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

Successful filing season

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

Extensions

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

Installment agreements

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

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

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

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

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

Amended returns

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

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

Targeted penalty relief

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

Records

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

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

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

Challenges

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

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

Supreme Court grants review

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

Individual mandate and penalty

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

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

Tax provisions

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

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

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

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

• Increased itemized deduction for unreimbursed medical expenses after 2012;

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

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

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

• Tax credit for therapeutic discovery projects;

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

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

• Codification of the economic substance doctrine.

Anti-Injunction Act

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

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

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

Testimony

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

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

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

JCT report

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

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

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

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

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

Code Sec. 1231 applies to gains and losses from property used in the trade or business and from involuntary conversions. Normally, you have to determine whether property is a capital asset or is ordinary income property. Property generally can’t be both. However, Code Sec. 1231 allows you to “have it” both ways. Any gains are taxed at low capital gains rates (generally 15 percent for 2012), and any losses are treated as ordinary losses, taxable at more favorable ordinary loss rates, and available (without limit) to offset other ordinary income.

Who qualifies?

Code Sec. 1231 gains include:

--Recognized gains on the sale or exchange of property used in the trade or business; and

--Recognized gains from the involuntary or compulsory conversion (into money or other property) of property used in a trade or business, or of property held for more than one year and either used in the trade or business or used in a transaction entered into for profit.

Property used in a trade or business is property that is subject to depreciation and held by the taxpayer for more than one year.

Code Sec. 1231 losses are any recognized loss from a sale, exchange, or conversion of the same categories of property.

A win-win equation

Gains and losses from these transactions are referred to as Code Sec. 1231 gains and Code Sec. 1231 losses. The character of the gain or loss depends on whether Code Sec. 1231 gains exceed Code Sec. 1231 losses for the tax year. If the Code Sec. 1231 gains exceed the Code Sec. 1231 losses, then all of the Code Sec. 1231 gains and losses are treated as long-term capital gains and losses. The result is a net long-term capital gain. This amount can then be netted with other capital gains and losses.

Code Sec. 1231 does not apply to depreciation that must be recaptured as ordinary income under either Code Sec. 1245 (depreciable personal property and certain real property) or Code Sec. 1250 (depreciable real property that is not Code Sec. 1245 property).

If, however, the Code Sec. 1231 losses equal or exceed the Code Sec. 1231 gains, then all of the Code Sec. 1231 gains and losses are treated as ordinary income and losses. The net result is an ordinary loss, which can offset other ordinary income.

The family partnership is a common device for reducing the overall tax burden of family members. Family members who contribute property or services to a partnership in exchange for partnership interests are subject to the same general tax rules that apply to unrelated partners. If the related persons deal with each other at arm's length, their partnership is recognized for tax purposes and the terms of the partnership agreement governing their shares of partnership income and loss are respected.

Interfamily gifts

Because of the tax planning opportunities family partnerships present, they are closely scrutinized by the IRS. When a family member acquires a partnership interest by gift, however, the validity of the partnership may be questioned. For example, a partnership between a parent in a personal services business and a child who contributes little or no services is likely to be disregarded as an attempt to assign the parent's income to the child. Similarly, a purported gift of a partnership interest may be ignored if, in substance, the donor continues to own the interest through his power to control or influence the donee's business decision. When a partnership interest is transferred to a guardian or trustee for the benefit of a family member, the beneficiary is considered a partner only if the trustee or guardian must act independently and solely in the beneficiary's best interest.

Capital or services

The determination of whether a person is recognized as a partner depends on whether capital is a material income-producing factor in the partnership. Any person, including a family member, who purchases or is given real ownership of a capital interest in a partnership in which capital is a material income-producing factor is recognized as a partner automatically. If capital is not a material income-producing factor (for example, if a partnership derives most income from services, a family member is not recognized as a partner unless all the facts and circumstances show a good faith business purpose for forming the partnership.

If the family partnership is recognized for tax purposes, the partnership agreement generally governs the partners' allocations of income and loss. These allocations are not respected, however, to the extent the partnership agreement does not provide reasonable compensation to the donor for services he renders to the partnership or allocates a disproportionate amount of income to the donee. The IRS can re-allocate partnership income between the donor and donee if these requirements are not met.

Investment partnerships

The general rule for determining gain recognition for marketable securities does not apply to the distribution of marketable securities by an investment partnership to an eligible partner. An investment partnership is a partnership that has never been engaged in a trade or business (other than as a trader or dealer in the certain specified investment-type assets) and substantially all the assets of which have always consisted of certain specified investment-type assets (which do not include, for example, interests in real estate or real estate limited partnerships).

If a family limited partnership (FLP) qualifies as an investment partnership, the FLP could redeem the partnership interest of an eligible partner with marketable securities without the recognition of any gain by the redeemed partner. To qualify, substantially all the assets of the FLP must always have consisted of the eligible investment assets, and the holding of even totally passive real estate interests (real estate that does not constitute a trade or business), for instance, must be kept to a minimum. In addition, any eligible partner must have contributed only the specified investment assets (or money) in exchange for his or her partnership interest.

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

May 2

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

May 4

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

May 9

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

May 10

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

May 11

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

May 16

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

May 18

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

May 23

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

May 25

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

May 31

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

June 1

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

Taxpayers can request a copy of their federal income tax return and all attachments from the IRS.  In lieu of a copy of your return (and to save the fee that the IRS charges for a copy of your tax return), you can request a tax transcript from the IRS at no charge. A tax transcript is a computer print-out of your return information.

Tax return copy

A copy of your tax return is exactly that: a copy of the return you filed with the IRS. According to the IRS, copies of individual tax returns are generally available for returns filed in the current year and the past six years. The IRS charges a fee of $57 to send taxpayers a copy of their return.

Requests for copies of tax returns should be filed on Form 4506, Request for Copy of Tax Return.  The IRS has advised on its website that taxpayers should allow 60 days to receive a copy of their tax return.

Tax return transcript 

A tax return transcript shows most line items from your return as it was originally filed, including any accompanying forms and schedules. However, a tax transcript does not show any changes the taxpayer or the IRS made after the return was filed. According to the IRS, a tax return transcript is generally available for the current and past three years.

Taxpayers can request transcripts online at the IRS web site, telephoning the IRS, or filing Form 4506T-EZ, Short Form Request for Individual Tax Return Transcripts. Businesses that need business-related information should file Form 4506-T, Request for Transcript of Tax Return. Taxpayers can request that the IRS send the transcript to their tax representative.  The IRS reported on its website that transcript requests made online or by telephone generally will be processed within five to 10 days; transcript requests made by filing a paper form take longer to process.

Tax account transcript

The IRS also can provide a tax account transcript.   This document shows basic data from the individual’s return and includes any adjustments the taxpayer or the IRS made after the return was filed.  A tax account transcript is generally available for the current and past three years, according to the IRS and is provided at no-cost.

If you have any questions about the types of tax records available from the IRS, please contact our office.

With the stock market fluctuating up and down (but especially down), some investors may decide to cash out investments that they initially planned to hold.  They may have taxable gains or losses they did not expect to realize.  Other investors may look to diversifying their portfolios further, moving a more significant portion into Treasury bills, CDs and other “cash-like” instruments, or even into gold and other precious metals. Here are reminders about some of the tax issues involved in these decisions.

Capital Assets and Dividends

Capital assets. Most items of property are capital assets, unless they are inventory or are used in a trade or business. Stock and securities are capital assets. Gains and losses from a capital asset are short-term if the property is held for one year or less, with gains taxed at ordinary income rates and deductible losses (short- or long-term) limited to $3,000 annually. Long-term gains (from property held more than one year) are generally taxed at a 15 percent rate.

Stock and securities. For stock and securities traded on an established market, the holding period begins the day after the trade (purchase) date and ends on the trade (sale) date. The settlement date, which is a few days later, is not relevant to the holding period determination.

Precious metals. The maximum capital gains rate on collectibles is 28 percent, rather than 15 percent. Collectibles include gems, coins, and precious metals, such as gold, silver or platinum bullion. If the taxpayer’s regular tax rate is lower than the maximum capital gain rate, the regular tax rate applies. Collectibles gain includes gain from the sale of an interest in a partnership, S corp or trust from unrealized collectibles’ appreciation, but does not include investments in a non-passthrough entity like holding shares in a mining company operating as a C corporation. Since gold is considered investment property in whatever form held, however, capital loss from a sale of gold (if a loss can be imagined) would be deductible.

Dividends. If a dividend is declared before the stock is sold but paid after the sale, the payee or owner of record when the dividend was declared is taxable on the dividend. Dividends are qualified (and taxed at the lower 15 percent rate) if the stock is held for at least 61 days during the 121-day period that begins 60 days before the “ex-dividend” date (the first date on which the buyer is not entitled to the next dividend payment). Again, the holding period includes the day the stock is disposed of but does not include the purchase date.

Wash sale rules. Taxpayers cannot deduct losses from a wash sale. A wash sale is a sale of stock or securities preceded or followed by a purchase of identical stock or securities within 30 days of the sale. A purchase includes a purchase by the taxpayer’s IRA. Thus, taxpayers cannot cash in a loss while, in effect, retaining the investment. The holding period for a wash sale begins when the old stock or securities were acquired. The loss that is disallowed is added to the basis of the stock or securities purchased.

Interest Income

Treasury securities. T-bills are sold at a discount for terms up to one year. The difference between the discounted price and the face value received at maturity is interest. Most U.S. Treasury bonds or notes pay interest every six months. The interest is taxable when paid. Certain issues of U.S. Treasury bonds can be exchanged tax-free for other Treasury bonds.

Corporate bonds. If a taxpayer sells a corporate bond between payment dates, part of the price represents accrued interest and must be reported as interest. 

Certificates of deposit.  For short-term CDs (one year or less), interest may be payable in one payment at maturity. Interest is generally taxable when paid or when not subject to a substantial penalty. If interest can only be withdrawn by paying a penalty, the interest may not be taxable as it accrues. A taxpayer that decides to cash out the CD must report the full amount of interest paid, but the penalty is separately deductible and can be deducted in full even if it exceeds the interest.

Savings bonds. A cash-basis taxpayer does not report the interest (or the increase in redemption price) until the proceeds are received, the bond is disposed of, or the bond matures. However, a cash-basis taxpayer can elect to report the increase in redemption price each year as current income.

Switching investments.  An exchange of mutual funds within the same family is still taxable -- a sale of one fund and a purchase of another. However, investments held in a tax-free account, such as a 401(k) plans or an IRA, can be switched tax-free, unless the owner takes a distribution.

Exempt organizations

Charitable organizations often are organized as tax-exempt entities. To be tax-exempt under Code Sec. 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes in Code Sec. 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization; that is, it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates. Churches that meet the requirements of Code Sec. 501(c)(3) are automatically considered tax exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS.

Tax-exempt organizations must file annual reports with the IRS. If an organization fails to file the required reports for three consecutive years, its tax-exempt status is automatically revoked. Recently, the tax-exempt status of more than 200,000 organizations was automatically revoked. Most of these organizations are very small ones and the IRS believes that they likely did not know about the requirement to file or risk loss of tax-exempt status.  The IRS has put special procedures in place to help these small organizations regain their tax-exempt status.

Contributions

Contributions to qualified charities are tax-deductible. They key word here is qualified. The organization must be recognized by the IRS as a legitimate charity.

The IRS maintains a list of organizations eligible to receive tax-deductible charitable contributions. The list is known as Publication 78, Cumulative List of Organizations described in Section 170(c) of the Internal Revenue Code of 1986.  Similar information is available on an IRS Business Master File (BMF) extract.

In certain cases, the IRS will allow deductions for contributions to organizations that have lost their exempt status but are listed in or covered by Publication 78 or the BMF extract.  Additionally, private foundations and sponsoring organizations of donor-advised funds generally may rely on an organization's foundation status (or supporting organization type) set forth in Publication 78 or the BMF extract for grant-making purposes.

Generally, the donor must be unaware of the change in status of the organization. If the donor had knowledge of the organization’s revocation of exempt status, knew that revocation was imminent or was responsible for the loss of status, the IRS will disallow any purported deduction.

Churches

As mentioned earlier, churches are not required to apply for tax-exempt status. This means that taxpayers may claim a charitable deduction for donations to a church that meets the Code Sec. 501(c)(3) requirements even though the church has neither sought nor received IRS recognition that it is tax-exempt.

Foreign charities

Contributions to foreign charities may be deductible under an income tax treaty. For example, taxpayers may be able to deduct contributions to certain Canadian charitable organizations covered under an income tax treaty with Canada.  Before donating to a foreign charity, please contact our office and we can determine if the contribution meets the IRS requirements for deductibility.

The rules governing charities, tax-exempt organizations and contributions are complex. Please contact our office if you have any questions.

The IRS has issued the limitations on depreciation deductions for owners of passenger automobiles, trucks and vans first "placed in service" (i.e. used) during the 2011 calendar year. The IRS also provided revised tables of depreciation limits for vehicles first placed in service (or first leased by a taxpayer) during 2010 and to which bonus depreciation applies.

The IRS has issued the limitations on depreciation deductions for owners of passenger automobiles, trucks and vans first "placed in service" (i.e. used) during the 2011 calendar year. The IRS also provided revised tables of depreciation limits for vehicles first placed in service (or first leased by a taxpayer) during 2010 and to which bonus depreciation applies.

Note. Bonus depreciation may not be applicable because, among other reasons, you purchased the vehicle used. You may elect out of bonus depreciation or elect to increase the alternative minimum tax (AMT) credit limit under Code Sec. 53 instead of claiming bonus depreciation.

Bonus depreciation backdrop

The Small Business Jobs Act of 2010 extended 50 percent bonus depreciation through the end of 2010. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 extended bonus depreciation for two years (through the end of 2012) and increased the bonus depreciation allowance rate from 50 percent to 100 percent for qualified property acquired after September 8, 2010 and before January 1, 2012, and placed in service before January 1, 2012.

Nevertheless, the additional first-year bonus depreciation amount applicable to vehicles is limited to $8,000, whether other assets in the same depreciation class are entitled to 50 percent or 100 percent bonus depreciation. Sport Utility Vehicles (SUVs) and pickup trucks with a gross vehicle weight rating (GVWR) in excess of 6,000 pounds continue to be exempt from the luxury vehicle depreciation caps (under Code Sec. 280F).

Passenger automobiles

The maximum depreciation limits under Code Sec. 280F for passenger automobiles first placed into service during the 2011 calendar year are:

- $11,060 for the first tax year ($3,060 if bonus depreciation is not taken);
- $4,900 for the second tax year;
- $2,950 for the third tax year; and
- $1,775 for each tax year thereafter.

Trucks and vans

The maximum depreciation limits under Code Sec. 280F for trucks and vans first placed into service during the 2011 calendar year are:

- $11,260 for the first tax year ($3,260 if bonus depreciation is not taken);
- $5,200 for the second tax year;
- $3,150 for the third tax year; and
- $1,875 for each tax year thereafter.

Leases

Lease payments for vehicles used for business or investment purposes are deductible in proportion to the vehicle's business use. Lessees, however, must include a certain amount in income during the year the vehicle is leased to partially offset the amount by which lease payments exceed the luxury auto limits.

In-plan Roth IRA rollovers are a relatively new creation, and as a result many individuals are not aware of the rules. The Small Business Jobs Act of 2010 made it possible for participants in 401(k) plans and 403(b) plans to roll over eligible distributions made after September 27, 2010 from such accounts, or other non-Roth accounts, into a designated Roth IRA in the same plan. Beginning in 2011, this option became available to 457(b) governmental plans as well. These "in-plan" rollovers and the rules for making them, which may be tricky, are discussed below.

In-plan Roth IRA rollovers are a relatively new creation, and as a result many individuals are not aware of the rules. The Small Business Jobs Act of 2010 made it possible for participants in 401(k) plans and 403(b) plans to roll over eligible distributions made after September 27, 2010 from such accounts, or other non-Roth accounts, into a designated Roth IRA in the same plan. Beginning in 2011, this option became available to 457(b) governmental plans as well. These "in-plan" rollovers and the rules for making them, which may be tricky, are discussed below.

Designated Roth account

401(k) plans and 403(b) plans that have designated Roth accounts may offer in-plan Roth rollovers for eligible rollover distributions. Beginning in 2011, the option became available to 457(b) governmental plans, allowing the plan to adopt an amendment to include designated Roth accounts to then offer in-plan Roth rollovers.

In order to make an in-plan Roth IRA rollover from a non-Roth account to the plan, the plan must have a designated Roth account option. Thus, if a 401(k) plan does not have a Roth 401(k) contribution program in place at the time the rollover contribution is made, the rollover generally cannot be made (however, a plan can be amended to allow new in-service distributions from the plan's non-Roth accounts conditioned on the participant rolling over the distribution in an in-plan Roth direct rollover). Not only may plan participants make an in-plan rollover, but a participant's surviving spouse, beneficiaries and alternate payees who are current or former spouses are also eligible.

Eligible amounts

To be eligible for an in-plan rollover, the amount to be rolled over must be eligible for distribution to you under the terms of the plan and must be otherwise eligible for rollover (i.e. an eligible rollover distribution). Generally, any vested amount that is held in 401(k) plans or 403(b) plans (or 457(b) plans) is eligible for an in-plan Roth rollover. Moreover, the distribution must satisfy the general distribution requirements that otherwise apply.

Direct rollover or 60-day rollover

An in-plan Roth rollover may be accomplished two ways: either through a direct rollover (wherein the plan's administrator directly transfers funds from the non-Roth account to the participant's designated Roth account) or through a 60-day rollover. With an in-plan Roth direct rollover, the plan trustee transfers an eligible rollover distribution from a participant's non-Roth account to the participant's designated Roth account in the same plan. With an-plan Roth 60-day rollover, the participant deposits an eligible rollover distribution within 60 days of receiving it from a non-Roth account into a designated Roth account in the same plan.

If you opt for the 60-day rollover option, the amounts rolled over are subject to 20 percent mandatory withholding.

Taxation

Taxpayers generally include the taxable amount (fair market value minus your basis in the distribution) of an in-plan Roth rollover in gross income for the tax year in which the rollover is received.

If you have questions about making an in-plan Roth IRA rollover, please contact our office.

Often, timing is everything or so the adage goes. From medicine to sports and cooking, timing can make all the difference in the outcome. What about with taxes? What are your chances of being audited? Does timing play a factor in raising or decreasing your risk of being audited by the IRS? For example, does the time when you file your income tax return affect the IRS's decision to audit you? Some individuals think filing early will decrease their risk of an audit, while others file at the very-last minute, believing this will reduce their chance of being audited. And some taxpayers don't think timing matters at all.

Often, timing is everything or so the adage goes. From medicine to sports and cooking, timing can make all the difference in the outcome. What about with taxes? What are your chances of being audited? Does timing play a factor in raising or decreasing your risk of being audited by the IRS? For example, does the time when you file your income tax return affect the IRS's decision to audit you? Some individuals think filing early will decrease their risk of an audit, while others file at the very-last minute, believing this will reduce their chance of being audited. And some taxpayers don't think timing matters at all.

What your return says is key

If it's not the time of filing, what really increases your audit potential? The information on your return, your income bracket and profession--not when you file--are the most significant factors that increase your chances of being audited. The higher your income the more attractive your return becomes to the IRS. And if you're self-employed and/or work in a profession that generates mostly cash income, you are also more likely to draw IRS attention.

Further, you may pique the IRS's interest and trigger an audit if:

• You claim a large amount of itemized deductions or an unusually large amount of deductions or losses in relation to your income;
• You have questionable business deductions;
• You are a higher-income taxpayer;
• You claim tax shelter investment losses;
• Information on your return doesn't match up with information on your 1099 or W-2 forms received from your employer or investment house;
• You have a history of being audited;
• You are a partner or shareholder of a corporation that is being audited;
• You are self-employed or you are a business or profession currently on the IRS's "hit list" for being targeted for audit, such as Schedule C (Form 1040) filers);
• You are primarily a cash-income earner (i.e. you work in a profession that is traditionally a cash-income business)
• You claim the earned income tax credit;
• You report rental property losses; or
• An informant has contacted the IRS asserting you haven't complied with the tax laws.

DIF score

Most audits are generated by a computer program that creates a DIF score (Discriminate Information Function) for your return. The DIF score is used by the IRS to select returns with the highest likelihood of generating additional taxes, interest and penalties for collection by the IRS. It is computed by comparing certain tax items such as income, expenses and deductions reported on your return with national DIF averages for taxpayers in similar tax brackets.

E-filed returns.  There is a perception that e-filed returns have a higher audit risk, but there is no proof to support it. All data on hand-written returns end up in a computer file at the IRS anyway; through a combination of a scanning and a hand input procedure that takes place soon after the return is received by the Service Center. Computer cross-matching of tax return data against information returns (W-2s, 1099s, etc.) takes place no matter when or how you file.

Early or late returns. Some individuals believe that since the pool of filed returns is small at the beginning of the filing season, they have a greater chance of being audited. There is no evidence that filing your tax return early increases your risk of being audited. In fact, if you expect a refund from the IRS you should file early so that you receive your refund sooner. Additionally, there is no evidence of an increased risk of audit if you file late on a valid extension. The statute of limitations on audits is generally three years, measured from the due date of the return (April 18 for individuals this year, but typically April 15) whether filed on that date or earlier, or from the date received by the IRS if filed after April 18.

Amended returns. Since all amended returns are visually inspected, there may be a higher risk of being examined. Therefore, weigh the risk carefully before filing an amended return. Amended returns are usually associated with the original return. The Service Center can decide to accept the claim or, if not, send the claim and the original return to the field for examination.

President Obama unveiled his fiscal year (FY) 2012 federal budget recommendations in February, proposing to increase taxes on higher-income individuals, repeal some business tax preferences, reform international taxation, and make a host of other changes to the nation's tax laws. The president's FY 2012 budget touches almost every taxpayer in what it proposes, and in some cases, what is left out.

Roadmap

Every federal budget proposal is just that: a proposal, or a list of recommendations from the White House to Congress. Ultimately, it is for Congress to decide whether to fund a particular government program and at what level. The same is true for tax cuts and tax increases. The final budget for FY 2012 will be a compromise. Nonetheless, President Obama's FY 2012 budget is a helpful tool to predict in what direction federal tax policy may move.

Individuals

In his FY 2012 budget, President Obama repeats his call for Congress to end the Bush-era tax cuts for higher-income individuals (which the president generally defines as single individuals with incomes over $200,000 and married couples with incomes over $250,000). The top individual income tax rates would increase to 36 percent and 39.6 percent, respectively, after 2012. For 2011 and 2012, the top two individual income tax rates are 33 percent and 35 percent, respectively. The president also proposes to limit the deductions of higher income individuals.

Additionally, the president wants Congress to extend the reduced tax rates on capital gains and dividends, but not for higher-income individuals. Single individuals with incomes above $200,000 and married couples with incomes above $250,000 would pay capital gains and dividend taxes at 20 percent rather than at 15 percent after 2012.

The president's FY 2012 budget, among other things, also proposes:

• An AMT patch (higher exemption amounts and other targeted relief) after 2011;
• A permanent American Opportunity Tax Credit (enhanced Hope education tax credit) after 2012;
• A permanent enhanced earned income credit;
• A new exclusion from income for certain higher education student loan forgiveness;
• One-time payments of $250 to Social Security beneficiaries, disabled veterans and others with a corresponding tax credit for retirees who do not receive Social Security; and
• A temporary extension of certain tax incentives, such as the state and local sales tax deduction and the higher education tuition deduction, for one year.

Some of the proposals in the president's FY 2012 budget impact how individuals interact with the IRS. Many taxpayers complain that when they call the IRS, the wait times to speak to an IRS representative are so long they hang up. The president proposes to increase the IRS's budget to hire more customer service representatives. The president also proposes to allow the IRS to accept debit and credit card payments directly, thereby enabling taxpayers to avoid third party processing fees.

Businesses

The tax incentives for businesses in the president's FY 2012 budget are generally targeted to specific industries. One popular but temporary business tax incentive would be made permanent. President Obama proposes to extend permanently the research tax credit. The president also proposes to permanently abolish capital gains tax on investments in certain small businesses.

Other business proposals include:

1. Employer tax credits for creating jobs in newly designated Growth Zones;
2. Additional tax breaks for investments in energy-efficient property;
3. More funds for grants in lieu of tax credits for specified energy property;
4. One-year extensions of some temporary business tax incentives, such as the Indian employment credit and environmental remediation expensing;
5. Modifying Form 1099 business information reporting; and
6. Extending and reforming Build America Bonds.

The president's FY 2012 budget does not include a cut in the U.S. corporate tax rate. Any reduction in the U.S. corporate tax rate is likely to come outside the budget process. The president has spoken often in recent weeks about reducing the U.S. corporate tax rate but he wants any reduction to be revenue neutral; that is, the cost of cutting the U.S. corporate tax rate must be paid for. President Obama has discussed closing some unspecific tax loopholes.

IRS operations

President Obama proposes a significant increase in funding for the IRS. Most of the money would go to hiring new revenue officers and boosting enforcement activities. The White House predicts that investing $13 billion in the IRS over the next 10 years will generate an additional $56 billion in additional tax revenue over the same time period.

Estate tax

Late last year, the White House and the GOP agreed on a maximum federal estate tax rate of 35 percent with a $5 million exclusion for 2010, 2011 and 2012. In his FY 2012 budget, the president proposes to return the federal estate tax to its 2009 levels after 2012 (a maximum tax rate of 45 percent and a $3.5 million exclusion). President Obama also proposes to limit the duration of the generation skipping transfer (GST) tax exemption and to make other estate-tax related changes.

Revenue raisers

The White House and Congress are both looking at ways to cut the federal budget deficit. Taxes are one way. The president's FY 2012 budget proposes a number of revenue raisers, especially in the area of international taxation and in fossil fuel production.

International taxation. The president's budget proposes to reduce tax incentives for U.S.-based multinational companies. One goal of this strategy is to encourage multinational companies to invest in job creation in the U.S. The president's FY 2012 budget calls for, among other things, to limit earnings stripping by expatriated entities, to limit income shifting through intangible property transfers, and to make more reforms to the foreign tax credit rules. If enacted, all of the proposed international taxation reforms would raise an estimated $129 billion in additional revenue over 10 years.

LIFO. President Obama proposes to repeal the last-in, first-out (LIFO) inventory accounting method for federal income tax purposes. Taxpayers that currently use the LIFO method would be required to write up their beginning LIFO inventory to its first-in, first-out (FIFO) value in the first tax year beginning after December 31, 2012. This proposal would raise an estimated $52.8 billion over 10 years.

Fossil fuel tax preferences. The Tax Code includes a number of tax incentives for oil, gas and coal producers. President Obama proposes to repeal nearly all of these tax breaks for oil, gas and coal companies. These proposals would raise an estimated $46.1 billion over 10 years.

Financial institutions. President Obama proposes to impose a financial crisis responsibility fee on large U.S. financial institutions. The fee, if enacted, would raise an estimated $30 billion in additional revenue over 10 years.

Carried interest. The president's FY 2012 budget proposes to tax carried interest as ordinary income. This proposal would raise an estimated $14.8 billion in additional revenue over 10 years.

Insurance company reforms. Insurance companies are subject to specific and very technical tax rules. President Obama proposes to overhaul the tax rules for insurance companies. If enacted, these reforms would raise an estimated $14 billion over 10 years.

These are just some of the revenue raisers in the president's FY 2012 budget. All of them will be extensively debated in Congress in the coming months. Our office will keep you posted on developments. If you have any questions about the president's FY 2012 budget proposals, please contact our office.

In exchange for voluntary disclosure of unreported foreign assets, the IRS is offering taxpayers a second opportunity for reduced penalties. A special offshore voluntary disclosure initiative was announced on February 8, 2011. The initiative is temporary and runs through August 31, 2011.

In exchange for voluntary disclosure of unreported foreign assets, the IRS is offering taxpayers a second opportunity for reduced penalties. A special offshore voluntary disclosure initiative was announced on February 8, 2011. The initiative is temporary and runs through August 31, 2011.

Offshore accounts

The IRS knows that Americans have undisclosed assets in foreign financial institutions. In some cases, taxpayers may not be aware that federal law requires disclosure of offshore accounts above a certain monetary threshold. In other cases, taxpayers know they must report their offshore assets but choose not to make disclosures.

The U.S. and the IRS are working on several fronts to discover unreported offshore assets. The U.S. is negotiating with so-called tax haven jurisdictions for more transparency in their banking and tax laws. These are countries that traditionally have had tough bank secrecy laws. The U.S. has had some success in this area, most notably in getting one of Switzerland's largest banks to agree to share account information with the IRS. Many experts predict that the U.S. will persuade banks in other countries to share account information with the IRS.

In 2010, Congress passed the Hiring Incentives to Restore Employment (HIRE) Act. The new law requires taxpayers with foreign assets exceeding an aggregate value of $50,000 to report them on information returns. This requirement is in addition to the current filing requirement for Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), which applies when the aggregate value of foreign accounts exceeds $10,000. The IRS is expected to release guidance on the HIRE Act's foreign account reporting rules in 2011.

The IRS has also used a carrot and stick approach to encourage taxpayers to come forward. In 2009, the IRS launched an offshore voluntary disclosure program. According to the IRS more than 15,000 taxpayers participated in the 2009 program. The IRS reported that the 2009 program uncovered undisclosed accounts in more than 60 countries.

2011 initiative

The 2011 voluntary disclosure initiative, like the 2009 program, offers a reduced penalty framework in exchange for voluntary disclosure. In the 2009 program, taxpayers faced up to a 20 percent penalty covering up to a six-year period. The penalty framework for 2011 is higher (at 25 percent for most taxpayers), meaning that taxpayers who did not participate in the 2009 voluntary disclosure program will not be rewarded for waiting.

For the 2011 initiative, the penalty framework requires taxpayers to pay a penalty of 25 percent of the amount in the foreign bank accounts in the year with the highest aggregate account balance covering the 2003 to 2010 time period. Participants also must pay back-taxes and interest for up to eight years as well as pay accuracy-related and/or delinquency penalties. Taxpayers participating in the initiative must file all the necessary paperwork and make all required payments with the IRS before August 31, 2011.

Reduced penalties

Some taxpayers may be eligible for a 12.5 or 5 percent penalty under the 2011 initiative. The 12.5 percent penalty applies to taxpayers whose offshore accounts or assets did not surpass $75,000 in any calendar year covered by the 2011 initiative. The five percent penalty generally applies to taxpayers who did not open the foreign account and who met other very specific criteria covered by the 2011 initiative. Individuals who are foreign residents and who were unaware they were U.S. citizens may also qualify for the five percent penalty.

How to participate

The first step is to talk to a tax professional. The program is not just for individuals. Entities such as partnerships and trusts can also request to participate. However, certain taxpayers are ineligible. They include taxpayers under examination (whether or not the examination relates to undisclosed foreign assets) and taxpayers under criminal investigation.

The IRS encourages taxpayers to file a pre-clearance request. The IRS will then notify the taxpayer if the taxpayer has been cleared to make a voluntary disclosure. Pre-clearance, however, does not guarantee acceptance into the program, the IRS cautioned. After pre-clearance, taxpayers submit a voluntary disclosure letter. The IRS will review the letter and notify the taxpayer if the taxpayer has been accepted into the initiative. If accepted, the IRS requires the taxpayer to submit an extensive voluntary disclosure package.

If you have any questions about the IRS voluntary offshore disclosure program, please contact our office.

Under the Patient Protection and Affordable Care Act (PPACA) enacted in March 2010, small employers may be eligible to claim a tax credit of 35 percent of qualified health insurance premium costs paid by a taxable employer (25 percent for tax-exempt employers). The credit is designed to encourage small employers to offer health-insurance to their employees.

Under the Patient Protection and Affordable Care Act (PPACA) enacted in March 2010, small employers may be eligible to claim a tax credit of 35 percent of qualified health insurance premium costs paid by a taxable employer (25 percent for tax-exempt employers). The credit is designed to encourage small employers to offer health-insurance to their employees.

Employees and wages

An employer can claim the maximum 35 percent credit if it has no more than 10 full-time equivalent (FTE) employees receiving average annual wages of $25,000 or less. The credit is phased out as the number of FTEs increases to 25 and as average annual wages increase to $50,000.  An employer with 25 or more employees, or paying average annual wages of $50,000 or more per employee, will not receive a credit.

In counting FTEs, the employer should not include owners and family members.  Seasonal employees are not counted unless they work at least 120 days during the year. In determining average annual wages, employers must count all wages, bonuses, commissions or other compensation, including sick leave and vacation leave.

Applicable years

The credit took effect in 2010.  It did not expire at the end of 2010 but can be claimed from year to year.  The credit applies at the 35/25 percent levels for four years, through 2013. After 2013, the maximum credit increases to 50 percent for for-profit employers and 35 percent for tax-exempt employers, but only for two years. Thus, the credit can be claimed every year for the six years from 2010 and 2015.  The credit is recalculated every year based on the total health insurance premiums paid. Only non-elective employer premiums are counted; salary reduction contributions paid through a cafeteria plan or other arrangement are not counted.

Premiums

An employer must pay at least 50 percent of the premium cost of health insurance coverage, and must pay the same uniform percentage of costs for each employee who obtains health insurance through the employer. A transition rule for 2010 treats an employer as satisfying the uniformity rule as long as the employer pays at least 50 percent of the coverage costs of each employee, based on the cost of employee-only (single) coverage, even if the employer does not pay the same percentage of costs for each employee.

The premiums must be paid for qualified health insurance, such as a hospital or medical service plan or health maintenance organization. It includes coverage for dental, vision, long-term care, nursing home care, and coverage for a specified disease or illness.  Coverage does not accident insurance, disability income insurance, and workers' compensation.

Claiming the credit

The credit is determined on Form 8941, Credit for Small Employer Health Insurance Premiums. For-profit employers report the amount of the credit on Form 3800, General Business Credit, and attach the forms to their income tax return. As a general business credit, any unused credit (in excess of taxable income) can be carried back one year (except for a credit arising in 2010, the first year) or carried forward 20 years.  For-profit employers deduct the credit from the premiums paid for health insurance, when computing the deduction for health insurance premiums.

Tax-exempt employers report the credit on Form 990-T, Exempt Organization Business Income Tax Return, regardless of whether the organization is subject to tax on unrelated business income. The credit is refundable for tax-exempt employers, provided it does not exceed the employer’s income tax withholding and Medicare taxes. The credit is not refundable if the employer does not claim the credit on Form 990-T.

The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

Dependency deduction

You are allowed one dependency exemption deduction for each person you claim as a qualifying dependent on your federal income tax return. The deduction amount for the 2010 tax year is $3,650. If someone else may claim you as a dependent on their return, however, then you cannot claim a personal exemption (also $3,650) for yourself on your return. Additionally, your standard deduction will be limited.

Only one taxpayer may claim the dependency exemption per qualifying dependent in a tax year. Therefore, you and your spouse (or former spouse in a divorce situation) cannot both claim an exemption for the same dependent, such as your son or daughter, when you are filing separate returns.

Who qualifies as a dependent?

The term "dependent" includes a qualifying child or a qualifying relative. There are a number of tests to determine who qualifies as a dependent child or relative, and who may claim the deduction. These include age, relationship, residency, return filing status, and financial support tests.

The rules regarding who is a qualifying child (not a qualifying relative, which is discussed below), and for whom you may claim a dependency deduction on your 2010 return, generally are as follows:

-- The child is a U.S. citizen, or national, or a resident of the U.S., Canada, or Mexico;

-- The child is your child (including adopted or step-children), grandchildren, great-grandchildren, brothers, sisters (including step-brothers, and -sisters), half-siblings, nieces, and nephews;

 -- The child has lived with you a majority of nights during the year, whether or not he or she is related to you;

 -- The child receives less than $3,650 of gross income (unless the dependent is your child and either (1) is under age 19, (2) is a full-time student under age 24 before the end of the year), or (3) any age if permanently and totally disabled;

 -- The child receives more than one-half of his or her support from you; and

 -- The child does not file a joint tax return (unless solely to obtain a tax refund).

Qualifying relatives

The rules for claiming a qualifying relative as a dependent on your income tax return are slightly different from the rules for claiming a dependent child. Certain tests must also be met, including a gross income and support test, and a relationship test, among others. Generally, to claim a "qualifying relative" as your dependent:

-- The individual cannot be your qualifying child or the qualifying child of any other taxpayer; -- The individual's gross income for the year is less than $3,650; -- You provide more than one-half of the individual's total support for the year; -- The individual either (1) lives with you all year as a member of your household or (2) does not live with you but is your brother or sister (include step and half-siblings), mother or father, grandparent or other direct ancestor, stepparent, niece, nephew, aunt, or uncle, or inlaws. Foster parents are excluded.

Although age is a factor when claiming a qualifying child, a qualifying relative can be any age.

Special rules for divorced and separated parents

Certain rules apply when parents are divorced or separated and want to claim the dependency exemption. Under these rules, generally the "custodial" parent may claim the dependency deduction. The custodial parent is generally the parent with whom the child resides for the greater number of nights during the year.

However, if certain conditions are met, the noncustodial parent may claim the dependency exemption. The noncustodial parent can generally claim the deduction if:

-- The custodial parent gives up the tax deduction by signing a written release (on Form 8332 or a similar statement) that he or she will not claim the child as a dependent on his or her tax return. The noncustodial parent must attach the statement to his or her tax return; or

-- There is a multiple support agreement (Form 2120, Multiple Support Declaration) in effect signed by the other parent agreeing not to claim the dependency deduction for the year.

Have you already mailed (on paper or electronically) your Form 1040 for the 2010 tax year but only now noticed you made an error when preparing the return? If you need to correct a mistake on your federal income tax return that you’ve already filed with the IRS, it’s not too late to correct the mistake by filing an amended return, Form 1040X, Amended U.S. Individual Income Tax Return. The IRS considers an amended return filed on or before the due date of a return to be the taxpayer’s return for the period.

How Do I? Correct a mistake on a tax return I’ve already filed?

Have you already mailed (on paper or electronically) your Form 1040 for the 2010 tax year but only now noticed you made an error when preparing the return? If you need to correct a mistake on your federal income tax return that you’ve already filed with the IRS, it’s not too late to correct the mistake by filing an amended return, Form 1040X, Amended U.S. Individual Income Tax Return. The IRS considers an amended return filed on or before the due date of a return to be the taxpayer’s return for the period.

Correcting a mistake

Taxpayers cannot file more than one original tax return per tax year. If you have already filed an original Form 1040 with the IRS, but want to correct an error on the return (such as claiming a deduction or credit you discovered you were entitled to, or removing a credit or deduction you are not qualified to take, changing your filing status, or income, for example) file and amended return, Form 1040X, on or before April 18, 2011 (the filing deadline for this tax season). If the return is filed on or before the deadline for filing, the IRS considers the amended return to be your return for the tax period. If you file an amended return reporting income taxes due after April 18, however, you may be subject to the assessment of interest and penalties.

Example. You filed your 2010 individual income tax return, Form 1040, on February 1, 2011. But in late February you discovered that you made a mistake on your return. You can file an amended return on or before April 18, 2011 (in most other tax years, it is April 15, but due to the Emancipation Day holiday celebrated in Washington, D.C., the deadline for filing returns this year has been moved to April 18). The last return filed on or before April 18 (your amended return) will be your official tax return. Thus, the last filed return you send before the filing deadline (April 18) is the one that counts as the original return for IRS purposes.

Amended returns after April 18

If you discover the error on your return after April 18 has passed, you still file an amended return, Form 1040X, to correct your previously filed return. Certain tax elections once made on the original return, however, are irrevocable.  Also, any tax not paid with the original return accrues interest.  However, as long as a mistake is corrected on an amended return before the original return is audited, penalties are generally waived.

While Congress extended the reduced individual income tax rates with passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) in late 2010, it also extended several educational tax benefits as well through 2012. As families plan their upcoming tax year, it is important to keep these benefits in mind.

American Opportunity Tax Credit

Individuals may continue to claim a credit against their federal tax liability based on tuition payments and certain related expenses. Previously referred to as the Hope Credit, the American Opportunity Tax Credit (AOTC) remains available for taxpayers for the 2011 and 2012 tax years. Qualifying families may claim an annual tax credit of up to $2,500 for undergraduate college expenses, up to $10,000 for a four-year program. According to a recently-issued report, Treasury predicts that 9.4 million families will be able to claim a total of $18.2 billion AOTC credits in 2011, an average of $1,900 per family.

Lifetime learning credit

Taxpayers can claim the lifetime learning credit for post-high school education, as well as courses to acquire or improve job skills. These institutions include colleges, universities, vocational schools, and any other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. The lifetime learning credit is limited to $2,000 per eligible student, based upon payment of tuition and other qualified expenses.  

The IRS released Tax Tip 2010-12 reminding taxpayers that they cannot claim both the lifetime learning credit and the AOTC for one child in a single tax year. However, if the family has multiple children in college, the family may apply the credits on a "per-student, per-year basis." This means that the family with two children in college, for example, could claim the AOTC for one child and the lifetime learning credit for the other.

Coverdell Education Savings Accounts

The 2010 Tax Relief Act also extended the increased maximum contribution amount to Coverdell education savings accounts. Taxpayers may contribute a maximum of $2,000 per year to these tax-preferred accounts. Earnings on these contributions grow tax-free, while amounts subsequently withdrawn are excludable from gross income to the extent used for qualified educational expenses.

Educational assistance programs

The 2010 Tax Relief Act also extended taxpayers' annual exclusion of up to $5,250 in employer-provided educational assistance from their gross income. The exclusion applies to both gross income for federal income tax purposes, as well as wages for employment tax purposes.

Federal Scholarships with Service requirements

The 2010 Tax Relief Act continues the gross income exclusion for scholarships with obligatory service requirements received by candidates at certain qualified educational organizations. The exclusion applies to scholarships granted by the National Health Service Corps Scholarship Program or the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance Program.

Qualified Tuition and Expense Deduction

The 2010 Tax Relief Act also extends the above-the-line deduction for qualified tuition and related expenses through 2011. The deduction applies to tuition and fees paid for the enrollment of the taxpayer, the taxpayer's spouse, or any dependent for which the taxpayer is entitled to a dependency exemption. Taxpayers can not claim both one of the education tax credits and the tuition and expense deduction in a single year. These continue to be either/or tax breaks.

Student loan interest deduction

Finally, after the student graduates, they may still claim an educational tax benefit by repaying their educational loans. Within certain adjusted gross income limits, taxpayers may claim a deduction for interest paid on student loans. The 2010 Tax Relief Act extends favorable limits on this deduction. Through 2012, the law extended the increased modified adjusted gross income phase-out ranges, meaning more taxpayers can claim the deduction. The 2010 Tax Relief Act also extended the repeal of the 60-month limit on deductible payments.

Included among the many important individual and business incentives extended and enhanced by the massive tax bill passed in late December is a 100-percent exclusion of gain from the sale of qualified small business stock. Under the Tax Relief, Unemployment Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act) individuals and other noncorporate taxpayers should not overlook the benefit of investing in qualified small business stock considering the ability for qualifying taxpayers to exclude 100-percent of gain from the sale or exchange of the stock. There are certain limitations, however, regarding who qualifies for the tax break, holding periods, and what qualifies as qualified small business stock.

What is qualified small business stock?

The 100-percent exclusion from gain for investing in qualified small business stock is intended to encourage investment in small businesses and specialized small business investment companies. To qualify as small business stock for purposes of the 100-percent exclusion:

-- The stock must be issued by a C corporation that invests 80-percent of its assets in the active conduct of a trade or business and that has assets of $50 million or less when the stock is issued;
-- Qualified stock must be must be held for more than five years (rollovers into other qualified stock are allowed);
-- The amount taken into account under the exclusion is limited to the greater of $10 million or ten times the taxpayer's basis in the stock;
-- Any taxpayer, other than a C corporation, can take advantage of the exclusion.

Tax benefits

The 2010 Small Business Jobs Act enhanced the exclusion of gain from qualified small business stock to non-corporate taxpayers. For stock acquired after September 27, 2010 and before January 1, 2011, and held for at least five years, the 2010 Small Business Jobs Act provided an exclusion of 100 percent.

The 2010 Tax Relief Act extends the 100 percent exclusion for one more year, for stock acquired before January 1, 2012. As a result of the extension of the 100-percent exclusion, none of the gain on qualifying sales or exchanges of qualified small business stock is subject federal income tax or AMT will be imposed on gain from the sale or exchange of qualified small business stock that is acquired after September 27, 2010 and before January 1, 2012, and that is held for more than five years. In addition, the excluded gain is not treated as a tax preference item for AMT purposes, so none of the gain will be subject to AMT.

The holding period requirement

Because of the various changes to the percentage of the exclusion, a taxpayer must be aware not only of meeting the five year holding requirement, but also of the date the qualified small business stock was acquired.

For example, if you acquired qualified small business stock after February 17, 2009 and before September 28, 2010, then only 75 percent of the gain will be subject to tax if the stock is sold or exchanged more than five years later. If you acquired qualified small business stock on February 17, 2009, then only 50 percent of the gain will be subject to tax if the stock is sold or exchanged after February 17, 2014. If you acquired the stock after September 27, 2010 and before January 1, 2012, then no tax will be imposed on the gain if the stock is sold or exchanged more than five years later.

Eligibility

To be eligible for the exclusion, the small business stock must be acquired by the individual at its original issue (directly or through an underwriter), for money, property other than stock, or as compensation for services provided to the corporation. Stock acquired through the conversion of stock (such as preferred stock) that was qualified stock in the taxpayer's hands is also qualified stock in the taxpayer's hands.

However, small business stock does not include stock that has been the subject of certain redemptions that are more than de minimis. If you acquire or acquired qualified stock by gift or inheritance, you are treated as having acquired that stock in the same manner as the transferor and will need to add the transferor's holding period to your own.

A partnership may distribute qualified stock to its partners so long as the partner held the partnership interest when the stock was acquired, and only to the extent that partner's share in the partnership has not increased since the stock was acquired.

Taxpayers may elect to deduct state and local general sales and use taxes in lieu of deducting state and local income taxes for 2010 and 2011. Before Congress passed the 2010 Tax Relief Act (Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010), the sales tax deduction was not available for the 2010 tax year. However, the 2010 Tax Relief Act retroactively extends the sales tax deduction for 2010 and also makes it available for the 2011 tax year.

Thus, all individual taxpayers who itemize their tax deductions for 2010 and 2011 on Schedule A, Form 1040, have a choice between deducting state and local income taxes (as has always been the case for itemized deductions) or deducting state and local general sales taxes as an itemized deduction instead. The state and local sales tax deduction is particularly beneficial for those taxpayers who live in states without state income taxes (Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Tennessee, Washington state, and Wyoming), and thus don't benefit from the state income tax deduction.

Planning Note. The extension of the deduction for state and local general sales taxes does not impact states such as California, Illinois, and Oregon that have decoupled from the deduction, or states such as Connecticut, Michigan, or West Virginia that do not allow federal itemized deductions.

Comment. It is important to remember for taxpayers who are claiming itemized deductions on Schedule A for the 2010 tax year (thus affecting deductions for state sales tax) that due to the late passage of the 2010 Tax Relief Act, the IRS will not be able to process returns of those whose filings are delayed (Schedule A filers, among others) until February 14, 2011.

Methods for calculating the deduction

The right decision is usually made simply by determining which deduction is higher for you (if you live in a state that provides for the state income tax deduction.)

If you elect to deduct state and local sales taxes in lieu of deducting state and local income taxes, you can chose between two methods of computation:

• The actual expense method; or
• The IRS's optional state sales tax tables method.

Actual expense method

Under the actual expense method, you must keep the actual sales receipts that show the sales tax paid. This may be somewhat more difficult for 2010 since the 2010 Tax Relief Act was not passed until December 2010, long after some taxpayers may have thrown most of their old sales slips for ordinary expenses into the trash. Nevertheless, collecting receipts, especially for major purchases, may prove enough to make use of the "actual expense method" instead of the IRS tables.

Some further complications. Qualifying state and local sales taxes allowed under the actual expense method include only sales taxes set at the general sales tax rate, with exceptions for food, clothing, medical supplies, and motor vehicles.

Optional state sales tax tables method

Under this method, you don't have to keep your receipts (although keeping some receipts from motor vehicle and other specified purchases may be advantageous (see below)).

The IRS optional state sales tax tables are supposed to reflect the average state sales tax deduction paid by the average resident of your state, based on both income level and number of exemptions. Income levels on the tables for each state run from $0 to "$200,000 or more;" exemption columns go from 1 to "more than 5."

Income for purposes of the IRS tables includes adjusted gross income, plus certain non-taxable income that increases your purchasing power. The later amounts include tax-exempt interest, veterans' and Social Security benefits, nontaxable IRA withdrawals and the like. Since the higher the income level, the higher the table deduction amount, it is to your advantage (although it is not required) to include these in this computation.

The local sales tax computation. The IRS tables do not reflect local sales taxes. The IRS does not publish the appropriate local sales tax rates. You have to find it. Taxpayers compute their combined state and local sales tax deduction amount by:

1. (a) Dividing the local general sales tax rate by the state general sales tax rate; (b) Multiplying that figure by the amount of state general sales taxes in the IRS tables; and
2. Adding the amount of local general sales taxes (1) to the amount of state general sales taxes in the tables.

Moving during the year

The IRS Optional State Sales Tax Tables cover most states and the District of Columbia. Your legal state of residence for the year determines which table to use.

If you lived in more than one state during 2010, you must multiply the table amount for each state you lived in by a fraction, equal to the number of days you lived in each state, divided by 365. Prorating local sales taxes is also required if you moved from one locality to another in the same state.

Figuring out the new sales tax itemized deduction takes several steps. Nevertheless, the tax savings available may make it well worth your while to "do the math." You should consult your tax advisor with questions since deduction planning can be more complicated than many think.

Businesses will benefit from a number of extended and enhanced tax breaks under the recently enacted Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act). The 2010 Tax Relief Act boosts 50-percent bonus depreciation to 100 percent through 2011 and provides increased Code Sec. 179 expensing in 2012.

100 percent bonus depreciation

The 2010 Tax Relief Act benefits businesses by increasing 50-percent bonus depreciation to 100-percent for qualified investments made after September 8, 2010 and before January 1, 2012 (before January 1, 2013 for certain longer-lived and transportation property). Thus, businesses that bought qualifying property after September 8, 2010 but before December 17, 2010 (the date of enactment of the 2010 Tax Relief Act) in anticipation of using 50-percent bonus depreciation received a welcome surprise as they will benefit from 100-percent bonus depreciation.

This provision is especially beneficial for businesses because bonus depreciation, unlike Code Sec. 179 expensing, is not limited to smaller companies, or capped at a certain dollar level. However, only new property qualifies for the 100-percent bonus depreciation (unlike Code Sec. 179 expensing, which can be claimed for both new and used property).

Example. In January 2011, Big Co., a calendar year business, buys $1 million of qualifying property eligible for the 100-percent bonus depreciation deduction. Under the 2010 Tax Relief Act's enhanced 100-percent bonus depreciation provision, Big Co. will be able to claim a $1 million depreciation deduction for the property on its 2011 tax return.

Post-2011 depreciation

Although enhanced 100-percent bonus depreciation is not extended into 2012, the new law does provide 50-percent bonus depreciation for qualified property placed in service after December 31, 2011 and before January 1, 2013.

Option to take refundable credits in lieu of bonus depreciation

The American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) provided that a corporation otherwise eligible for additional first-year depreciation may elect to claim additional research or minimum tax credits in lieu of claiming depreciation for qualified property placed in service after March 31, 2008 and before December 31, 2008. The 2010 Tax Relief Act generally extends similar treatment for two years, through December 31, 2012.

Code Section 179 expensing

Over the years, Congress has repeatedly increased dollar and investment limits under Code Sec. 179 to encourage spending by businesses. For tax years beginning in 2010 and 2011, the 2010 Small Business Jobs Act increased the Code Sec. 179 dollar and investment limits to $500,000 and $2 million, respectively. For tax years beginning in 2012, the new law provides for a $125,000 dollar limit and a $500,000 investment limit (both indexed for inflation). Without this provision, the dollar and investment limits would have reverted to $25,000 and $200,000 respectively for tax years beginning after 2011. Amounts that are not eligible for expensing due to excess investments can not be carried forward and expensed in a later year; they may only be recovered through depreciation.

Off-the-shelf computer software. The 2010 Tax Relief Act also provides that off-the-shelf computer software qualifies as eligible property for Code Sec. 179 expensing. The software must be "placed in service" (used) in a tax year beginning before 2013.

If you have any questions about these two business incentives under the 2010 Tax Relief Act, please call our office.

In 2011, millions of employees will receive a significant boost in their take-home pay as a result of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act) enacted December 17. In addition to maintaining the current lower individual income tax rates, the 2010 Tax Relief Act reduces the employee's share of the OASDI portion of Social Security two percentage points, from 6.2 percent to 4.2 percent, for wages earned during the 2011 calendar year, up to the taxable wage base of $106,800. Many workers can expect to see an average tax savings of more than $1,000 as a result of this payroll tax cut. Moreover, the payroll tax reduction is available to all wage earners irrespective of income level, with no phaseout. In effect, individuals earning at or above the OASDI cap of $106,800 will receive $2,136 in tax savings in 2011.

The employer's share of OASDI, however, remains at 6.2 percent. As a result of this payroll tax "holiday" for employees, employers will need to implement the 2011 cut in payroll taxes, in addition to new income-tax withholding tables that employers will use in 2011.

Withholding and adjustments

It is the responsibility of employers and payroll companies to handle the new payroll tax cut under the 2010 Tax Relief Act. Employees do not have to take any action regarding the payroll tax cut. For example, employees will not need to complete a new W-4 withholding form.

Employers should begin to use the new withholding tables released by the IRS (2011 Percentage Method Tables) to implement the 4.2 percent employee tax rate as soon as possible, and in any event, no later that January 31, 2011.

After implementing the new 4.2 percent rate, employers will need to make any offsetting adjustments to subsequent pay periods in order to correct for any over-withholding. For any Social Security tax that is over-withheld in January, an offsetting adjustment to an employee's pay should be made as soon as possible, but no later than March 31, 2011, the IRS advises.

Self-Employed individuals

Self-employed individuals would pay 10.4 percent on self-employment income up to the threshold. Under the 2010 Tax Relief Act, self-employed persons would calculate the deduction for employment taxes without regard to the temporary rate reduction (that is, one half of 15.3 percent of self-employment income). On the other hand, however, the new law provides an enhanced percentage representing the employer portion of the reduction.

A business can deduct ordinary and necessary expenses paid or incurred in carrying on any trade or business. The expense must be reasonable and must be helpful to the business.

Gifts to a business client, customer or contact can be deductible business expenses. However, the maximum deduction for gifts to any individual is $25 per year (Code Sec. 274(b)). A gift is any item that is excluded from income under Code Sec. 102. Gifts that cost $4.00 or less, as well as promotional items, are not subject to the $25 limitation.

Gifts by individuals to co-workers are normally considered nondeductible personal expenses. However, employee achievement awards ($400 limit) and qualified plan awards are not subject to the $25 limitation.

Substantiation

Taxpayers must be able to substantiate certain business expenses by adequate records or sufficient evidence to take them as a deduction. Substantiation is required for business gifts, as well as traveling, lodging and entertainment expenses, because they are considered more susceptible to abuse (Tax Code Sec. 274(d)).

For business gifts, IRS regulations require that taxpayers substantiate the following elements of the gift:

- Amount (the cost to the taxpayer);
- Time (the date of the gift);
- Description of the gift;
- Business purpose - the business reason for the gift, or the nature of the business benefit derived or expected to be derived as a result of the gift; and
- Business relationship - occupation or other information relating to the recipient, including name, title and other designation, sufficient to establish the business relationship to the taxpayer.

The IRS provides substantiation rules in Treasury Reg. 1.274-5T(c). The taxpayer must maintain and produce, on request, "adequate records" or "sufficient evidence" that corroborate the taxpayer's own statement. Written evidence has "considerably more probative value" than oral evidence alone. While a contemporaneous log is not required, written evidence is more effective the closer in time it relates to the expense. Support by sufficient documentary evidence is highly credible.

Adequate records

Adequate records include an account book, diary, log, statement of expenses or similar records, as well as documentary evidence, which in combination establish each element of the expense. However, it is not necessary to record information that duplicates information on a receipt. The record should be prepared at or near the time of the expenditure, when the taxpayer has full present knowledge of each element. A statement, such as a weekly log, submitted by an employee to his employer in the regular course of good business practice is considered an adequate record.

An adequate record of business purpose generally requires a written statement of business purpose. However, the degree of substantiation will vary depending on the facts and circumstances.

Sufficient evidence

A taxpayer that does not have adequate records may establish an element by other sufficient evidence, such as the taxpayer's written or oral statement with specific, detailed information, and other corroborative evidence. A description of a gift shall be direct evidence, such as a detailed statement by the recipient or documentary evidence otherwise required as an adequate record.

If the taxpayer loses records through circumstances beyond the taxpayer's control, the taxpayer may substantiate the deduction by reasonably reconstructing his expenditures.