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.

A. Generally, if you do volunteer work for a charity, you are not entitled to deduct the cost of services you perform for the charity. However, if in connection with the volunteer work you incur out-of-pocket expenses, you may be entitled to deduct some of those expenses.

Qualifying expenses
If the amounts that you pay for food and other supplies used in the preparation and packaging of the meals are not reimbursed by the charity, generally you may deduct these expenses as contributions to the charity.

In addition, if the amounts that you pay to travel by car or other means to deliver the meals are not reimbursed by the charity, and you derive no personal benefit from the travel, the expenses are deductible. Qualifying expenses include gasoline for your car and fares for taxis or public transportation.

Special mileage rate
If you drive your own vehicle to deliver the meals, you can use a special IRS mileage rate to calculate charitable contribution deductions involving use of your car. This special rate is 14 cents per mile, which is statutorily set.

Other expenses
Other out-of-pocket expenses incurred in connection with services you provide to a charity that are deductible include costs related to uniforms, travel, meals, and lodging. Sometimes, expenses incurred while serving as a charity’s delegate to a convention may be deducted.

Keep receipts
If you take a deduction for out-of-pocket expenses you incurred incident to your performance of services for a charity, it is important to have receipts to document expenses. It is also a good idea to get a written acknowledgement from the charity for the services you provide.

Contact us for more details regarding deductions for charitable work.

Estate tax
The federal estate tax was abolished as of January 1, 2010. In its place, a modified carryover basis regime is applied to large estates. However, this treatment is temporary and the federal estate tax will return in 2011 at higher rates than in recent years.

Congress has tried several times, but failed, to extend the federal estate tax. In late 2009, the House approved a permanent extension of the estate tax but the bill has languished in the Senate. The estate tax was put on the back burner as the Senate debated health care reform and financial reform. The Senate could take up the House bill this summer or pass its own bill. In that case, the bill would have to go back to the House, delaying passage even more.

Individual tax rates
Almost 10 years ago, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The law gradually reduced the individual marginal tax rates. For 2010, the individual marginal tax rates are 10, 15, 25, 28, 33, and 35 percent. After December 31, 2011, the rates will revert to their pre-EGTRRA percentages. The top two rates will rise from 33 and 35 percent to 36 and 39.6 percent.

President Obama has asked Congress to extend all of the lower rates except for the top two rates. The 36 percent and 39.6 percent rates would apply to individuals with incomes over $200,000 and married couples filing joint returns with incomes over $250,000. Congress could extend the lower rates permanently or for a period of years. The large federal budget deficit has some lawmakers talking about a temporary extension of the lower rates and revisiting them when the economy rebounds.

Democratic leaders in the House and Senate have not indicated when legislation extending the lower rates will be introduced. Many lawmakers are wary of raising taxes before the November Congressional elections so legislation may wait until a lame duck session in December.

Capital gains and dividends
The maximum dividends and capital gains tax rate for 2010 is 15 percent (zero percent for taxpayers in the 10 or 15 percent brackets). After December 31, 2010, the maximum capital gains tax rate will rise to 20 percent for all taxpayers. Dividends will return to being taxed as ordinary income.

President Obama has also asked Congress to extend the current dividends and capital gains tax rate but impose a higher rate on higher-income taxpayers. The maximum rate on dividends and capital gains for individuals with incomes over $200,000 and married couples filing jointly with incomes over $250,000 would be 20 percent. The 15 and zero percent rates would apply to all other taxpayers.

AMT patch
The alternative minimum tax (AMT) is, as its name says, an alternative tax to the regular tax. Because the AMT was not indexed for inflation, and for other reasons, the AMT is gradually encroaching on middle income taxpayers, contrary to Congress’s original intent. The large federal budget deficit again makes lawmakers wary of repealing the AMT. Instead, Congress has “patched” it annually.

The AMT patch provides relief by giving taxpayers higher exemption amounts. Additionally, the nonrefundable personal tax credits are allowed to the full extent of the taxpayer’s regular tax and AMT liability.

Child tax credit
In 2009, Congress enhanced the child tax credit by increasing the refundable portion of the credit for the 2009 and 2010 tax years to 15 percent of earned income in excess of $3,000. Several bills are pending in Congress to make permanent the $3,000 threshold or reduce it even further.

More bills
Many tax bills have been introduced since the start of the year and have been referred to the House and Senate tax writing committees. Among the pending bills are ones to:
- Extend the Making Work Pay Credit
- Extend the American Opportunity Tax Credit
- Renew the first-time homebuyer tax credit
- Reforming the worker classification rules
- Enhance transportation fringe benefits
- Make permanent the Build America Bonds program

Please contact us if you have any questions about pending federal tax legislation.

It also revised Form 941, Employer’s Quarterly Federal Tax Return, and Forms W-2, Wage and Tax Statement, and W-3, Transmittal of Wage and Tax Statements, to reflect the HIRE Act.

Temporary Incentive
Under the HIRE Act, qualified employers can enjoy a payroll tax holiday from their share of OASDI tax paid for covered employees. The “holiday” applies to all covered employees for wages after March 18, 2010 and before January 1, 2011. Additionally, the new employee can begin employment anytime after February 3, 2010, although only 2010 wages paid after March 18 count for the holiday.

The HIRE Act also allows qualified employers to claim a worker retention credit. For each covered employee, the employer’s general business credit is increased by the lesser of $1,000 or 6.2 percent of the retained worker’s wages during a 52-week consecutive period. That 52-week period can start anytime after February 3, 2010 and through December 31, 2010.

Form W-11
The HIRE Act requires employers to obtain a statement from each eligible new hire certifying that he or she has been unemployed or underemployed. Employers can use new Form W-11, Hiring Incentives to Restore Employment (HIRE) Act Employee Affidavit.

Form W-11 asks the covered employee to certify that he or she has been unemployed or has not worked for anyone for more than 40 hours during the 60-day period ending on the date that the individual began employment with the employer. The covered employee must sign the form under penalties of perjury. Form W-11 does not have to be filed with the IRS but the employer must make the form available to the IRS if requested.

Form 941
The IRS has also revised Form 941, Employer’s Quarterly Federal Tax Return, for the HIRE Act. The payroll tax exemption is claimed on Form 941 beginning with the second quarter of 2010. For wages paid to covered employees during the period of March 19 through March 31, 2010, the payroll tax exemption is claimed on the employer’s Form 941 for the second quarter of 2010.

Forms W-2, W-3
Employers that hire a covered employee under the HIRE Act must report the amount of Social Security wages and tips paid after March 18, 2010 for which the employer claimed a payroll tax exemption. Employers will report these amounts in Box 12 on Form W-2 using new code CC. The amount may not exceed $106,800 (the maximum Social Security wage base for 2010). The total of code CC is reported in new Box 12b on Form W-3.

Mileage rates The business standard mileage rate is used to compute the deductible costs of operating an automobile for business use in lieu of the extra burden of tracking actual costs. The business standard mileage rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage.

As of January 1, 2010, the following mileage rates will be available for use by taxpayers:

• 50 cents per mile for business miles driven
• 16.5 cents per mile driven for medical or moving purposes
• 14 cents per mile driven in service of charitable organizations

The depreciation component for the business mileage rate will be 23 cents-per-mile for 2010, which is an increase from 21 cents-per-mile in 2009.

Limitations

The business standard mileage rate cannot be used to compute the deductible expenses of automobiles used for hire or five or more automobiles owned or leased by a taxpayer and used simultaneously. The business standard mileage rate also cannot be used in the case of an automobile that is leased by the taxpayer, unless he or she uses either the business standard mileage rate or the variable rate allowance (FAVR allowance) to compute the deductible business expenses of an automobile for the entire lease period (including renewals).

High wealth individuals  The IRS has created a Global High Wealth Industry Group. Teams of IRS experts will comb returns of individuals with tens of millions of dollars of assets or income to uncover aggressive tax strategies. The Global High Wealth Industry Group will also look at, among other issues, businesses controlled by high wealth individuals to better assess the risk that such arrangements may pose to tax compliance, Shulman said. Shulman did not give any precise criteria that the U.S. Global High Wealth Industry Group will use to identify taxpayers but noted that their returns are easy to identify. “High wealth individuals are not your typical Form 1040 filers with a W-2, some 1099 income, and maybe a Schedule C enclosed with their return. Their tax picture is much more complicated and nuanced,” Shulman said. Other countries have also created similar initiatives. “Tax agencies around the world, including those in Japan, Germany, the UK, Canada and Australia, have also formed high wealth groups,” Shulman said.

Offshore accounts  Shulman also praised the outcome of the IRS’s recent voluntary offshore compliance initiative. More than 14,000 taxpayers requested to participate in the initiative, which offered a reduced penalty framework in exchange for full disclosure of unreported offshore accounts. The IRS is just starting to review all the disclosures and the process will take some time. “The IRS will be mining the voluntary disclosures for information to identify financial institutions, advisors, and others who promoted or otherwise facilitated U.S. persons hiding assets and income offshore and attempted to shirk their tax responsibilities at home,” Shulman said. Shulman cautioned taxpayers not to become complacent after the conclusion of the offshore initiative. “A ‘hide-in-the- sand’ approach to reporting offshore accounts and income has become a much riskier calculus for U.S. taxpayers holding assets anywhere around the world,” Shulman said. The IRS has a long history of cooperating with tax authorities in other countries. The U.S. has negotiated tax treaties with many countries, which provide for the exchange of information. Traditionally, international cooperation has stopped short of joint audits. Shulman said that joint audits may be conducted in the future. “We are working on a protocol to conduct joint audits with some of our treaty partners,” Shulman said.

Transfer pricing  Finally, Shulman said that the IRS is also establishing a Transfer Pricing Practice within its Large and Mid-Size Business operating division to administer transfer pricing issues. According to Shulman, the group will be composed of transfer pricing experts who will identify emerging issues and trends in transfer pricing and provide consistent outcomes in transfer pricing cases.

Offshore compliance

In 2010, the government will continue its follow-up work in pursuing disclosures made by UBS AG, as well as by individuals who, in 2009, disclosed names of advisors and other facilitators in record numbers. According to IRS Commissioner Doug Shulman, an “unprecedented” number of offshore account disclosures have been made. In addition, the IRS will make inroads in its multi-plank offshore tax reform plan, publishing (and enforcing) loophole-closing guidance such as recent temporary regulations that tightened restrictions on corporate inversion transactions.

Net operating losses

Net operating losses took center stage in 2009 as the economic downturn continued to generate NOLs that were useless to many businesses as immediate cash generators under the regular two year carryback provisions. The five-year 2008 NOL carryback for small businesses of the American Recovery and Reinvestment Act of 2009 and the modified five-year 2008 or 2009 NOL carryback option under the Worker, Homeownership, and Business Assistance Act of 2009 created much IRS guidance on elections and refund claims. Since the modified five-year election between 2008 and 2009 need not be made until the extended due dates for 2009 tax returns (although the business pressure to claim cash refunds immediately remains intense), NOLs – how to compute them, how to generate them and how to claim them –are guaranteed to continue to be a hot focal point in 2010, as will the intense business pressure to claim cash refunds on the election as soon as possible.

Tax gap

As part of its effort to close the “tax gap” – the difference between what taxpayers owe and what is collected – the IRS (with encouragement from Capitol Hill) set into motion in 2009 an array of programs and initiatives that will expand in 2010. In addition to the offshore compliance initiative, IRS efforts will include a new employment tax audit program, plans to more tightly regulate tax return preparers, development of rules for credit card reporting on merchants, and laying the groundwork for implementing basis reporting by stockbrokers, as well as continuing the use of penalty provisions to create a virtual second tier of tax liability for missteps in determining when a tax strategy “crosses the line.”

Cancellation of indebtedness income

Although the recession has put a damper on acquiring real income, there continues to be no lack of cancellation of indebtedness (COD) income – nor issues over how exceptions to COD income should operate. Guidance regarding certain COD income continues to be a work in progress and the Treasury Department has promised rules on certain COD income in early 2010.

Homebuyer tax credit

The first-time homebuyer tax credit’s latest iteration extends through April 30, 2010 (or closings before July 1 on contracts executed before May 1). The credit has certainly been one of the most publicized tax breaks in recent years. As a result, many homeowners and real estate agents have acted first and then called on their tax professional to “confirm and collect” on the credit. Nevertheless, after-the-fact strategies are available for both 2009 and 2010 purchases. This is especially true in connection with the long-time homebuyer portion of the credit under which income, residency, and the election to claim on the prior year’s return offer some flexibility.

Change of accounting

In 2009, the IRS made significant revisions to its required procedures for taxpayers to obtain automatic IRS consent to a change in accounting method. A new revenue procedure added a number of methods for which taxpayers may obtain automatic consent and modified the rules that must be followed for obtaining automatic consent to an accounting method change. More companies are looking at accounting methods as part of their tax planning to enhance cash flow. Based on that evidence, filings of accounting method changes should continue into 2010 at a record pace.

AFRs and asset values at historical lows

These days, it is difficult to have a below-market loan on which interest must be imputed considering that the rate charged would need to be below the current applicable federal rate (AFR). Low asset valuation also creates a particularly advantageous environment in which to convert from a corporation to a partnership, with taxable gain fixed in many cases at its lowest point in years. In addition to these factors, add the deadline created by the probability of higher taxes starting in 2011. 2010 strategies to take advantage of low interest rates and low values cannot be overemphasized.

Legislation

The tax implications of health care reform, corporate tax reform, international tax reform, and a rise in the higher individual income tax rates (from the current 33 and 35 percent brackets to 36 and 39.6 percent, respectively, as well as higher capital gains rates) will all impact on long-term tax strategies undertaken in 2010 – so will those issues continuing to arise from the bumper crop of 2008 and 2009 tax legislation we have just gone through. Without any new case law, Treasury regulations or IRS initiatives in 2010 (of which there are sure to be plenty of surprises), tax legislation will keep individuals and businesses busy.

Estate tax

Effective for decedents dying on or after January 1, 2009, the traditional federal estate tax with its stepped-up basis at death rules no longer apply. New carryover basis at death rules apply. In addition, the generation skipping transfer (GST) tax does not apply to generation skipping transfers made after December 31, 2009. The federal give tax, however, does continue, albeit in modified form from 2009.

All of these changes were set in motion by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which abolished the federal estate tax for 2010 but only for 2010. At that time, supporters expected the temporary elimination of the federal estate tax to be made permanent before 2010. They lacked sufficient support in Congress to make that happen. During 2009, many lawmakers in Congress proposed an extension of the 2009 estate tax rules with a $3.5 million exclusion ($7 million for married couples) and a top tax rate of 35 percent. In fact, the House passed such a bill. The Senate, however, did not approve the House bill before the end of 2009. Consequently, the rules put in place in 2001 have come into effect in 2010.

What does this mean? The flux in the estate tax adds to uncertainty in estate planning. However, Congress is expected remedy the situation shortly. Congress will enact retroactive legislation in January or early in 2010 to extend the 2009 estate tax regime with its $3.5 million exclusion and 35 percent top tax rate for 2010. Carryover basis at death is expected to be short-lived.

Please contact our office if you have any questions about your estate plan. Congress’ inaction at the end of 2009 has caused confusion. We will review your plan and make sure you are well prepared for Congress’ expected extension of the 2009 estate tax treatment.

AMT

Another area of uncertainty is the AMT. The AMT was designed to ensure that very wealthy individuals did not evade federal taxes. However, Congress did not index the AMT for inflation. Consequently, the AMT has encroached on more middle income taxpayers, especially two income couples in high tax states.

In recent years, Congress has passed an AMT “patch” to help middle income taxpayers avoid the AMT. The patch provides higher exemption amounts and other relief. Congress enacted a patch for 2009 but recessed for the December holidays before passing a patch for 2010. One stumbling block is the cost of a patch and disagreements in the House and Senate whether the cost should be offset by revenue raisers. We will keep you updated of developments.

Health care

House and Senate Democrats are drafting a final health care reform bill for passage by both chambers, possibly in January. In December, the House and Senate passed similar health care reform bills but with important differences in revenue raisers. The Senate passed, by a vote of 60-39, the Patient Protection and Affordable Care Act late on Christmas Eve. The chief revenue raiser in the House bill is a proposed surtax on higher income individuals (individuals with incomes over $200,000 and families with incomes over $250,000). The Senate rejected the House surtax and instead approved a new excise tax on high-dollar insurance plans. Other revenue raisers under negotiation include new limits on health flexible spending arrangements and health savings accounts, a new excise tax on indoor tanning, an additional Medicare tax for higher-income individuals, and more.

The final conference bill is expected to require employers to provide health insurance to their employees.  Employers that do not will be subject to an additional tax with an exception for small employers. The final bill could classify a small employer as one with 50 or fewer full time employees or use a lower threshold; for example, 25 full-time employees. The conference bill is also expected to provide tax credits to help small businesses purchase health insurance for their employees. Individuals without coverage generally would be liable for an additional tax unless covered by Medicare or other qualified coverage.

The conference bill will change the fundamental landscape of health care in the U.S. The tax-related provisions in themselves are monumental. To complicate matters, some provisions go into force immediately and some are delayed for up to three years. Please contact our office if you have any questions about this important legislation.

COBRA

COBRA continuation coverage provides eligible individuals the opportunity to continue their employer-provided health insurance coverage after a layoff or other qualified event. However, COBRA requires individuals to 100 percent self-pay their premiums. The cost makes COBRA out of reach for many individuals.

In the American Recovery and Reinvestment Act of 2009, Congress created a temporary subsidy to help eligible individuals pay for COBRA coverage. Eligible individuals pay 35 percent of the premium cost and the former employer pays 65 percent, which it recovers through a payroll tax credit. Under the 2009 Recovery Act, eligibility for COBRA premium assistance expired after December 31, 2009.

Congress provided a temporary extension in the FY 2010 Defense Appropriations Bill. This bill extends eligibility for COBRA premium assistance through February 28, 2010.

COBRA premium assistance is limited to eligible individuals (and certain beneficiaries) who are involuntarily terminated from employment. Generally, this means a lay-off or furlough but other separations from employment may also qualify. If you have experienced a separation from employment, please contact our office. You may qualify for COBRA premium assistance.

Jobs bill

Just before recessing for the December holidays, the House approved the Jobs for Main Street Act. The House jobs bill would extend eligibility for COBRA premium assistance through June 30, 2010. The House bill would also extend unemployment benefits and make the child tax credit available to more taxpayers.

The Senate did not take up the House jobs bill in December. Democrats in the Senate are drafting their own jobs bill, the details of which are expected to be revealed early this year. The Senate bill may include some tax incentives for businesses, such as an extension of bonus depreciation and enhanced Code Sec. 179 expensing. These incentives expired after December 31, 2009.

More bills

On January 1, 2010, the state and local sales tax deduction, the higher education tuition deduction and many other tax deductions and credits expired. These popular incentives are temporary and are known as extenders because Congress usually extends that every year. The House voted to extend these provisions through 2010 but the Senate recessed in December without taking up the House bill. The extenders bill could be put on the back burner until spring.

Congress is also debating whether to impose tougher rules on the reporting of foreign bank accounts owned by U.S. taxpayers. In December, the House passed a bill that would impose new penalties on taxpayers that fail to disclose certain foreign accounts on their tax returns. The House bill would also encourage foreign banks to enter into agreements with the IRS to voluntarily disclose the existence of certain accounts. The Senate did not vote on the House bill before its December recess. The provisions are popular in the Senate, which in the past has promised to crack down on so-called tax havens and Americans who hide money and assets offshore.

Planning

As 2010 unfolds, we’ll have a clearer picture of when these and other tax bills will be enacted. In the meantime, please contact our office if you have any questions about the bills we have discussed or any others.

Nonbusiness energy property credit

The nonbusiness energy property tax credit equals 30 percent of a homeowner’s expenses on eligible energy-saving improvements, up to $1,500 for the combined 2009 and 2010 tax years. Expenses that can qualify for the credit include certain high-efficiency heating and air conditioning systems, water heaters, and stoves that burn biomass. Labor costs associated with the installation of these items also qualify as expenses eligible for the credit. Additionally, the costs of energy-efficient windows, skylights and doors, as well as qualifying insulation and certain roofs are also eligible for the credit. However, the costs of installing these items do not qualify.

Residential energy property credit

The residential energy property credit equals 30 percent of qualifying property expenses. There is no cap on the amount of the credit available, except for fuel cell property. Property that qualifies for the credit includes electric systems, solar hot water heaters, geothermal heat pumps, wind turbines, and fuel cells. Generally, the credit covers labor costs as well. The credit is available until 2016.