be offset, at least in part, by beneficial economic factors. Several Senate Democrats and Republicans have said they would not vote for extending or creating tax cuts that increase the federal deficit.

The IRS faces numerous challenges, most of which are attributable to funding cuts, the National Taxpayer Advocate Nina Olson told a Senate panel on July 26. "The IRS needs adequate funding to do its job effectively," Olson told lawmakers.

The IRS faces numerous challenges, most of which are attributable to funding cuts, the National Taxpayer Advocate Nina Olson told a Senate panel on July 26. "The IRS needs adequate funding to do its job effectively," Olson told lawmakers.

IRS Funding

Olson, while testifying at a Senate Finance Committee (SFC) Taxation and IRS Oversight Subcommittee hearing, placed blame on both congressional appropriations and IRS management for the Service’s challenges. "While some of the IRS’s struggles can be addressed by better management, much of the IRS’s challenges are attributable to funding cuts," Olson said.

The IRS has simultaneously seen an increased workload and budget reduction of 20 percent when accounting for inflation between fiscal years 2010 and 2018, according to Olson. "Because of these reductions, the IRS does not have enough employees to answer the phones, to conduct outreach and education, or to provide basic taxpayer service," she added.

Further, Olson noted that the IRS answered only 29 percent of telephone calls received on the Accounts Management lines during this year’s filing season. Additionally, IRS compliance and enforcement efforts have also struggled, Olson said, adding that the audit rate is at its lowest level in "memory."

Likewise, Phyllis Jo Kubey, testifying on behalf of the National Association of Enrolled Agents, IRS Advisory Council, remarked on decreased IRS funding. "The agency is handicapped by budgeting that is not only insufficient to meet its large and growing portfolio, but also inefficiently structured," Kubey told lawmakers.

IRS Reform

The SFC subcommittee hearing came just days after the 20-year anniversary of the IRS Restructuring and Reform Act of 1998. The House and Senate are currently working toward approving bipartisan legislation that would significantly reform the IRS for the first time in 20 years.

SFC Taxation and IRS Oversight Subcommittee Chairman Rob Portman, R-Ohio, and Sen. Ben Cardin, D-Md., unveiled on July 26 the bipartisan Protecting Taxpayers Bill. The measure aims to reform a number of IRS functions and administrative practices, according to a joint press release issued the same day.

"It has been 20 years since the last significant IRS reform, and it is time to update the agency once again," Portman said in the press release. Similarly, Cardin praised the bill for including needed updates to modernize the IRS. "Americans of all income levels deserve a responsive, effective IRS, and the updates contained in this bipartisan bill will help keep the IRS on that path," Cardin said.

Additionally, SFC Chairman Orrin G. Hatch, R-Utah, and ranking member Ron Wyden, D-Ore., recently introduced the bipartisan Taxpayer First Bill ( Sen. 3246). The measure would also reform certain administrative practices at the IRS.

To that end, the House approved its bipartisan IRS reform package, the Taxpayer First Bill ( HR 5444) last April. The House package contains several proposals, which would, among other things:

• establish a single point of contact for tax-related identity theft victims;
• expand the use of Low-Income Taxpayer Clinics (LITCs); and
• require electronic filing for certain tax-exempt organizations

Path Forward

Hatch previously told Wolters Kluwer that the House’s IRS reform proposals are a "welcomed step forward." Additionally, Hatch told Wolters Kluwer that he will work with his "colleagues in Congress to find a path forward that reflects both the House and Senate views."

Senate Finance Committee (SFC) Republicans are clarifying congressional intent of certain tax reform provisions. In an August 16 letter, GOP Senate tax writers called on Treasury and the IRS to issue tax reform guidance consistent with the clarifications.

Senate Finance Committee (SFC) Republicans are clarifying congressional intent of certain tax reform provisions. In an August 16 letter, GOP Senate tax writers called on Treasury and the IRS to issue tax reform guidance consistent with the clarifications.

The letter, addressed to Treasury Secretary Steven Mnuchin and Acting IRS Commissioner David Kautter, identifies three sections of the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) needing clarification:

• Section 13204 – qualified improvement property expensing;
• Section 13302 – net operating losses (NOLs) deduction; and
• Section 13307 – sexual misconduct settlement deduction.

Real Property Depreciation

Congressional intent for Section 13204 under the TCJA was to provide a 15-year modified accelerated cost recovery system (MACRS) recovery period for qualified improvement property, the lawmakers wrote. Additionally, the letter states that the new law should also provide a 20-year alternative deprecation system (ADS) recovery period for qualified improvement property.

NOLs

The TCJA contains a typographical error in Section 13302. The law should state that the NOL carryforward and carryback modifications are effective for NOLs arising in tax years beginning after December 31, 2017, the lawmakers noted. Currently, the legislative text states the effective date is for tax years ending after December 31, 2017.

Attorney’s Fees

Generally, section 13307 of the TCJA denies a deduction for attorney’s fees related to a settlement or payment stemming from a sexual harassment/abuse nondisclosure agreement (NDA). Congressional intent was that attorney’s fees would not be subject to the rule prohibiting the deduction, the letter states.

Technical Corrections

SFC Republicans intend to introduce a technical corrections bill addressing other needed clarifications of the TCJA, the letter notes. The intended technical corrections bill is not expected to be a part of Republican "Tax Reform 2.0" efforts.

"While this letter focuses on these three important provisions, we are continuing a thorough review…to identify other instances in which the language as enacted may require regulatory guidance or technical corrections to reflect the intent of the Congress. After this review, we intend to introduce technical corrections legislation to address any items identified in the on-going review."

Taxpayers and practitioners need clarity on certain S corporation issues by next tax filing season, the American Institute of CPAs (AICPA) has said. In an August 13 letter sent to Treasury and the IRS, the AICPA requested immediate guidance on certain S corporation provisions under the Tax Cuts and Jobs Act (TCJA) (P.L. 115-97).

Taxpayers and practitioners need clarity on certain S corporation issues by next tax filing season, the American Institute of CPAs (AICPA) has said. In an August 13 letter sent to Treasury and the IRS, the AICPA requested immediate guidance on certain S corporation provisions under the Tax Cuts and Jobs Act (TCJA) (P.L. 115-97).

S Corporations

S corporations elect to pass corporate income, losses, deductions, and credits through to shareholders for federal tax purposes. Thus, S corporations are considered a pass-through entity. This election allows S corporations to avoid double taxation on the corporate income, according to the IRS.

"Taxpayers and practitioners need clarity on S corporation issues in order to comply with their 2018 tax obligations and to make informed decisions regarding cash-flow, entity structure, and tax planning issues," Annette Nellen wrote in the letter on behalf of the AICPA. Generally, the letter noted the following three areas for which guidance is needed:

• application of the new laws on loss carryforwards;
• clarification of certain provisions relating to the post-termination transition period (PTTP) and the eligible terminated S corporation period (ETSC Period); and
• treatment of deferred foreign income upon transition to participation exemption system of taxation for S corporation trust shareholders.

Earlier this year, the AICPA also called for guidance on the Code Sec. 199A new pass-through deduction.

Your 2011 tax return has been filed, or you have properly filed for an extension. In either case, now it’s time to start thinking about important post-filing season activities to save you tax in 2012 and beyond.  A few loose ends may pay dividends if you take care of them sooner instead of later.

Successful filing season

The IRS reported that the 2012 filing season moved along without significant problems. The IRS continued to upgrade its return processing programs and systems.  Early in the filing season, some filers experienced a short delay in receiving refunds but the delay was quickly resolved.  The IRS reported just before the end of the filing season that it had processed nearly 100 million returns and issued 75 million refunds. 

Extensions

Individuals are eligible for an automatic six-month extension until October 15 to file a return. To get the extension, taxpayers must estimate their tax liability and pay any amount due.  When a taxpayer properly files for an extension, he or she avoids the late-filing penalty, generally five percent per month based on the unpaid balance, which applies to returns filed after the April 17 deadline. Any payment made with an extension request will reduce or eliminate interest and late-payment penalties that apply to payments made after April 17. The current interest rate is three percent per year, compounded daily, and the late-payment penalty is normally 0.5 percent per month.

Installment agreements

Installment agreements generally can be set up quickly with the IRS and help to spread out payments to make them more manageable.  In 2012, the IRS increased the threshold for a streamlined installment agreement from $25,000 to $50,000. Installment agreements however, come with some costs.  The IRS charges a fee to set up an installment agreement.  If you cannot pay the full amount within 120 days, the fee for setting up an agreement is:

• $52 for a direct debit agreement;
• $105 for a standard agreement or payroll deduction agreement; or
• $43 for qualified lower income taxpayers.

It’s important to make your scheduled payments timely and in full. The IRS expects you to pay the minimum amount agreed on; you can always pay more if you are able.  If your installment agreement goes into default, the IRS can charge a reinstatement fee.

An installment agreement does not reduce the amount of the taxes, interest, or penalties owed, and penalties and interest will continue to accrue. In determining the amount of the penalty for failure to pay tax, the penalty is reduced from 0.5 percent per month to 0.25 percent per month during any month that an installment agreement for the unpaid tax is in effect.

You must specify the amount you can pay and the day of the month (1st-28th) on which you wish to make your payment each month. The IRS expects to receive your payment on the date you select. The IRS will respond to your request, usually within 30 days, to advise you as to whether your request has been approved or denied, or if more information is needed.

Amended returns

Taxpayers can file an amended return if they find an error, uncover unreported income or discover an item that will generate a deduction. Amended returns are filed on Use Form 1040X, Amended U.S. Individual Income Tax Return, to correct a previously filed Form 1040, Form 1040A, Form 1040EZ, Form 1040NR, or Form 1040NR-EZ. If you are filing to claim an additional refund, wait until you have received your original refund. If you owe additional tax for a tax year for which the filing date has not passed, file Form 1040X and pay the tax by the filing date for that year to avoid penalties and interest. 

Generally, to claim a refund, Form 1040X must be filed within 3 years from the date of your original return or within two years from the date you paid the tax, whichever is later. Returns filed before the due date (without regard to extensions) are considered filed on the due date. Taxpayers must file a separate Form 1040X for each year they are amending.

Targeted penalty relief

This year – for the first time – the IRS offered penalty relief to qualified individuals who were unable to pay their taxes by the April 17 deadline. Unemployed filers and self-employed individuals whose business income dropped substantially can apply for a six-month extension of time to pay, the IRS explained. Eligible taxpayers will not be charged a late-payment penalty if they pay any tax, penalty and interest due by October 15, 2012. Taxpayers qualify if they were unemployed for any 30-day period between January 1, 2011 and April 17, 2012. Self-employed people qualify if their business income declined 25 percent or more in 2011, due to the economy.  However, income limits apply, which excluded many taxpayers from the program.

Records

The IRS advises that taxpayers maintain tax records for three years.  In many cases, especially for individuals with complex returns, records should be kept longer. Our office maintains taxpayer records with the utmost care and confidentiality.

We encourage you to contact us if you have any questions about the end of the 2011 filing season and how your 2011 return can provide a roadmap to tax savings in 2012.

After three days of oral arguments in March, the Supreme Court is deciding the fate of the Pension Protection and Affordable Care Act (PPACA) and its companion law, the Health Care and Education Reconciliation Act (HCERA).  Not only do the new laws impact health care, they contain numerous tax provisions, many of which have yet to take effect.  The Supreme Court may uphold the laws, strike them down in whole or in part, or decide that the case is premature.  The Supreme Court is expected to render its decision in June.  In the meantime, a quick checklist of the tax provisions in the two laws reveals how extensively they impact individuals, businesses and taxpayers of all types.

Challenges

Congress passed, and President Obama signed, the PPACA and HCERA in 2010.  Almost immediately, several states and taxpayers challenged the laws in court.  The lawsuits generally argued that Congress had exceeded its authority by requiring individuals to obtain health insurance.

The cases made their way from federal district courts to the various federal courts of appeal, which reached different conclusions.  One circuit court invalidated the individual mandate; two circuit courts upheld the individual mandate and another circuit court dismissed the challenge on procedural grounds.

Supreme Court grants review

On November 14, 2011, the United States Supreme Court agreed to review the Eleventh Circuit Court’s decision in Florida v. U.S. Department of Health and Human Services.  The Supreme Court stated it would examine four issues: (1) the Constitutionality of the individual mandate; (2) whether the individual mandate is severable from the PPACA; (3) whether the challenge to the individual mandate is barred by the Anti-Injunction Act^; and (4) whether PPACA’s expansion of Medicaid exceeded Congress's authority. The Supreme Court heard oral arguments in the case on March 26-28 in Washington, D.C. 

Individual mandate and penalty

The individual mandate generally requires individuals to maintain minimum essential coverage for themselves and their dependents after 2013. Individuals will be required to pay a penalty for each month of noncompliance, unless they are exempt (such as individuals covered by Medicaid and Medicare).  The PPACA also provides tax incentives to help individuals obtain minimum essential coverage.  Beginning in 2014, individuals with incomes within certain federal poverty thresholds may qualify for a refundable health insurance premium assistance tax credit.  The PPACA also provides for advance payment of the credit.

In Florida v. HHS, the Eleventh Circuit struck down the individual health insurance mandate but did not declare the entire PPACA unconstitutional.  In contrast, the Sixth Circuit held that the individual mandate was a valid exercise of Congress’ power to regulate commerce (Thomas More Law Center v. Obama).  The Court of Appeals for the District of Columbia Circuit also upheld the individual mandate (Mead v. Holder).  The Supreme Court could find the entire PPACA unconstitutional or could find that the individual mandate is severable, thereby preserving other parts of the statute, including various tax provisions.

Tax provisions

While much attention has focused on the individual mandate, the Supreme Court may also decide the fate of many tax provisions in the PPACA and the HCERA. Among the tax provisions potentially affected by the Supreme Court’s decision are:

• Code Sec. 45R small employer health insurance tax credit;

• 3.8 percent Medicare contribution tax on unearned income for higher income taxpayers after 2012;

• Additional 0.9 percent Medicare tax on wages and self-employment income of higher income taxpayers after 2012;

• Increased itemized deduction for unreimbursed medical expenses after 2012;

• Prohibition on over-the-counter medicines being eligible for health flexible spending arrangement (FSA), health reimbursement arrangement (HRA), health savings account (HSA), and Archer Medical Savings Account (MSA) dollars.

• Additional tax on distributions from HSAs and Archer MSAs not used for qualified medical expenses;

• Excise tax on high-dollar health plans after 2017;

• Tax credit for therapeutic discovery projects;

• Annual fees on manufacturers and importers of branded prescription drugs;

• Reporting of employer-provided health coverage on Form W-2;

• Codification of the economic substance doctrine.

Anti-Injunction Act

The Supreme Court could decide that the challenge to the PPACA is premature.  Under the Anti-Injunction Act, a taxpayer must wait to oppose a tax until after it is collected.  The PPACA’s individual mandate and its related penalty do not take effect until 2014.  The Fourth Circuit Court of Appeals found that the penalty amounted to a tax and taxpayers could not challenge the tax until it took effect (Liberty University v. Geithner).

If you have any questions about the tax provisions in the health care reform laws, please contact our office. We will be following developments as they ensue after the Supreme Court issues its decision in June.

Proposals to reform retirement savings plans were highlighted during an April 2012 hearing by the House Ways and Means Committee.  Lawmakers were advised by many experts to move slowly on making changes to current retirement programs that might discourage employers from sponsoring plans for their workers.  Nevertheless, it is clear that Congress wants to make some bold moves in the retirement savings area of the tax law and that likely it will do so under the broader umbrella of general “tax reform.” While tax reform is gaining momentum, it is unlikely to produce any change in the tax laws until 2013 or 2014. Considering that retirement planning necessarily looks long-term into the future, however, now is not too soon to pay some attention to the proposals being discussed.

Testimony

The Chief of Actuarial Issues and Director of Retirement Policy for the American Society of Pension Professionals and Actuaries testified that current federal tax incentives can transform taxable bonuses for business owners into retirement savings contributions that benefit both owners and employees. “This incentive for the business owner to contribute for other employees results in a distribution of tax benefit that is more progressive than the current income tax structure," she observed.

An American Benefits Council representation warned at the hearing that the wisest course for lawmakers is to not enact new laws that would disrupt the success of the current system. Short-term retirement legislation designed to boost tax revenues generally do so by eliminating the existing savings incentives and eroding the amount that workers actually save.

Committee Chairman Dave Camp, R-Mich. questioned whether the large number of retirement plans now existing with their different rules and eligibility criteria leads to confusion, reducing the effectiveness of the incentives in increasing retirement savings. Ranking member Sander Levin, D-Mich., questioned the value of making tax reform-inspired changes to retirement plans. "Tax reform should approach retirement savings incentives with an eye toward strengthening our current system and expanding participation, not as an opportunity to find revenue," Levin said.

JCT report

In advance of the hearing, the Joint Committee on Taxation (JCT) summarized the tax treatment of current-law retirement savings plans and described some recent reform proposals in a report, “Present Law and Background Relating to the Tax Treatment of Retirement Savings” (JCX-32-12). The report highlighted several of the recent proposals on retirement savings:

Automatic enrollment payroll deduction IRA.  President Obama has proposed mandatory automatic enrollment payroll deduction IRA programs.  An employer that does not sponsor a qualified retirement plan, SEP, or SIMPLE IRA plan for its employees (or sponsors a plan and excludes some employees) would be required to offer an automatic enrollment payroll deduction IRA program with a default contribution to a Roth IRA of three percent of compensation. An employer would not be required to offer the program if the employer has been in existence less than two years or has 10 or fewer employees.

Expand the saver's credit.  The Administration has also proposed to make the retirement savings contribution credit, known as the saver's credit, fully refundable and for the saver’s credit to be deposited automatically in an employer-sponsored retirement plan account or IRA to which the eligible individual contributes. In addition, in place of the current credit ranging from 10 percent to 50 percent for qualified retirement savings contributions up to $2,000 per individual, the proposal would provide a credit of 50 percent of such contributions up to $500 (indexed for inflation) per individual.

Consolidate plans.  The JCT also reviewed two retirement proposals from the Bush administration:  Consolidating traditional and Roth IRAs into a single type of account called Retirement Savings Accounts (RSAs) and creating Lifetime Savings Accounts (LSAs) that could be used to save for any purpose with an annual limit for contributions of $2,000. The JCT explained that the tax treatment of RSAs and LSAs would be similar to the current tax treatment of Roth IRAs (contributions would not be deductible, and earnings on contributions generally would not be taxable when distributed). Additionally, the Bush Administration had proposed to consolidate various current-law employer-sponsored retirement arrangements under which individual accounts are maintained for employees and under which employees may make contributions into a single type of arrangement called an employer retirement savings account (ERSA).

The American Society of Pension Professionals and Actuaries (ASPPA) told the Ways and Means Committee that the large number of plans with different rules and criteria does not reduce the effectiveness of the incentives in increasing retirement savings. ”Consolidating all types of defined-contribution type plans into one type of plan would not be simplification,” the ASPPA cautioned. “It would disrupt savings, and force state and local governments and nonprofits to modify their retirement savings plans and procedures.”

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of May 2012.

May 2

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 25–27.

May 4

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 28–May 1.

May 9

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 2–4.

May 10

Employees who work for tips. Employees who received $20 or more in tips during April must report them to their employer using Form 4070.

May 11

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 5–8.

May 16

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 9–11.

May 18

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 12–15.

May 23

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 16–18.

May 25

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 19–22.

May 31

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 23–25.

June 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 26–29.

The just-released 2011 IRS Data Book provides statistical information on IRS examinations, collections and other activities for the most recent fiscal year ended in 2011. The 2011 Data Book statistics, when compared to the 2010 version, shows, among other things, a notable increase in the odds of being audited within several high-income categories.

Individual audits

Individual taxpayers collectively were audited at a 1.1% rate over the FY 2011 period, based on 1,564,690 audited returns out of the 140,837,499 returns that were filed. While this rate is about the same as in 2010, variations occurred within the income ranges. An uptick was particularly noticeable in the upper brackets (see statistics, below).

Both correspondence and field audits were counted within the statistics. Correspondence audits accounted for 75% of all audits for FY 2011 (down from 77.1% in FY 2010), while audits conducted face-to-face by revenue agents were only 25% of the total, albeit representing an increase from the 21.7% level in FY 2010. Business returns and higher-income individuals are more likely to experience an audit by a revenue agent; while correspondence audits are generally single-issue audits, a revenue agent is likely to explore other issues "while he or she is there."

Examination coverage: individuals

The following audit statistics taken from the FY 2011 Data Book (and contrasted with FY 2010 Data Book stats) show an increase in the audit rate especially in proportion to adjusted gross income (AGI) level:

• No AGI: 3.42% (3.19% in 2010)
• Under $25K: 1.22% (1.18% in 2010)
• $25K-$50K: 0.73% (0.73% in 2010)
• $50K-$75K: 0.83% (0.78% in 2010)
• $75K-$100K: 0.82% (0.64% in 2010)
• $100K-$200K: 1.00% (0.71% in 2010)
• $200K-$500K: 2.66% (1.92% in 2010)
• $500K-$1M: 5.38% (3.37% in 2010)
• $1M-$5M: 11.80% (6.67% in 2010)
• $5M-$10M: 20.75% (11.55% in 2010)
• $10M and over: 29.93% (18.38% in 2010)

Examination coverage: business returns

For individual income tax returns that include business income (other than farm returns), the 2011 audit rate statistics based upon business income (total gross receipts) reveals the IRS's recognition that audits of small business returns yield proportionately higher deficiency amounts:

• Gross receipts under $25K: 1.3% (1.2% in 2010)
• Gross receipts $25K to $100K: 2.9% (2.5% in 2010)
• Gross receipts $100K to $200K: 4.3% (4.7% in 2010)
• Gross receipts over $200K: 3.8% (3.3% in 2010)

The difference in audit rates between returns with and without business income, as measured by total positive income of at least $200K and under $1M provide further evidence of the IRS's tendency toward auditing business returns: 3.6% for returns with business income versus 3.2% without in FY 2011 (2.9% versus 2.5% in FY 2010).

Corporate/other returns

The audit rates for corporations are consistent with the deficiency experience that the IRS has had examining corporations of varying sizes. Some selected audit rates include:

• For small corporations showing total assets of $250K to $1M, the audit rate for FY 2011 was 1.6% (1.4% in 2010); $1M to $5 million, the rate was 1.9% (1.7% in 2010), and for $5M to $10M, the rate was 2.6% (3% in 2010).
• For larger corporations showing total assets of $10M-$50M, the audit rate was 13.3% (13.4% in 2010) in contrast to those at the top end with total assets from $5B to $20B (50.5% (45.3% in 2010)).
• For S corporations and partnerships, the overall audit rate was 0.4% (same as in 2010), in contrast to an overall 1.5% rate for corporations (1.4% in 2010).

Everybody knows that tax deductions aren't allowed without proof in the form of documentation. What records are needed to "prove it" to the IRS vary depending upon the type of deduction that you may want to claim. Some documentation cannot be collected "after the fact," whether it takes place a few months after an expense is incurred or later, when you are audited by the IRS. This article reviews some of those deductions for which the IRS requires you to generate certain records either contemporaneously as the expense is being incurred, or at least no later than when you file your return. We also highlight several deductions for which contemporaneous documentation, although not strictly required, is extremely helpful in making your case before the IRS on an audit.

Everybody knows that tax deductions aren’t allowed without proof in the form of documentation.  What records are needed to “prove it” to the IRS vary depending upon the type of deduction that you may want to claim.  Some documentation cannot be collected “after the fact,” whether it takes place a few months after an expense is incurred or later, when you are audited by the IRS.  This article reviews some of those deductions for which the IRS requires you to generate certain records either contemporaneously as the expense is being incurred, or at least no later than when you file your return.  We also highlight several deductions for which contemporaneous documentation, although not strictly required, is extremely helpful in making your case before the IRS on an audit.

Charitable contributions.  For cash contributions (including checks and other monetary gifts), the donor must retain a bank record or a written acknowledgment from the charitable organization. A cash contribution of $250 or more must be substantiated with a contemporaneous written acknowledgment from the donee.  “Contemporaneous” for this purpose is defined as obtaining an acknowledgment before you file your return.  So save those letters from the charity, especially for your larger donations.

Tip records.  A taxpayer receiving tips must keep an accurate and contemporaneous record of the tip income.  Employees receiving tips must also report the correct amount to their employers.  The necessary record can be in the form of a diary, log or worksheet and should be made at or near the time the income is received.

Wagering losses.  Gamblers need to substantiate their losses. The IRS usually accepts a regularly maintained diary or similar record (such as summary records and loss schedules) as adequate substantiation, provided it is supplemented by verifiable documentation.  The diary should identify the gambling establishment and the date and type of wager, as well as amounts won and lost. Verifiable documentation can include wagering tickets, canceled checks, credit card records, and withdrawal slips from banks.

Vehicle mileage log.  A taxpayer can deduct a standard mileage rate for business, charitable or medical use of a vehicle.  If the car is also used for personal purposes, the taxpayer should keep a contemporaneous mileage log, especially for business use.  If the taxpayer wants to deduct actual expenses for business use of a car also used for personal purposes, the taxpayer has to allocate costs between the business and personal use, based on miles driven for each.

Material participation in business activity.  Taxpayers that materially participate in a business generally can deduct business losses against other income.  Otherwise, they can only deduct losses against passive income.  An individual’s participation in an activity may be established by any reasonable means.  Contemporaneous time reports, logs, or similar documents are not required but can be particularly helpful to document material participation.  To identify services performed and the hours spent on the services, records may be established using appointment books, calendars, or narrative summaries.

Hobby loss.  Taxpayers who do not engage conduct an activity with a sufficient profit motive may be considered to engage in a hobby and will not be able to deduct losses from the activity against other income.  Maintaining accurate books and records can itself be an indication of a profit motive.  Moreover, the time and activities devoted to a particular business can be essential to demonstrate that the business has a profit motive.  Contemporaneous records can be an important indicator.

Travel and entertainment.  Expenses for travel and entertainment are subject to strict substantiation requirements. Taxpayers should maintain records of the amount spent, the time and place of the activity, its business purpose, and the business relationship of the person being entertained. Contemporaneous records are particularly helpful.