A number of important tax developments occurred in the past nine months
that may affect you, your family, and your livelihood. I've summarized these
developments. Please call us for more information about any of these
developments and what steps you should implement to take advantage of
favorable developments and to minimize the impact of those that are
unfavorable.
Chances of being audited. The IRS has issued its annual
data book, which provides statistical data on its fiscal year 2006
activities, including how many tax returns it examines (audits), and what
categories of returns it focuses its resources on. Out of a total of 132
million individual returns filed in calendar year 2005, about 1,284,000
individual income tax returns (.97%) were audited during fiscal year 2006,
more than double the number examined in FY 2000.
Kiddie Tax Expanded to older children. Starting next
year, the kiddie tax will reach a child age 18 or age 19-23 if a full time
student. This could cause the investment income of such a child to be taxed
at the parent's higher tax bracket but there may be a way to completely
avoid this result if the child has enough earned income.
New guidance on new rollover option for nonspouse beneficiaries
of retirement plan accounts. The IRS has issued guidance on a
new-for-2007 choice for nonspouse beneficiaries of an inherited qualified
plan account. These beneficiaries may be able to transfer part (or all) of
the deceased employee's account balance into an inherited IRA. Under the new
guidance, a nonspouse beneficiary can, in most situations, receive payouts
from the inherited IRA over his or her lifetime. This can make an inherited
IRA a powerful tax-deferral tool, but expert help is a must to assure that
key rules are met (such as when distributions from the inherited IRA must
begin). The one downside is that under the IRS's latest guidance, company
retirement plans may, but are not required to, offer the rollover option for
nonspouse beneficiaries.
IRS explains new IRA-to-charity rollover options for older
taxpayers. For 2006 and 2007, an IRA owner who is age 70 1/2 or
older can directly transfer tax-free up to $100,000 per year from an IRA to
an eligible charitable organization. Amounts transferred are not taxable and
a deduction can't be claimed for the amount given to the charity.
Transferred amounts are counted in determining whether the owner has met the
IRA required minimum distribution rules. The IRS's explanation of how this
rollover rule works takes a decidedly liberal approach. For example, it
permits each spouse to make an up-to-$100,000 tax-free transfer, and allows
an IRA owner either to make a direct transfer from the IRA to the charity or
hand-deliver a check from the IRA made out to the charity. The IRS also
permits otherwise qualifying IRA beneficiaries (not just IRA owners) to make
the nontaxable rollover.
Liberalized 401(k) rules for hardship withdrawals. You
can take a distribution from a 401(k)-type plan only on account of certain
events, such as disability, retirement, or “hardship”—you need to withdraw
cash to satisfy an immediate and heavy financial need. The rules used to say
that to take a hardship payout, you (and, in some cases, your spouse or
dependent) had to have the immediate and heavy financial need. But under a
change mandated by the 2006 Pension Protection Act, the IRS has amended the
rules to allow 401(k) payouts for a primary beneficiary's hardship. This
primary beneficiary doesn't have to be your dependent. However, the hardship
must be for certain specific expenses, such as medical bills or tuition
costs.
New regs on depreciation of property acquired in like-kind swap
or involuntary conversion. The IRS has issued final regs on how to
depreciate MACRS property acquired in a
Code Sec. 1031 like-kind exchange or as a result of a
Code Sec. 1033 involuntary conversion. The regs apply when both the
acquired and relinquished property are subject to the MACRS accelerated
depreciation rules in the hands of the acquiring taxpayer. These regs are
extremely complex and could be burdensome for taxpayers that engage in many
like-kind exchanges during the year, or must deal with multiple involuntary
conversions. However, taxpayers may elect not to apply the new regs—an
option that should be given careful consideration—unless the final regs'
approach significantly accelerates depreciation deductions.
Foreign housing allowances again boosted for high-cost areas.
In general, taxpayers who live and work abroad may be able to claim a
foreign income exclusion and a housing cost exclusion. The Tax Increase
Prevention and Reconciliation Act (signed into law on 5/17/2006), toughened
these exclusions, effective as of the beginning of 2006. It also gave the
IRS the power to issue guidance relaxing the rules based on geographic
differences in housing costs relative to housing costs in the U.S. The IRS
recently issued such guidance that not only increased higher maximums that
IRS had earlier authorized (e.g., for Vienna, Austria, and Moscow, Russia)
but also added new high cost locations to the pre-existing list of such
locations (e.g., Beijing and Shanghai, China, Mumbai and New Delhi, India,
and Zurich, Switzerland).
Full credit for Ford, GM and Nissan qualifying hybrids through
September of 2007. Taxpayers who purchase new qualified hybrid
motor vehicles may claim a tax credit that varies in amount with the car
model, but the credit begins to phase out after the manufacturer sells a
fixed number of hybrid vehicles. Based on manufacturer sales figures, the
IRS has announced that the full hybrid credit remains available through at
least Sept. 30, 2007, for qualified hybrid vehicles manufactured by Ford, GM
and Nissan.
Mazda joins the hybrid club. The IRS has announced that
Mazda's 2008-model-year Tribute hybrids qualify for the alternative motor
vehicle credit. The two-wheel Tribute hybrid credit amount is $3,000; it's
$2,200 for the four-wheel drive version).
The IRS also put the following vehicles on the list of those that qualify
for the hybrid credit (credit amounts are in parentheses): Ford Escape 2WD
Hybrid Model Year 2008 ($3,000); Mercury Mariner 2WD Hybrid Model Year 2008
($3,000); Ford Escape 4WD Hybrid Model Year 2008 ($2,200); Mercury Mariner
4WD Hybrid Model year 2008 ($2,200); and 2007 Saturn Aura ($1,300).
Be sure to take these changes into account when figuring any future
estimated tax payments due for 2007
Please call our office if you would like to discuss these tax law changes in
more detail.
Although the Small Business and Work Opportunity Tax Act of 2007 (2007
Small Business Act) dominated the tax news in the second quarter of 2007,
there were other important tax developments that may affect you, your
family, and your livelihood. The new law changes and other key developments
are summarized below. Please call us for more information about any of these
developments and what steps you should implement to take advantage of
favorable developments and to minimize the impact of those that are
unfavorable.
Code Sec. 199 final regs on computer software. The IRS
has issued final regs that explain when a taxpayer's gross receipts from the
provision of online software (i.e., software provided to customers while
they are directly connected to the Internet or to any other public or
private communications network) are “domestic production gross receipts”
that are eligible to be taken into account in computing the taxpayer's
Code Sec. 199 domestic production activities deduction. Generally, this
eligibility occurs when the taxpayer or another person derives gross
receipts from qualifying dispositions of the same or similar software
affixed to a tangible medium (e.g., DVDs or CD-ROMs) or by download. For
2007 tax years, the
Code Sec. 199 domestic production activities deduction is 6% of
“qualified production activities income”-i.e, domestic production gross
receipts net of properly allocable expenses-subject to a 50%-of-W-2-wages
limitation.
2007 Small Business Act. On May 25, the President signed
into law new legislation to increase the minimum wage and provide relief to
small businesses. However, some other rules were toughened in order to
generate revenue to pay for the relief. Key provisions in the Act include:
- Several S corporation rules have been liberalized with various
effective dates. For example, for tax years beginning after 2006, an
electing small business trust (a trust than can hold S stock for a
beneficiary) may deduct interest expense it incurs when it borrows funds
to purchase S stock.
- The work opportunity tax credit is extended for 44 months with
liberalized rules for hiring disabled veterans and workers in rural
renewal counties.
- Expensing—the option to currently deduct the cost of business
machinery and equipment—is extended and enhanced. For tax years
beginning in 2007, the limit is increased to $125,000 and the
investment-based phaseout is increased to $500,000, and the enhanced
expensing provision is extended for through 2010.
- Starting with the 2007 return filed in 2008, a husband and wife
operating a partnership and meeting certain conditions may instead
choose to file as sole proprietor. Choosing this new option would ensure
that each spouse receives credit for paying Social Security and Medicare
taxes.
- The law was changed so that next year's increase in the Federal
minimum wage won't cause a reduction in the FICA tip credit for
restaurants.
- IRS generally must suspend interest and penalties if it doesn't
notify an individual about his tax liability within 18 months of the
later of the date he filed or date the return was due. For notices
provided after Nov. 25, 2007, the 18-month period will be increased to
36 months.
- There's a new penalty for refund claims filed after May 25, 2007
without any reasonable basis.
- Various tax incentives for the GO Zone (encompassing areas hard hit
by hurricanes in 2005) are enhanced and/or extended.
Final regs on 409A nonqualified deferred compensation plan rules.
The IRS issued final regs clarifying the IRC §409A nonqualified deferred
compensation plan rules. They cover key definitions, deferral elections,
permissible payments, and the application of the effective date. The regs
apply for tax years beginning after 2007, but taxpayers may rely on them for
tax years beginning before 2008.
Final regs on distributions from designated Roth accounts.
A 401(k) plan may include a feature allowing plan participants to elect to
have all or part of their elective deferrals treated as Roth
contributions—that is, to make designated Roth contributions. Designated
Roth contributions are currently includible in income, but qualified
distributions are tax-free. The IRS has issued final regs providing
comprehensive guidance on the taxation of distributions from designated Roth
accounts and on the reporting requirements for these accounts. The regs
generally apply for tax years beginning after 2006.
Guidance on passthrough entities and statistical sampling for the
domestic production deduction. The IRS explains which partnerships
and S corporations may calculate qualified production activities income and
W-2 wages at the entity level for purposes of the IRC §199 domestic
production activities deduction. The guidance also details how qualified
production activities income and W-2 wages are to be allocated to partners
and shareholders for IRC §199 purposes. Separate guidance explains when
statistical sampling may be used for various IRC §199 allocation purposes
and details acceptable statistical methodologies.
Consequences of nonqualified plans for highly compensated
executives. The IRS has provided a comprehensive explanation of the
tax consequences of a nonqualified funded employees' trust for all the
parties involved—the employees who are trust beneficiaries, the employer who
contributes to the trust, and the trust itself. A participant includes in
gross income as compensation his vested accrued benefit (other than his
investment in the contract) as of the end of the tax year of the trust
ending with or within the participant's tax year. The trust is the employer
for wage withholding purposes with respect to the nonqualified plan for
these highly compensated employees, regardless of whether contributions made
for the benefit of the employee are vested at the time of contribution. The
employer's contributions to a nonexempt employees' trust on behalf of a
highly compensated employee is subject to FICA and FUTA tax when the amounts
(and any earnings on them) are vested. If the contribution isn't vested at
the time of contribution, the trust is considered the employer liable for
the payment of the FICA and FUTA tax.
The IRS will no longer treat trade discounts as includible in
income. IRS will treat cash advances by a wholesaler to a retailer
in exchange for a volume purchase commitment (i.e., an advance trade
discount) as not includible in gross income if the retailer adopts the
“Advance Trade Discount Method” of accounting. Under this method, an advance
trade discount isn't recognized as gross income on receipt, but instead
generally is taken into account for federal income tax purposes in the
amount and manner that the retailer accounts for the discount in its
applicable financial statements.
Deduction limits liberalized for entertainment use of planes by
key personnel. The IRS has issued proposed regs that taxpayers may
rely on explaining how an employer calculates its restricted deduction for
the entertainment, amusement, or recreational use of employer-owned aircraft
by “specified individuals” (e.g., officers, directors). Generally, the
employer's deduction for the cost of providing an aircraft for entertainment
use by a specified individual is disallowed, except to the extent that the
cost of providing the aircraft is treated as compensation to that
individual. The regs have liberalized rules relating to which expenses must
be allocated, the methods that may be used, and travel that's exempt from
the deduction limit.
Please keep in mind that I've described only the
highlights of the most important changes in the new law. Please contact
our office at 978-537-0709 for more details on how you may be affected, and
whether immediate action is needed to take advantage of the tax breaks in this
important tax legislation.
