The IRS has now followed up with transitional guidance on how taxpayers can obtain IRS approval to change their method of accounting to comply with the new regulations. In light of the transitional guidance, the IRS’s Large Business and International Division (LB&I) followed with a Directive that provides guidance on the handling of audits for various years before and after the regulations take effect.

The temporary regulations address two primary areas: (1) whether taxpayers must capitalize or can immediately deduct costs to acquire, produce, or improve tangible property; and (2) whether capitalization of certain expenses requires special adjustments under the depreciation rules. The IRS provided transitional guidance in two revenue procedures to implement the regulations. Because the regulations apply beginning in 2012, the transition guidance applies to accounting method changes for tax years beginning on or after January 1, 2012.

Guideline to IRS auditors.
The LB&I Directive is addressed to LB&I’s examiners and managers, and instructs to cease conducting examinations of repair versus capitalization issues for costs related to tangible property. The Directive applies to both current examinations and new examinations of the repair/capitalization issue for tax years beginning before January 1, 2012, before the regulations apply. Instead, LB&I is reserving its exam activity for issues arising under the temporary capitalization regulations.

Guidelines in change-of-accounting approvals.
Taxpayers need the IRS’s consent to change their method of accounting. The revenue procedures instruct taxpayers how they can obtain automatic IRS consent to change their accounting method(s) to a method permitted under the capitalization-repair temporary regulations. Taxpayers must file Form 3115, Application for Change in Accounting Method, and follow the general procedures for automatic changes described in a 2011 revenue procedure.

Ordinarily, a taxpayer cannot request automatic consent to change its accounting method if particular conditions apply, such as the taxpayer being under audit. The IRS waived these “scope limitations” for a taxpayer that changes its accounting method in its first or second taxable year beginning after December 31, 2011. Waiving the scope limitations allows taxpayers to file automatic changes even if they are under examination, without waiting for a window or requesting the IRS’s consent.

Required adjustments for past years.
Taxpayers changing their method of accounting must make a full Code Sec. 481 adjustment, in effect making the regulations retroactive. Taxpayers who undercapitalized their costs under the regulations must go back and figure out the differences in treatment. If the taxpayer has additional income, the taxpayer can recognize the income over four years, beginning in the year of the change.

The Framework contains a large number of general business-oriented proposals which, according to the administration, will make the Tax Code less complicated for businesses and increase the nation’s competitiveness in the global economy. A reduction in the corporate tax rate would be fully paid for by repeal of business tax preferences. The Framework also calls for a new minimum tax on overseas profits and encourages companies to return work to the U.S. by offering a new relocation tax incentive.

Congressional reaction to the administration’s Framework was mixed. Democrats in Congress generally applauded the Framework for laying out a plan to reduce the corporate tax rate, a proposal that enjoys bipartisan support in Congress. Republicans were less enthusiastic, but some GOP lawmakers said that the Framework could serve as a starting point for comprehensive tax reform. While the November elections certainly play a part in the release of the current proposals, major tax reform now is considered inevitable by most observers. The question remains, however, as to how it will develop over the coming months.

Five-part framework
The President’s overall proposal, which currently is framed only in general terms, is grounded in five elements:

1. Eliminating tax expenditures and subsidies, broadening the corporate tax base, and cutting the corporate tax rate from 35 percent to 28 percent
2. Strengthening U.S. manufacturing and innovation by effectively lowering the rate for manufacturers to 25 percent (through an enhanced manufacturing credit), making the research tax credit permanent, and providing a number of clean-energy incentives
3. Fixing the international tax system that includes imposing a minimum tax on overseas profits, creating a 20 percent tax credit for moving operations back to the U.S., denying deductions for moving operations overseas, limiting the transfer of patents and other intellectual property to offshore subsidiaries, and delaying deductions for interest paid for overseas investments
4. Simplifying and cutting taxes for small businesses (not just for corporations) through a number of reforms, including a 100 percent expensing up to $1 million; cash accounting for businesses with gross receipts up to $5 million; enhanced deductions for start-up expenses, and an enhanced Code Section 45R small employer health insurance tax credit
5. Restoring fiscal responsibility and not add to the deficit through making reform revenue neutral, including a need to do so for whatever portion of the $250 billion in reoccurring extender tax benefits that Congress deems necessary to continue.

Individual tax reform
In unveiling this framework for business tax reform, Treasury Secretary Timothy Geithner stated that individual tax reform does not necessarily need to be considered at the same time as business tax reform. With individual tax reform clearly the most politically volatile component to total tax reform, most Washington observers believe that tax reform will follow a sequential route, with business tax reform going first.

Audits
Individuals In FY 2009, the IRS undertook 28,349 audits of individuals with incomes in excess of $1 million, according to the Oversight Board. In FY 2008, the number of audits of individuals with incomes above $1 million was 21,874. The difference between FY 2008 and FY 2009 represented a 29 percent increase, the Oversight Board reported.

In total, the IRS conducted 1,099,630 audits of individuals in FY 2009. The FY 2009 number of all individual audits was down slightly (-34,307) from FY 2008.

Corporations Audits of corporations with assets of more than $10 million also grew in FY 2009 compared to FY 2008, but at a slower rate than audits of individuals. The IRS undertook 9,406 audits of corporations with assets in excess of $10 million in FY 2009. That number rose to 9,536 audits of corporations with assets above $10 million in FY 2009. The growth rate in audits of corporations with assets of $10 million or more from FY 2008 and FY 2009 was 1.4 percent.

Tax administration
The Oversight Board warned that U.S. tax administration has two systemic weaknesses: the tax gap and archaic information technology. The tax gap, which is the difference between what taxpayers owe and what they actually pay, is estimated to be approximately $290 billion. The Board cautioned that this to be “unacceptably high.”

The Oversight Board also warned that the IRS relies on outdated technology. The agency uses obsolete automated systems for key operational and financial management functions, the Oversight Board reported. According to the Oversight Board, the IRS has made little progress in correcting these two weaknesses.

However, the Oversight Board found some changes. The IRS launched a return preparer oversight initiative earlier this year, which the Board predicted would increase compliance with the tax laws. The agency also has restructured its Customer Account Data Engine (CADE).

Customer service
The Oversight Board also added its voice to the recent chorus of criticism about poor customer service at the IRS. “For the past two years, the IRS toll-free telephone service has been characterized by constant resources and growing demand; the inevitable result of these two factors has been a decline in service levels,” the Oversight Board noted.

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By Kathy Hillenburg, CPA – Manager

While the Internal Revenue Service and Department of Labor have collectively spent a considerable amount of time and effort overseeing the compliance of the rules governing 401(k) retirement plans, they have spent very little time, up until now, examining the ways tax-exempt organizations operate their 403(b) retirement plans.  This has all changed following the enactment of new 403(b) retirement plan regulations. 

 For 2009, the new 403(b) regulations dramatically change the way tax-exempt organizations manage their employees retirement plan.  Under the “old” 403(b) regulations, tax-exempt organizations typically relied on contracts with insurance companies and mutual fund providers to offer retirement accounts to their employees.  These contractual arrangements required very little, if any, involvement on the part of the tax-exempt organization as to the administration or compliance reporting of their 403(b) plan.  

 A “contract” arrangement will no longer be sufficient for the tax-exempt organization to maintain a qualified 403(b) plan.  By December 31, 2009, tax-exempt organizations must adopt a written plan document setting forth the rights of employees under the plan.  The new 403(b) regulations also require full IRS compliance reporting on Form 5500, and large plans with at least 100 eligible employees will need to have a plan audit.

 403(b) Written Plan Document Requirement

The new regulations require all 403(b) plans, except certain church plans, to have a written plan document in place by December 31, 2009, and made effective January 1, 2009.  403(b) plans that already have a written plan document will need to amend their plan document by December 31, 2009, to include the provisions of the new 403(b) regulations.

The new 403(b) regulations require the written plan document to contain all of the material terms and conditions for plan eligibility, benefits, applicable limitations, the contracts available under the plan, and the time and form of distributions.  The written plan document may also contain optional features such as hardship distributions, loans, and rollover provisions.    

Even though 403(b) plan sponsors have until December 31, 2009 to adopt a written plan document, they are required to begin operating under the new 403(b) regulations starting January 1, 2009.  By the end of 2009, plan sponsors also must retroactively correct any operational failures that may have occurred prior to 2009.

403(b) Filing and Audit Requirements

With a few exceptions, the new regulations make it clear that 403(b) plans are subject to ERISA rules covering employee eligibility, vesting requirements, plan reporting, audit requirements, fidelity bonding, and nondiscrimination testing.  Church plans, government plans, and plans meeting specific safe harbor provisions are still exempt from ERISA oversight.  Safe harbor 403(b) plans are voluntary employee deferral only plans in which the tax-exempt organization has limited involvement with the plan.

Beginning in 2009, sponsors of 403(b) plans, who are subject to ERISA, are required to file a complete Form 5500 with the IRS and DOL.  Prior to 2009, some 403(b) plans were exempt from filing a Form 5500, or filed an abbreviated Form 5500. 

By far the greatest impact of the new regulations will be on 403(b) plans which cover 100 or more employees.  Starting with the 2009 plan year, these “large” plans are required to engage a qualified public accountant to conduct an independent audit of the plan.

Revisions to how companies account for off-balance-sheet items and loan-loss provisions will knock fair-value accounting off the front page with respect to financial reporting, according to James Kroeker, acting chief accountant at Securities and Exchange Commission. Read more…

Several provisions of the economic stimulus plan may have a significant impact on your company or clients’ business, including the “Making Work Pay” tax credit and a host of COBRA requirements and provisions, ranging from a special 60-day election period and an additional plan enrollment option for COBRA recipients.

Read the article for a summary of the provisions that may affect your business.