Estimated tax payments
You are required to pay estimated tax if you receive income from which tax is not withheld, including income from self-employment, dividends and interest, capital gains and losses, rental income, and alimony, and your tax is expected to be $1,000 or more (after subtracting credits and withholding). Generally, individuals who do not pay at least 90 percent of their tax through withholding must estimate their income tax liability and make equal quarterly payments of the “required annual payment” liability throughout the year.

Higher-income taxpayers.
For higher-income taxpayers whose adjusted gross income (AGI) shown on the preceding year’s tax return exceeds $150,000 ($75,000 for married individuals filing separately), the required annual payment is the lesser of 90 percent of the tax for the current year, or 110 percent of the tax shown on the return for the preceding tax year.

Estimated tax payments are due quarterly. For most individuals, the due dates for the 2010 tax year are: April 15, June 15, and September 15 of 2010, and January 15, 2011. Failing to pay enough estimated tax on each installment date may result in a penalty for underpayment of estimated tax, even if you are due a refund. Therefore, properly calculating your payments is vital to avoid the penalties, including calculating adjustments needed in remaining quarters (including as soon as September 15, 2010 for the third quarter).

Third quarter payments are around the corner – September 15, 2010 – for the period June 1 through August 31. Fourth quarter payments will be due January 15, 2011 for the period September 1, 2010 through December 31, 2010. If your total estimated payments and withholding add up to less than 90 percent of what you owe, you may face an underpayment penalty.

Withholding
With the third and fourth quarter payments becoming due, ensure you are properly withholding and paying enough in estimated tax. Look at your projected year-end tax payments as compared with your expected tax liability to determine if your estimated tax payments need some tweaking. If your payments are expected to be less than 90 percent of current-year tax, you will generally need to increase your withholding or make estimated tax payments.

You may want to file a new W-4 with your employer adjusting your withholding to withhold more from your final paychecks for the year if you are currently underwithholding. This will help avoid being subject to a penalty when you file your return.

Adjusting estimated tax payments
A change in your business’s income, deductions, credits, and exemptions may also make it necessary to refigure your estimated payments for the remainder of the year. To avoid either a penalty from the IRS or overpaying the IRS interest-free, consider increasing or decreasing the amount of your remaining estimated payments.

If, during the quarter, you learn that a change in your business’s anticipated income, deductions, credits, exemptions, or other adjustments will either increase or decrease your business’s tax liability, and therefore affecting your required annual payment for the remainder of the year, you should adjust your remaining quarterly payments accordingly.

Refiguring tax payments due
To change your estimated tax payments, refigure your total estimated payments due. Next, determine the payment due for each remaining payment period. Be careful when refiguring your remaining payments. The IRS may assess a penalty against you when filing your return at the end of the year if an estimated tax payment for a previous period is less than one-fourth of your amended estimated tax. So be cautious when refiguring any tax payments.

Pre-PPACA law
Pre-PPACA law generally requires businesses to file an information return with the IRS reporting payments to non-corporate service providers that exceed $600 in a given year. Payments to providers of goods are excluded from reporting. Payments to a corporation for goods or services are excluded from reporting with some limited exceptions.

Sea change ahead
Effective for purchases made after December 31, 2011 the PPACA requires all businesses purchasing $600 or more in goods or services from another entity (including corporations but not tax-exempt corporations), to provide the vendor and the IRS with an information return. Presumably, Form 1099-MISC will be used for purposes of the new reporting rule, or the IRS will develop a new form. We will keep you posted on developments.

Example. In February 2012, your business buys computers, printers, and fax machines from an office supply company, doing business as a corporation, for $4,000. Your business also spends $1,000 at a local caterer, doing business as a partnership, for office breakfasts and lunches throughout the year. Additionally, the company spends $600 for business travel on Amtrak. Your business must provide each of these vendors with a Form 1099 for 2012, as well as the IRS.

Day-to-day transactions
Here are some more examples of purchases after 2011 that appear to fall under the PPACA’s reporting requirements:
- You make small, incremental purchases from the same vendor; for example, your business purchases more than $600 of office supplies, such as staples, toner, pens, paper, and calendars from the same vendor.
- You pay more than $600 throughout the year in mail and shipping costs to the same vendor; however each individual charge costs no more than $10 or $12.
- You purchase floral arrangements for the office throughout the year, although each purchase may be no more than $40 to $70, your cumulative purchases are more than $600
- You purchase an $800 computer for your new employee
- You hold a summer picnic for your employees and purchase more than $600 in food from a local grocery store
- Every Friday you buy breakfast pastries from the local bakery for your employees, and even though each purchase is no more than $40, you spend more than $600 in the year.

Backup withholding
The PPACA requires sellers to provide, and purchasers to collect, Taxpayer Identification Numbers (TINs). If a seller fails to furnish a correct TIN, you must impose backup withholding at the rate of 28 percent of the purchase price.

Moreover, if your business fails to issue an accurately completed Form 1099 to a vendor, the IRS can assess a penalty.

Preparing now
There are some proactive steps your business can take now to prepare for the new reporting requirement and its heavy administrative and paperwork burden. The way you collect and manage vendor information will be more important then ever. Basic information you will need to track includes every vendor’s name and TIN, the amounts spent at each vendor and the total annual amount spent at each vendor. You should also begin requesting that each of your vendors, particularly your regular vendors, complete IRS Form W-9 for your records. Form W-9 will provide you with the vendor’s legal name, address, and TIN.

Pending legislation
Opponents of the expanded information requirement are hoping that Congress will repeal it before 2012. Outright repeal is a long-shot. As written now, the PPACA reporting requirement is estimated to raise $17 billion over 10 years. Congress will need to find another source of revenue if it repeals the reporting requirement. More likely, Congress will modify the requirement.

Senate Democrats have introduced legislation to raise the reporting threshold from $600 to $5,000 and exclude some routine payments, such as office supplies, from reporting. All purchases made with a credit card would also be exempt from the reporting requirement. Additionally, small businesses employing not more than 25 employees would be completely exempt from the reporting requirement.

Congress may scale back the PPACA’s reporting requirements in the autumn of 2010. We will keep you posted on developments.

Lifetime Learning Credit
The Lifetime Learning credit can be claimed for qualified tuition and fees paid by an individual for his or her (or a spouse’s or dependent’s) enrollment at any college, university, vocational school, or postgraduate school. The credit is equal to 20 percent of up to $10,000 of the qualified tuition and related expenses paid by a taxpayer during the tax year. Thus, the maximum credit amount per taxpayer return is $2,000.

The Lifetime Learning credit can be claimed for all years of postsecondary school (as well as for courses to acquire or improve job skills). However, the credit phases out as your modified AGI rises, and you can not claim the credit if you are married filing separately. You cannot claim a credit if your modified AGI is $60,000 or more ($120,000 or more if you file a joint return).

American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC), which was previously the Hope scholarship credit but temporarily enhanced and renamed the AOTC for 2009 and 2010, can also be claimed for qualified tuition and fees paid by an individual for his or her (or a spouse’s or dependent’s) enrollment or attendance at any college, university, vocational school or postgraduate school.

The AOTC can be used for all four years of post-secondary school. Further, the credit can be taken for more expenses, such as text books and course materials. And, although the credit phases out as adjusted gross income (AGI) rises, the income phase out range is increased through 2010 as well. Additionally, 40 percent of the credit is refundable.

For 2010, the AOTC is available up to a maximum of $2,500 per eligible student, per year (100 percent of the first $2,000 eligible expenses plus 25 percent of the next $2,000 eligible expenses). The credit phases out at higher income levels, making the credit available to more families as well. The amount of the credit begins to phase out when an individual’s AGI falls between $80,000 to $90,000 AGI. For married joint filers the credit phases out when AGI falls between $160,000 and $180,000.

AOTC vs. Lifetime Learning credit
The AOTC and Lifetime Learning credits cannot both be taken for the same student in the same year. If you pay the qualified education expenses of more than one student in the same year, however, you can choose to take the credits on a per-student basis for that year (for example, you may claim the AOTC for your daughter and the lifetime learning credit for your son, etc). You should calculate the effect of the AOTC, Lifetime Learning Credit (and, if retroactively reinstated for the 2010 year, the higher education expense deduction) on your tax return to see which incentive achieves the greatest tax savings. Remember, also, in “doing the math” that the tax benefits are based on calendar tax years and not school academic years.

Coverdell Education Savings accounts
Individuals can contribute up to $2,000 a year to a Coverdell Education Savings account, which is established to help pay for the costs of education of an account beneficiary. A beneficiary is someone who is under age 18 or with special needs.

Although contributions to a Coverdell account are not deductible, earnings grow tax-free, and distributions are also tax free if used for qualified education expenses, including tuition and fees, required books, supplies and equipment, as well as qualified expenses for room and board. The account can help pay for the costs of attending an elementary or secondary school, whether public, private or religious, as well as a college or university.

As with the education credits, there are contribution limits based on the contributor’s modified AGI.

IRA withdrawals for education expenses
Generally, if you take a distribution from your IRA before you reach age 59 1/2 you must pay a 10 percent additional tax on the early distribution, as well as income tax on the amount distributed. This applies to any IRA you own, whether it is a traditional IRA, a Roth IRA or a SIMPLE IRA. However, you can take an IRA distribution before age 59 1/2 and avoid the 10 percent tax (but not the inclusion of the distributed amount in income for income tax purposes), if the distribution is used to pay the qualified education expenses for:

– Yourself;
– Your spouse; or
– Your or your spouse’s child, grandchild or foster child.

The amount of the withdrawal is generally limited to $10,000. Qualified education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at any college, university, vocational school or other post-secondary educational institution. In addition, if the student is at least a part-time student, room and board are generally qualified education expenses, subject to certain limitation.

Section 529 college savings plans
Qualified tuition programs, more commonly referred to as 529 plans, allow you to either prepay education expenses or contribute to an account set up for paying a student’s qualified education expenses at eligible educational institutions. A 529 plan allows you to save money, tax-free, to pay for qualified education expenses for college. Although contributions are not deductible for federal tax purposes, many states allow residents to deduct contributions on their state tax return. Moreover, withdrawals from a 529 plan are tax-free unless the amount distributed is greater than the account beneficiary’s adjusted qualified education expenses. Qualified education expenses include amounts paid for tuition, fees, books, supplies and equipment, as well as reasonable costs of room and board for individuals are at least part-time students.

Computer and technology expenses. Through 2010, parents and students can take tax-free withdrawals from their 529 plans to buy computers and computer-related equipment for college. The 2009 Recovery Act added computers, computer equipment, technology, internet access, and “related services” to the list of qualified higher education expenses that can be paid for with tax-free 529 withdrawals. However, as with the AOTC, this expanded incentive is temporary and applies only through 2010 (unless Congress extends this tax break). However, tax-free withdrawals can not be taken for computer software designed for games, sports or hobbies, unless the software is “predominantly educational in nature.”

Caution. While the tax law allows you to combine the tax benefits of a 529 plan with one of the education credits or deductions, you cannot “double dip.” That is, the expenses you use to compute the AOTC (or Lifetime Learning Credit) cannot also be included as a qualified higher education expense for purposes of determining your tax exclusion for 529 plan withdrawals. Remember, too, that states have their own rules regarding education benefits, such as withdrawals from 529 plans. These must be considered as part of your education tax savings strategy.

Student loan interest deduction
Eligible individuals can take an above-the-line deduction for up to $2,500 of interest paid on student loans used to pay for the cost of attending any college, university, vocational school, or graduate school. A student loan, for purposes of the deduction, is a loan you took out and is designated solely to pay your (or your spouse’s or dependent’s) qualified education expenses. For example, if you take out a home equity loan to pay for college tuition, the interest may be deductible as mortgage interest, but it is not considered above-the-line interest for a student loan since the lender did not specifically restrict the proceeds to education expenses.

Good news on student loan interest, however, is that qualified education expenses include not only tuition and fees, but also room and board, books, supplies and equipment, and other necessary expenses such as transportation. Interest paid on a loan that is made to you by a related person, such as parents or grandparents, or from a qualified employer plan do not qualify for the deduction.

The deduction is available regardless of whether or not you itemize. The amount of the deduction begins to phase out when an individual’s modified AGI exceeds $55,000 a year (or $115,000 for married couples filing jointly). The deduction is completely eliminated once an individual’s modified AGI reaches $70,000 (or $145,000 for joint filers). If you are claimed as a dependent on another’s tax return, you can not take the deduction, however.

Expired incentives hanging in the wings
At the end of 2009, two popular, but temporary, tax incentives expired: the higher education tuition deduction and the teachers’ classroom expense deduction of up to $250. Congress is working on legislation to extend these benefits through 2010. We will keep you posted on its progress.

Please contact us to discuss the higher education tax saving strategies that can benefit your particular situation.

Business bad debt deduction
Taxpayers may deduct any business receivable that becomes totally or partially worthless during the tax year under Tax Code Sec. 166(a). However, the business bad debt deduction is limited to the taxpayer’s adjusted basis in the receivable.

The deduction allowed for bad debts is an ordinary deduction. To claim the deduction, you must establish that the debt is genuine and that the amount cannot be recovered from the debtor. You must also make a reasonable attempt to collect the debt (however, you do not have to turn the debt over to a collection agency or file a lawsuit in an attempt to collect on the debt if doing so has little probability of success). The law requires most taxpayers to use the specific charge-off method of accounting for bad debts. Under the specific charge-off method, the taxpayer must specifically identify the accounts or notes charged off as partially or completely worthless (it is also referred to as the direct write-off method).

If you meet these conditions, you can take the deduction in the year in which the debts became worthless. This includes certain previous years since, for some debts, worthlessness may not be immediately apparent. You can deduct a bad debt before the debt is due if you can establish the partial or complete worthlessness of the debt.

Partially worthless. If you failed to claim the bad debt deduction for a receivable that became partially worthless in a prior tax year, you have until the later of (1) three years after you file the tax return (including extensions) or (2) two years from the time you paid the tax to file an amended return and deduct the bad debt.

Totally worthless. If you failed to claim a deduction for a receivable that became completely worthless in a previous tax year, you have until the later of (1) seven years after the due date of the tax return (not including extensions) or (2) two years from the time you paid the tax to file an amended return and claim a deduction for the worthless receivable.

Cash basis taxpayers
Cash basis taxpayers cannot claim a bad debt deduction for accounts receivable that are not collectible. However, notes received by a cash basis taxpayer in the ordinary course of business are treated as the equivalent of cash to the extent of the note’s fair market value (FMV) at the time received. Thus, the initial basis in such a note is its FMV. Cash basis taxpayers may claim a bad debt deduction for uncollectible notes receivable if they have included the FMV of the notes in gross income.

Accrual and hybrid taxpayers
Accrual basis taxpayers may claim a bad debt deduction for accounts receivable that become partially or completely worthless during the tax year. Accrual basis taxpayers must include the face value of a note receivable in gross income if a reasonable expectancy of collection exists at the time it is received. Taxpayers that use a hybrid method of accounting may deduct bad debts if they have included the revenue from the receivable in gross income.

Reporting
For self-employed taxpayers, the bad business debt deduction is reported on Schedule C, Profit or Loss from Business (Sole Proprietorship), or Schedule F (Profit or Loss from Farming (for self-employed farmers)). Corporations report bad debts on Line 15 of Form 1120, U.S. Corporation Income Tax Return. S corporations report bad debts on Line 10 of Form 1120S, U.S. Income Tax Return for an S Corporation. Partnerships report bad debts on Line 12 of Form 1065, U.S. Return of Partnership Income.

Recovering bad debts
If you recover a bad debt during the year, the amount recovered is gross income to the extent that you claimed the deduction for the bad debt in a previous tax year, reducing your taxable income. This is called the tax benefit rule. The bad debt you recovered may not be offset against the bad debt deduction for the tax year of the recovery.

Do you have any questions about the tips in this article? Please contact us and we will be glad to assist your business with these strategies.

New non-health related reporting requirements imposed by the Patient Protection and Affordable Care Act of 2010 (PPACA) will go into full force in 2012. They expanded existing information reporting requirements to apply to payments made to corporations and generally to include payments of “gross proceeds” for property and services, and all “amounts [paid] in consideration for property.”

The expansion of information reporting was anticipated for corporations, but not for “property transactions” and “gross proceeds.” Many tax practitioners are already complaining loudly that businesses need guidance on what are gross proceeds and what property transactions are covered. Others predict that the new requirements will give rise to an expensive compliance burden for businesses, with as much as a tenfold increase in reporting on Form 1099-MISC.

After comments are received next month, the IRS likely will release preliminary rules on the new information requirement either at year end or by early 2011.

1. Payroll deduction IRAs
Many small employers find a payroll deduction IRA very attractive because it allows them to offer their employees a retirement savings vehicle at little cost. A business of any size, even self-employed individuals, can establish a payroll deduction IRA. Under a payroll deduction IRA, only your employees make contributions to an IRA. Your responsibility as an employer is simply to transmit the employee’s authorized deduction to the financial institution that maintains the IRA.

The IRA is set up with a financial institution, such as a bank, mutual fund or insurance company. You can limit the number of IRA providers to as few as one. The employee establishes a traditional IRA or a Roth IRA (based on the employee’s eligibility and personal choice) with the financial institution and authorizes the payroll deductions. As the employer, you withhold the payroll deduction amounts authorized by your employees and send the funds to the financial institution.

An employee’s decision to participate in a payroll deduction IRA is entirely voluntarily. If an employee decides to participate, he or she can only contribute up to a certain amount to the payroll deduction IRA every year. For 2010, the contribution limit is $5,000. An employee age 50 or older may make an additional “catch-up” contribution of $1,000 for a yearly total of $6,000. Every employee who participates is 100 percent vested in the contributions to their payroll deduction IRA.

Let’s look at an example of a payroll deduction IRA:
Aidan’s employer offers its employees the opportunity to have deductions taken from their paychecks to contribute to IRAs that the employees have set up for themselves. Aidan signs up for the program and has $100 from his $1,000 bi-weekly paycheck deposited into his IRA for a yearly total of $2,600. At the end of the year, Aidan’s employer would report the full $26,000 he earned on his Form W-2 and Aidan would add the $2,600 to any other IRA contributions he made during the year for Form 1040 deduction purposes.

The costs of a payroll deduction IRA are low. Moreover, payroll deduction IRAs are not subject to the often complex filing, documentation and administration requirements that are imposed on other employer-sponsored retirement arrangements, such as 401(k) plans.

2. SEP Plans
“SEP” stands for “Simplified Employee Pension” plan. While there are filing, administration and documentation requirements for SEP plans, the goal of an SEP plan is to keep these as simple as possible. The IRS has created, for example, model SEP language for plan documents.

An SEP plan is similar to a payroll deduction IRA. Under an SEP plan, employers make contributions to traditional IRAs set up for employees (including self-employed individuals). An SEP-IRA is funded solely by employer contributions whereas a payroll deduction IRA is funded solely by employee contributions.

As the employer, you must select the financial institution for your SEP. This decision must be made carefully because you and the financial institution will very work closely to administer the plan. After you send the SEP contributions to the financial institution, the financial institution will manage the funds. Depending on the financial institution, SEP contributions can be invested in individual stocks, mutual funds, and other similar types of investments.

Federal law requires you and the trustee to keep employees informed about the administration and health of the SEP. Employees must be provided with plan documents, an annual statement that reports the fair market value of each employee’s account and a copy of an annual statement that is filed by the financial institution with the IRS. Like a payroll deduction IRA, each employee is 100 percent vested in his or her SEP-IRA.

Generally, the annual contributions an employer makes to an employee’s SEP-IRA cannot exceed the lesser of:
– 25 percent of compensation,or
– $49,000 for 2010.

Generally, contributions are not required to be made every year to an SEP. In years that contributions are made to an SEP, they must be made to the SEP-IRAs of all eligible employees. Contributions to an SEP-IRA must be made in cash; property cannot be contributed to an SEP-IRA. Special rules apply if you, as the employer, also contribute to a 401(k) or similar plan on the employee’s behalf.

All eligible employees must be allowed to participate. An eligible employee is any employee who is at least age 21 and has worked for you in at least three of the immediate past five years.

To encourage employers to establish SEPs, the government offers a tax credit. You may be eligible for a tax credit of up to $500 for each of the first three years for the cost of starting the SEP.

3. SIMPLE IRAs
A “SIMPLE IRA” is a Savings Incentive Match Plan for Employees IRA. Like an SEP plan, a SIMPLE IRA is intended to be easily created and administrated.

A SIMPLE IRA is funded both by employer and employee contributions. As the employer, you can choose either to (1) match the contributions of employees who decide to participate or (2) contribute a fixed percentage of all eligible employees’ pay. Under option (2), which is known as the nonelective contribution formula, even if an eligible employee does not contribute to his or her SIMPLE IRA, you must make a contribution to the employee’s SIMPLE IRA equal to a fixed percent of the employee’s salary. Each employee is 100 percent vested in his or her SIMPLE IRA.

While similar to a payroll deduction IRA, a SIMPLE IRA has additional requirements. One important requirement is the number of employees. Generally, your business must have 100 or fewer employees to be eligible for a SIMPLE IRA.

Let’s look at an example of a SIMPLE IRA. In this example, the employer matches the employee contributions of employees who decide to participate.

Allison’s employer has established a SIMPLE IRA plan for its employees. The employer will match its employees’ contributions dollar-for-dollar up to three percent of each employee’s salary. If an employee does not contribute to his or her SIMPLE IRA, then that employee does not receive a matching employer contribution. Allison decides to contribute five percent ($2,500) of her annual salary of $50,000 to a SIMPLE IRA. The employer’s matching is $1,500 (three percent of $50,000). Therefore, the total contribution to Allison’s SIMPLE IRA that year is $4,000.

There are contribution limits for SIMPLE IRAs. For employees, the annual contribution limit is $11,500 in 2010. Employees age 50 and older may make additional catch-up contributions of $2,500 in 2010.

The SIMPLE IRA contribution for the employer is dependent upon which contribution formula you select. If you decide to make matching contributions, only eligible employees who have elected to make contributions will receive an employer contribution. If you decide to make a nonelective contribution, each eligible employee must receive a contribution regardless of whether the employee makes contributions.

As with an SEP plan, a SIMPLE IRA creates a relationship between you and the financial institution that manages the funds. SIMPLE IRA plan contributions can be invested in individual stocks, mutual funds and similar types of investments. Each participating employee must receive an annual statement indicating the amount contributed to his or her SIMPLE IRA for the year.

As with SEP plans, you may be eligible for a tax credit to help you offset start-up costs. The tax credit can reach up to $500 per year for each of the first three years for the cost of starting a SIMPLE IRA plan.

We’ve covered a lot of material about retirement plans for small businesses. There are more detailed requirements, especially for SEP plans and SIMPLE IRAs, which we can discuss in depth. Please contact us to set up an appointment to explore these and other retirement arrangements for small businesses.

Officially known as the Senate Substitute Amendment to H.R. 5297, the Senate’s Small Business Tax bill makes significant additions to the tax title that the House passed on June 15, 2010. Most of these tax incentives are retroactive to January 1, 2010, but are only temporary; once they pass, most businesses need to act quickly to maximize their benefits.

Here’s what’s in store for businesses if the Senate bill is approved:
Bonus depreciation. Extends, through December 31, 2010, 50-percent first-year bonus depreciation that had expired at the end of 2009.

Code Sec. 179 expensing. Increases the maximum Code Sec.179 expensing deduction from $250,000 to $500,000 and the investment limit from $800,000 to $2 million for tax years beginning in 2010 and 2011.

S corp built-in gain. Shortens the holding period for appreciated C corp assets after an S corp conversion to five years, if the fifth tax year in the holding period precedes the S corp’s tax year beginning in 2011.

Cell phones. Removes cell phones and similar communication devices from their current classification as listed property, thereby lifting strict substantiation requirements, depreciation limitations, and imputed income for employee use.

General business credit. Extends the carryback period for general business credits from one to five years for eligible small businesses, applied to tax years beginning after December 31, 2009; similarly extends the carryforward period.

AMT offset. Removes the limitations on which general business credits may offset AMT liability for eligible small businesses.

SECA deduction for health insurance. Allows the deduction for health insurance to be taken into account in determining earnings for self-employment tax purposes.

Qualified small business stock. Raises the exclusion for qualifying gain from 75 percent to 100 percent on Code Sec. 1202 stock acquired anytime from the date of enactment through the end of 2010.

Code Sec. 6707A penalty relief. Moderates the penalties that the IRS must apply to taxpayers failing to disclose participation in certain tax shelters. For listed transactions, a $5,000 minimum penalty would apply to individuals, $10,000 to corporations.

Start-up expense deduction. Raises the deduction limit on start-up expenses from $5,000 to $10,000, and increase the threshold to $60,000 for one year, 2010.

Roth retirement options. Authorize 401(k), 403(b) and 457 retirement plans to allow participants to roll over pre-tax account balances into a Roth account.

Revenue offsets. Many of the tax incentives in the bill must be “paid for” under Congressional budget rules with reciprocal offsets. In addition to counting on revenues from voluntary Roth conversions, the Senate bill would raise more than $4 billion through broadened information reporting rules and higher penalties for ignoring those rules.

Congress is set to return from its month-long August recess on September 14th. In addition to considering further tax breaks to jump-start business growth when it returns, Congress will be focused on whether to raise individual tax rates, revise capital gains and dividends treatment, preserve the estate tax, and shorten the growing reach of the alternative minimum tax (AMT).

We will continue to closely monitor these developments and recommend appropriate tax strategies as they evolve. If you have any questions about these changes, please contact us today.

Individual income tax rates
EGTRRA set in motion a gradual reduction of the individual marginal income tax rates. EGTRRA also created a new and temporary 10 percent regular income tax bracket for a portion of taxable income that was previously taxed at 15 percent.

The federal individual income tax rates for 2010 are:
Single individuals: If taxable income is not over $8,375: 10% of the taxable income; Over $8,375 but not over $34,000: $837.50 plus 15% of the excess over $8,375; Over $34,000 but not over $82,400: $4,681.25 plus 25% of the excess over $34,000; Over $82,400 but not over $171,850: $16,781.25 plus 28% of the excess over $82,400; Over $171,850 but not over $373,650: $41,827.25 plus 33% of the excess over $171,850; and Over $373,650: $108,421.25 plus 35% of the excess over $373,650.

Married couples filing a joint return: If taxable income is not over $16,750: 10% of the taxable income; Over $16,750 but not over $68,000: $1,675 plus 15% of the excess over $16,750; Over $68,000 but not over $137,300: $9,362.50 plus 25% of the excess over $68,000; Over $137,300 but not over $209,250: $26,687.50 plus 28% of the excess over $137,300; Over $209,250 but not over $373,650: $46,833.50 plus 33% of the excess over $209,250; and Over $373,650: $101,085.50 plus 35% of the excess over $373,650.

Unless extended or made permanent, the individual marginal income tax rates will all rise after December 31, 2010 when EGTRRA sunsets. The 10 percent regular income tax bracket will also disappear after December 31, 2010 and the first portion of an individual’s taxable income will be taxed at 15 percent rather than at 10 percent.

According to the Joint Committee on Taxation (JCT), after EGTRRA sunsets and with no modification by Congress, the federal individual income tax rates for 2011 will be:
Single individuals: If taxable income is not over $34,850: 15% of the taxable income; Over $34,850 but not over $84,350: $5,227.50 plus 28% of the excess over $34,850; Over $84,350 but not over $176,000: $19,087.50 plus 31% of the excess over $84,350; Over $176,000 but not over $382,650: $47,499 plus 36% of the excess over $176,000; and Over $382,650: $121,893 plus 39.6% of the excess over $382,650

Married couples filing a joint return: If taxable income is not over $58,200: 15% of the taxable income; Over $58,200 but not over $140,600: $8,730 plus 28% of the excess over $58,200; Over $140,600 but not over $214,250: $31,802 plus 31% of the excess over $140,600; Over $214,250 but not over $382,650: $54,633.50 plus 36% of the excess over $214,250; and Over $382,650: $115,257.50 plus 39.6% of the excess over $382,650.

President Obama has asked Congress to permanently extend the current 10, 15, 25, and 28 percent rates. Under the president’s proposal, these rates would continue for individuals without interruption after December 31, 2010. However, the president’s proposal would allow the 33 percent rate bracket and the 35 percent rate brackets to become 36 percent and 39.6 percent, respectively, after December 31, 2010.

The president has also asked Congress to expand the tax rate bracket for the 28 percent rate so that individuals with less than $195,550 of taxable income in 2011 ($200,000 of AGI), assuming one personal exemption and the basic standard deduction, indexed from 2009) will not be subject to the 36 percent rate that applies after December 31, 2010. For married individuals filing joint returns and surviving spouses, the dollar threshold for the 36 percent bracket would be set so that married couples and surviving spouses with AGI below $237,300 of taxable income in 2011 ($250,000 of AGI, assuming two personal exemptions and the basic standard deduction, indexed from 2009), subject to the 33 percent rate in 2010, will not become subject to the 36 percent rate after December 31, 2010.

Capital gains/dividends
At the same time taxpayers are looking at higher individual marginal income tax rates, the capital gains and dividend tax rates will also increase after December 31, 2010. For 2010, the maximum capital gains and dividends tax rate is 15 percent (zero percent for taxpayers in the 10 and 15 percent brackets). Effective January 1, 2011, the tax rate on qualified long-term capital gains will be 20 percent and taxpayers will pay tax on dividends at the same rates that apply to ordinary income.

President Obama has asked Congress to impose a 20 percent capital gains and dividends tax rate on individuals with incomes above $200,000 (less the standard deduction and one personal exemption indexed from 2009). The 20 percent rate would also apply to married couples filing a joint return with income above $250,000 (less the standard deduction and two personal exemptions indexed from 2009). All other taxpayers would pay capital gains and dividends taxes of 15 percent unless they qualify for the zero percent tax rate.

If Congress does not act, the tax rate on dividends after December 31, 2010 will be the same as that currently for dividends failing to qualify for the current 15 percent rate; that is, the same as a taxpayer’s personal income tax bracket.

Limitation on itemized deductions
Along with reducing the individual marginal income tax rates, EGTRRA also repealed the limitation on itemized deductions for 2010, but only for 2010. President Obama has asked Congress to allow the limitation on itemized deductions to return but to modify it for 2011 and beyond. Under the president’s proposal, the limitation on itemized deductions would apply to an AGI threshold determined by taking a 2009 dollar amount and adjusting for subsequent inflation. The Obama administration has proposed a dollar amount of $200,000 for single individuals and $250,000 for married couples filing a joint return.

Also impacting higher-income taxpayers is repeal of the personal exemption phase-out. Under EGTRRA, the personal exemption phase-out is repealed for 2010 – but only for 2010.

What’s next
Congress likely will vote on the administration’s proposal to raise only the top two tax brackets this fall. Whether that vote will come in September or in a lame-duck session after the mid-term elections remains uncertain at this time, as does the outcome of that vote. In the interim, our office will continue to monitor the debate and, as Congress gets closer to a decision, prepare year-end tax strategies that respond most effectively to what Congress decides.

Do you have a question about this article? Contact us today.

It appears unlikely that Congress will pass any transfer tax reform in 2010. As a result, 2010 could be the best of times for gifting by affluent clients. Part I of this article on gifting in 2010 (see Newsstand e-mail 7/26/2010) by noted author and planning expert John J. Scroggin considered the multiple factors that encourage making gifts this year. Part II covered select gift planning opportunities available this year (see Newsstand e-mail 7/26/2010). Part III of the article, below, covers 2010 strategies and planning for terminally ill clients.

Trusts created in 2010. Assume a married client is terminally ill and will clearly pass in 2010. The healthier spouse can transfer assets to the terminally ill spouse who redrafts dispositive documents to establish a testamentary bypass and/or QTIP trust. Use of both trusts will allow for a greater step-up in basis under Code Sec. 1022 and provide for a broader group of beneficiaries (i.e., as opposed to just the surviving spouse). If the ill spouse dies in 2010, neither trust will be included in the healthy spouse’s estate in later years and the trusts may provide asset protection to the beneficiaries.

What happens to the basis of the assets bequeathed back to the surviving spouse in trust? For 2010, Code Sec. 1022(d)(1)(C)(i) provides that if assets were gifted to the decedent within three years of the decedent’s death, no basis adjustment may be allocated to the assets. However, Code Sec. 1022(d)(1)(C)(ii) provides that, unless the asset being gifted was acquired by the gifting spouse “by gift or by inter vivos transfer for less than adequate and full consideration in money or money’s worth,” the asset can still receive a basis adjustment pursuant to Code Sec. 1022 . Code Sec. 1014(f) provides that Code Sec. 1014(e) (which eliminates a step up in basis on certain assets gifted within a year of demise) is revoked for 2010.

Basis planning in 2010. With no estate tax and the potential under Code Sec. 1022 of up to $4.3 million in basis adjustments, basis planning for terminally ill clients may trump any estate tax planning in 2010. A few examples:

• If a client is expected to pass in 2010 and owns assets which might be discounted in value, terminally ill clients should consider how to obtain a higher basis for heirs by eliminating the expected discount. For example, assume a married client owns 40% of an LLC which owns several real estate properties. If the estate’s total appreciated value (i.e., the difference between fair market value and the client’s basis) is less than $4.3 million, consider (before death occurs) redeeming the client’s LLC interest for one or more of the underlying pieces of real estate (i.e., direct ownership of the real estate eliminates the LLC minority ownership discount). In the alternative, another LLC member (e.g., a spouse) could gift or sell an 11% LLC interest to the client, permitting the application of a control premium to the LLC value in the decedent’s estate. Obviously, there are other factors which may adversely impact such a plan (e.g., maintaining family control of the asset).
• Assume a terminally ill married client owns an asset with a basis of $500,000 and a fair market value of $200,000. If the client dies, the asset’s basis will step down to its fair market value, resulting in the termination of the tax benefit of the inherent loss in the asset. Instead, the terminally ill client could gift the asset to a spouse or another heir. If the donee subsequently sells the asset for a value from $200,000 to $500,000, no taxable gain will be reported on the sale.
• The tax losses of a decedent are not normally carried over to the estate or heirs, but 2010 offers a unique opportunity. Assume a client holds an asset worth $1.0 million with a basis of $3.0 million. If the client dies owning the asset, the basis will step down to $1.0 million (i.e., its fair market value) and the inherent loss of $2.0 million will disappear. However, for decedents dying in 2010, pre-death tax losses can increase the step-up in basis of the remaining assets in the estate. If the loss asset were sold before death and the client died in 2010, up to an additional $2.0 million in basis adjustments would be allowed for the estate’s assets.
• A client’s wife is terminally ill, but owns no assets. In 2010, the donor transfers low-basis assets to the spouse, who revises her will to provide that those specific assets pass into one or more trusts (see the comments at the start of this article). The assets could receive a basis step-up of up to $4.3 million pursuant to Code Sec. 1022.

Charitable bequests. Many clients make charitable bequests, but if a client is expected to die in 2010, there is no 2010 estate or income tax benefit from making a charitable bequest. To obtain the benefits, make the gift before the client’s death and take advantage of the charitable income tax deduction for the grantor to reduce the grantor’s income taxes. For example, moving a $50,000 charitable gift into the last year of the client’s life could save the family up to $17,500 in federal income taxes (i.e., $50,000 times the 35% top federal income tax rate in 2010). Make sure the dispositive documents are changed to remove the charitable bequests, or the charity might have a claim against the estate. Also make sure the client has sufficient income to use the charitable income tax deduction.

As an alternative to the above example, the will could be changed to make the bequest of $50,000 to an heir in 2010 and request that the heir make the charitable contribution. If the $50,000 gift is an asset with a low basis in the hands of the decedent, funding it through the estate could allow for an increase in the basis using the 2010 basis adjustment rules and might provide for a larger charitable deduction for the heir who makes the charitable contribution.

Planning for gift splitting. Code Sec. 2035(b) does not include gift tax payments in the donor’s estate to the extent that the gift tax was paid by the decedent’s spouse pursuant to a gift-splitting arrangement. The relevant tax policy is that there is no incentive to restore the decedent’s estate under Code Sec. 2035 because no amounts were removed from the estate by the gift tax payment. This offers a planning opportunity. If one spouse is in poorer health than the other, consider making a gift splitting election and have the healthier spouse (assuming he or she has the available funds from their own resources) pay the total gift tax (See: PLR 9214027 (Jan. 7, 1992)). This eliminates the chance that the gift tax will be included in the unhealthy spouse’s taxable estate. What if neither spouse is in great health? Consider gift splitting and having each spouse pay half the gift tax, increasing the chance that at least one of them will survive beyond the three years.

Death-bed gifts. Death-bed annual exclusion gifts are a significant planning tool. However, in Rev Rul 96-56, 1996-2 CB 161, IRS ruled that if the donor dies before a gift check clears his or her account, the gift is not removed from the estate. In general, charitable death-bed checks do not have to clear the decedent’s accounts before death, while non-charitable gifts do have to clear the account.

Death-bed gifts may make sense for clients who will pass after 2010. Assume a terminally ill client has no descendants, but does have a taxable estate in 2011. In her will she made 20 special bequests of $5,000 each to friends, with the balance of her estate passing to nieces and nephews. The will provides that the residue pays any estate tax. Have the client make the $100,000 in transfers during life as annual exclusion gifts and revise the will to eliminate those bequests. Assuming the client dies after 2010, converting the bequests to annual exclusion gifts saves the nieces and nephews $41,000 to $60,000 in estate taxes (i.e., the range of effective estate tax rates in 2011).

Estate planning advisors need to prepare their clients for the looming 2011 tax changes and consider the unique planning opportunities of 2010. Congress’s decision or inability to deal with EGTRRA’s sun-setting provisions in 2010 is going to keep the estate and tax planning industry busy for some time.

As chaotic as the last few years have been, there is at least one remaining time bomb in EGTRRA. Section 901(a) of EGTRRA reads: “All provisions of, and amendments made by, this Act shall not apply to… (2) in the case of title V [the transfer tax changes] to estates, of decedents dying, gifts made or generation skipping transfers, after December 31, 2010.” Section 901(b) reads: “The Internal Revenue Code of 1986… shall be applied and administered to years, estates, gifts and transfers described in subsection (a) as if the provisions and amendments described in section (a) had never been enacted.” The inability to understand the full implications of the underlined language will add to the tax planning chaos after 2010 and will undoubtedly result in the creation of new and highly questionable planning proposals.

Author: John J. Scroggin, AEP, J.D., LL.M., member of the Georgia and Florida Bars and practices in Atlanta. He is a nationally recognized speaker and author of over 250 articles and columns on estate, tax and business planning.

Deadline extended for closing home purchase to qualify for homebuyer credit. Relief has been provided to taxpayers who couldn’t meet a key June 30, 2010, closing date for qualifying for the homebuyer credit. As a general rule, both the regular first-time homebuyer credit of $8,000 and the reduced credit of $6,500 for long-term residents generally expired for homes purchased after Apr. 30, 2010. However, if a written binding contract to purchase a principal residence was entered into before May 1, 2010, the credit could be claimed if the purchase closed before July 1, 2010. Under the relief measure, if a written binding contract to purchase a principal residence was entered into before May 1, 2010, the credit may be claimed if the purchase is closed before Oct. 1, 2010. Thus, this extension allows homebuyers who signed a contract no later than the April 30th deadline to complete their closing by the end of September.

Guidance addresses tax breaks for hiring new employees. Employers are exempted from paying the employer 6.2% share of Social Security (i.e., OASDI) employment taxes on wages paid in 2010 to newly hired qualified individuals. These are workers who: (1) begin employment with the employer after Feb. 3, 2010 and before Jan. 1, 2011, (2) certify by signed affidavit, under penalties of perjury, that they haven’t been employed for more than 40 hours during the 60-day period ending on the date the individual begins employment with the qualified employer; (3) do not replace other employees of the employer (unless those employees left voluntarily or for cause), and (4) aren’t related to the employer under special definitions. The payroll tax relief applies only for wages paid from Mar. 19, 2010 through Dec. 31, 2010.

Employers may qualify for an up-to-$1,000 tax credit for retaining qualified individuals. The workers must be employed by the employer for a period of not less than 52 consecutive weeks, and their wages for such employment during the last 26 weeks of the period must equal at least 80% of the wages for the first 26 weeks of the period.

The IRS has issued guidance on these tax breaks in the form of frequently asked questions. They carry valuable information on subjects such as the scope of the exemption, how it interacts with other tax breaks, and when an employer must receive the employee’s certification of former unemployment status. For example, the IRS explains that the exemption and credit can be claimed for a new employee replacing a downsized employee.

Detailed guidance released on new small business health care credit. The IRS has issued detailed guidance on the small employer health insurance credit created by the recently-enacted health reform legislation. Under the new law, effective for tax years beginning after Dec. 31, 2009, an eligible small employer (ESE) may claim a tax credit for nonelective contributions to purchase health insurance for its employees. An ESE is an employer with no more than 25 full-time equivalent employees (FTEs) employed during its tax year, and whose employees have annual full-time equivalent wages that average no more than $50,000.

However, the full credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages from the employer of not more than $25,000. The new guidance adopts a liberal approach to the new law’s requirements, including three alternative methods for figuring total hours of service (important for determining how may FTEs an employer has), and also explains how small employers claim the credit if their State provides a credit or subsidy for employee health coverage. The IRS has released a state-by-state table of average health insurance premiums for the small group market for the 2010 tax year. The table is needed to calculate the credit for this year.

Guidance issued on new under-age-27 rule for health coverage of children. The IRS has issued guidance on the tax treatment of health coverage for children under age 27 under the new health reform law. The new under-age-27 rule, which went into effect March 30, 2010, applies broadly to employer-provided coverage or reimbursements, cafeteria plans, flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs), voluntary employees’ beneficiary associations (VEBAs), and the above-the-line deduction for a self-employed individual’s medical care insurance costs.

Availability of FICA exception for medical residents to be resolved. The Supreme Court has agreed to review a 2009 decision of the Court of Appeals for the Eighth Circuit, which upheld the validity of regulations that generally prevent medical residents from qualifying for the FICA student exception. Under these regulations, an employee includes a medical resident who works 40 hours or more for a school, college or university is not eligible for the student exception. The Supreme Court will now decide their validity. Its decision will have important ramifications for the many teaching hospitals and their residents.

States address estate planning uncertainty. As of now, there is no estate or generation-skipping transfer (GST) tax for individuals who die this year. There are issues as to how formula clauses in wills and trusts using estate or GST tax terms (e.g., “the applicable exclusion amount,” or “the marital deduction”) will be construed, if the decedent dies in 2010. Several states have addressed this situation by enacting laws providing a special rule of construction under which formula clauses that refer to certain estate and GST tax terms generally will be construed as referring to the federal estate tax and GST tax laws which applied to estates of decedents dying on Dec. 31, 2009. These statutes could impact the amount that will pass under one’s will to a person’s spouse and children.

Deadline extended for retirement plans in federally declared disaster areas in eight states. The IRS has administratively extended to July 30, 2010, the April 30, 2010, deadline for restating affected pre-approved defined contribution plans and, if applicable, for submitting determination letters to the IRS, and the Code Sec. 401(b) remedial amendment period for these retirement plans. The relief applies to sponsors of defined contribution plans that were affected by the storms and other severe weather in counties in Alabama, Connecticut, Massachusetts, Mississippi, New Jersey, Rhode Island, Tennessee and West Virginia that were federally declared disaster areas in the period from March 1 through May 31, 2010.

Therapeutic Discovery Project Program implemented. The IRS has established the guidelines for applying for the new Therapeutic Discovery Project Program created by the recently enacted health reform legislation. The program will provide tax credits and grants to small firms that show significant potential to produce new and cost-saving therapies, support good jobs and increase U.S. competitiveness. Small firms may apply for certification for tax credits or grants under the program on Form 8942, which must be postmarked no later than July 21, 2010.

Temporary regulations fill in statutory gaps on new indoor tanning tax. The IRS has issued temporary regulations on the health reform’s legislation’s new 10% excise tax on indoor tanning services provided on or after July 1, 2010. The regs address practical considerations that may not have been contemplated when the law was drafted. For example, they addresses prepayments for tanning services and services provided as part of a gym membership.

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.