Maximizing Deductions for Business-Use Vehicles

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How would you like to squeeze more time out of your busy week, cut down on record-keeping duties, and reduce piles of paperwork and old receipts? The optional standard mileage rates for business vehicles can help you do just that. Businesses that operate up to four vehicles at the same time can deduct this standard mileage rate rather than keeping track of depreciation, gas, and repairs.

The business standard mileage rate for 2013 is 56.5 cents-per-mile. The business rate reflects, among other things, gasoline, depreciation and maintenance costs each year. The business standard mileage rate for 2012 has been 55.5 cents-per-mile (the same as for the second half of 2011 and up from 51 cents-per-mile for the first half of 2011).

Four or more vehicles

Businesses using no more than four vehicles for business purposes can use the business standard mileage rate. Generally, the IRS prohibits taxpayers from using the business standard mileage rate to compute the deductible expenses of five or more vehicles the taxpayer owns or leases and uses simultaneously, such as in a fleet operation.

Depreciation

The depreciation component of the business standard mileage rate is 23 cents-per-mile for 2013, the same as for 2012. In 2011 the rate was 22 cents-per-mile. Businesses that use the standard mileage rate are not allowed to take actual depreciation deduction amounts, even if they are higher than the depreciation component. Before deciding to use the standard mileage rate, a look at whether you will do better under the actual expense method, which includes actual depreciation, should be considered. Especially for circumstances in which Code Section 179 expensing and/or bonus depreciation is available; taking actual expenses, including actual depreciation, may be worth the effort.

Luxury vehicle caps. If actual depreciation is taken on a business vehicle, Congress wanted to be sure that vehicles selling above a certain price point did not enable their owners to take a larger write-off because of that premium cost. The “luxury vehicle” limits are designed to do just that, although taxpayers may debate the price points above which Congress set the “luxury” level. For example, using the standard mileage rate to value an employee’s personal use of a business vehicle is not allowed if the vehicle is valued at more than $15,900 for 2012 (projected to rise to $16,000 in 2013); Light trucks or vans are governed by a slightly higher level of $16,700 for 2012 (and $17,000 for 2013). This value also translates into the cap allowed on depreciation taken each year on the vehicle. For example, the maximum depreciation deduction for passenger automobiles first placed in service by the taxpayer in the 2012 calendar year is $3,160 for the first year (in addition to $8,000 for bonus depreciation, if applicable). For light trucks and vans, the first year cap is slightly higher: $3,360 (but with the same additional $8,000 deduction for bonus depreciation).

Special rules for heavy SUVs. For many years, SUV owners enjoyed a special tax break, often referred to as the “SUV loophole.” As explained, the “luxury car” rules place strict limits on the maximum amount of depreciation that may be claimed on passenger automobiles, including trucks and vans, during each year of a vehicle’s recovery (depreciation) period. Generally, however, the luxury vehicle limits only apply to vehicles primarily used on public streets with an unloaded gross weight of 6,000 pounds or less. A truck or van, including an SUV built on a truck chassis, is not subject to the annual vehicle depreciation limitations if its gross vehicle weight rating (maximum loaded weight) is in excess of 6,000 pounds. This “loophole” treatment had allowed many taxpayers who purchased an SUV with a gross weight in excess of 6,000 pounds to write off the entire cost in the year of purchase under the Code Sec. 179 expensing deduction.

Congress started to crack down on the so-called “SUV loophole” when, in the American Jobs Creation Act of 2004, it put the brakes on the cost of any SUV that may be expensed under Code Sec. 179 to $25,000, in addition to being counted toward the total caps on deductions for Code Sec. 179 property of all types. For example, a $139,000/$560,000 overall Section 179 expensing limits apply for 2012 (this is scheduled to drop to $25,000 for 2013, with a $200,000 investment ceiling, unless Congress takes further action). If the SUV is not built on a truck chassis or if it does not have a gross vehicle weight of more than 6,000 pounds, however, the “luxury vehicle” limit puts an even lower cap on those deductions. Nevertheless, heavy SUVs continue to benefit from a “bonus depreciation” loophole in the law in which a deduction for bonus depreciation is not capped for those vehicles not falling under the luxury-vehicle depreciation caps (that is, heavy SUVs). Although bonus depreciation applies to 2012, Congress may not extend it into 2013, or it may do so but without retaining what some have termed an unintended benefit for heavy SUV owners.

Bonus depreciation. Bonus depreciation for 2012 may be added to the available first-year deductions allowed on the purchase of a vehicle used for business if certain criteria are met. For most vehicles (those that are not fully depreciated in their first-year after applying the cap), business taxpayers claiming 50 percent bonus depreciation in 2012 are allowed an additional $8,000 in first year depreciation over and above the $3,160 first-year limit, for a total of $11,160 in the first tax year. Bonus depreciation, however, is for new vehicles only, and only if placed in service within the tax year. The section 179 expensing deduction, on the other hand, is available for both used and new vehicles.

Personal and business use

If you use your business vehicle for personal trips (including commuting back and forth from home and your principle business location) you must pro-rate your deduction to exclude the percentage of personal use. The magic number here is 50 percent. As long as you use your vehicle more than 50 percent for business during the year, you can pro-rate your deduction. You also have the option of using the standard mileage rate, based on miles of business use for the year times the prescribed rate.

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Overview of the 2012 American Taxpayer Relief Act / Fiscal Cliff Legislation

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After weeks, indeed months of proposals and counter-proposals, seemingly endless negotiations and down-to-the-wire drama, Congress has passed legislation to avert the tax side of the so-called “fiscal cliff.” The American Taxpayer Relief Act permanently extends the Bush-era tax cuts for lower and moderate income taxpayers, permanently “patches” the alternative minimum tax (AMT), provides for a permanent 40 percent federal estate tax rate, renews many individual, business and energy tax extenders, and more. In one immediately noticeable effect, the American Taxpayer Relief Act does not extend the 2012 employee-side payroll tax holiday.

The American Taxpayer Relief Act is intended to bring some certainty to the Tax Code. At the same time, it sets stage for comprehensive tax reform, possibly in 2013. Moreover, it creates important planning opportunities for taxpayers, which we can discuss in detail.

Individuals:

Unlike the two-year extension of the Bush-era tax cuts enacted in 2010, the debate in 2012 took place in a very different political and economic climate. If Congress did nothing, tax rates were scheduled to increase for all taxpayers at all income levels after 2012.  President Obama made it clear that he would veto any bill that extended the Bush-era tax cuts for higher income individuals. The President’s veto threat gained weight after his re-election.  Both the White House and the GOP realized that going over the fiscal cliff would jeopardize the economic recovery, and the American Taxpayer Relief Act is, for the moment, their best compromise.

Tax rates.  The American Taxpayer Relief Act extends permanently the Bush-era income tax rates for all taxpayers except for taxpayers with taxable income above certain thresholds:

$400,000 for single individuals, $450,000 for married couples filing joint returns, and $425,000 for heads of households.  For 2013 and beyond, the federal income tax rates are 10, 15, 25, 28, 33, 35, and 39.6 percent.  In comparison, the top rate before 2013 was 35 percent.  The IRS is expected to issue revised income tax withholding tables to reflect the 2013 rates as quickly as possible and provide guidance to employers and self-employed individuals.

Additionally, the new law revives the Pease limitation on itemized deductions and personal exemption phaseout (PEP) after 2012 for higher income individuals but at revised thresholds. The new thresholds for being subject to both the Pease limitation and PEP after 2012 are $300,000 for married couples and surviving spouses, $275,000 for heads of households, $250,000 for unmarried taxpayers; and $150,000 for married couples filing separate returns.

Capital gains.  The taxpayer-friendly Bush-era capital gains and dividend tax rates are modified by the American Taxpayer Relief Act. Generally, the new law increases the top rate for qualified capital gains and dividends to 20 percent (the Bush-era top rate was 15 percent). The 20 percent rate will apply to the extent that a taxpayer’s income exceeds the $400,000/$425,000/$450,000 thresholds discussed above. The 15 percent Bush-era tax rate will continue to apply to all other taxpayers (in some cases zero percent for qualified taxpayers within the 15-percent-or-lower income tax bracket).

Payroll tax cut.  The employee-side payroll tax holiday is not extended. Before 2013, the employee-share of OASDI taxes was reduced by two percentage points from 6.2 percent to 4.2 percent up the Social Security wage base (with a similar tax break for self-employed individuals).  For 2013, two percent reduction is no longer available and the employee-share of OASDI taxes reverts to 6.2 percent. The employer-share of OASDI taxes remains at 6.2 percent. In 2012, the payroll tax holiday could save a taxpayer up to $2,202 (taxpayers earning at or above the Social Security wage base for 2012).  As a result of the expiration of the payroll tax holiday, everyone who receives a paycheck or self-employment income will see an increase in taxes in 2013.

AMT. In recent years, Congress routinely “patched” the AMT to prevent its encroachment on middle income taxpayers. The American Taxpayer Relief Act patches permanently the AMT by giving taxpayers higher exemption amounts and other targeted relief. This relief is available beginning in 2012 and going forward. The permanent patch is expected to provide some certainty to planning for the AMT. No single factor automatically triggers AMT liability but some common factors are itemized deductions for state and local income taxes; itemized deductions for miscellaneous expenditures, itemized deductions on home equity loan interest (not including interest on a loan to build, buy or improve a residence); and changes in income from installment sales. Our office can help you gauge if you may be liable for the AMT in 2013 or future years.

Child tax credit and related incentives.  The popular $1,000 child tax credit was scheduled to revert to $500 per qualifying child after 2012.  Additional enhancements to the child tax credit also were scheduled to expire after 2012.  The American Taxpayer Relief Act makes permanent the $1,000 child tax credit. Most of the Bush-era enhancements are also made permanent or extended. Along with the child tax credit, the new law makes permanent the enhanced adoption credit/and income exclusion; the enhanced child and dependent care credit and the Bush-era credit for employer-provided child care facilities and services.

Education incentives.  A number of popular education tax incentives are extended or made permanent by the American Taxpayer Relief Act.  The American Opportunity Tax Credit (an enhanced version of the Hope education credit) is extended through 2017.  Enhancements to Coverdell education savings accounts, such as the $2,000 maximum contribution, are made permanent.  The student loan interest deduction is made more attractive by the permanent suspension of its 60-month rules (which had been scheduled to return after 2012). The new law also extends permanently the exclusion from income and employment taxes of employer-provided education assistance up to $5,250 and the exclusion from income for certain military scholarship programs.  Additionally, the above-the-line higher education tuition deduction is extended through 2013 as is the teachers’ classroom expense deduction.

Charitable giving.  Congress has long used the tax laws to encourage charitable giving.  The American Taxpayer Relief Act extends a popular charitable giving incentive through 2013:  tax-free IRA distributions to charity by individuals age 70 ½ and older up to maximum of $100,000 for qualified taxpayer per year.  A special transition rule allows individuals to recharacterize distributions made in January 2013 as made on December 31, 2012.  The new law also extends for businesses the enhanced deduction for charitable contributions of food inventory.

Federal estate tax.  Few issues have complicated family wealth planning in recent years as has the federal estate tax.  Recent laws have changed the maximum estate tax rate multiple times. Most recently, the 2010 Taxpayer Relief Act set the maximum estate tax rate at 35 percent with an inflation-adjusted exclusion of $5 million for estates of decedents dying before 2013. Effective January 1, 2013, the maximum federal estate tax will rise to 40 percent, but will continue to apply an inflation-adjusted exclusion of $5 million. The new law also makes permanent portability between spouses and some Bush-era technical enhancements to the estate tax.

Businesses:

The business tax incentives in the new law, while not receiving as much press as the individual tax provisions, are valuable. Two very popular incentives, bonus depreciation and small business expensing, are extended as are many business tax “extenders.”

Bonus depreciation/small business expensing.  The new law renews 50 percent bonus depreciation through 2013 (2014 in the case of certain longer period production property and transportation property). Code Sec. 179 small business expensing is also extended through 2013 with a generous $500,000 expensing allowance and a $2 million investment limit.  Without the new law, the expensing allowance was scheduled to plummet to $25,000 with a $200,000 investment limit.

Small business stock.  To encourage investment in small businesses, the tax laws in recent years have allowed noncorporate taxpayers to exclude a percentage of the gain realized from the sale or exchange of small business stock held for more than five years.  The American Taxpayer Relief Act extends the 100 percent exclusion from the sale or exchange of small business stock through 2013.

Tax extenders.  A host of business tax incentives are extended through 2013.  These include:

  • Research tax credit or R&D credit
  • Work Opportunity Tax Credit (WOTC)
  • New Markets Tax Credit
  • Employer wage credit for military reservists
  • Tax incentives for empowerment zones
  • Indian employment credit
  • Railroad track maintenance credit
  • Subpart F exceptions for active financing income
  • Look through rules for related controlled foreign corporation payments

Energy:

For individuals and businesses, the new law extends some energy tax incentives.  The Code Sec. 25C, which rewards homeowners who make energy efficient improvements, with a tax credit is extended through 2013.  Businesses benefit from the extension of the Code Sec. 45 production tax credit for wind energy, credits for biofuels, credits for energy-efficient appliances, and many more.

Looking ahead

The negotiations and passage of the new law are likely a dress rehearsal for comprehensive tax reform during President Obama’s second term.  Both the President and the GOP have called for making the Tax Code more simple and fair for individuals and businesses.  The many proposals for tax reform include consolidation of the current individual income tax brackets, repeal of the AMT, moving the U.S. from a worldwide to territorial system of taxation, and a reduction in the corporate tax rate. Congress and the Obama administration also must tackle sequestration, which the American Taxpayer Relief Act delayed for two months. All this and more is expected to keep federal tax policy in the news in 2013. Our office will keep you posted of developments.

If you have any questions about the American Taxpayer Relief Act, please contact Azran Financial at (310) 691-5040 or (818) 691-1234 or via e-mail at info@azran.mycloudserver.online.  We can schedule an appointment to discuss how the changes in the new law may be able to maximize your tax savings.

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Planning Opportunities for New 3.8-Percent Medicare Tax Using S Corporations

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Planning Opportunities for New 3.8-Percent Medicare Tax Using S Corporations

The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act implemented Code Sec. 1411, which imposes a new 3.8-percent Medicare tax on unearned income of higher-income individuals. The tax will take effect January 1, 2013, and applies to the net investment income of individuals, estates, and trusts that exceeds specified thresholds. Although the tax does not apply to corporations, it will apply to dividends and other passive income derived from corporations.

Because the tax on net investment income applies to individuals, it may apply to amounts received by individuals from passthrough entities, such as partnerships, limited liability companies, and S corporations. Under general principles, items of income that flow through a partnership, S corporation, or limited liability company (LLC) to partners, shareholders, or members retain their character. Thus, for example, interest income earned by a partnership is still characterized as interest when it passes through to a partner.

Net Investment Income

The tax, known as the Medicare contribution tax, equals 3.8 percent of the lesser of (1) an individual’s net investment income or (2) the excess of the individual’s modified adjusted gross income (AGI) over the threshold amount. The thresholds are $250,000 for married taxpayers filing a joint return; $125,000 for married taxpayers filing a separate return; and $200,000 for all other taxpayers.

Trusts and estates are subject to a much lower threshold. They should strive to distribute their income to their individual beneficiaries to minimize the tax.

The tax does not apply to non-resident aliens, charitable trusts, or corporations.

Net investment income includes gross income from interest, dividends, royalties, and rents, as well as net gain from the disposition of property, unless such income is derived from a passive activity. The tax also applies to other gross income from a trade or business that is a passive activity. Thus, the application of the tax depends on the character of the amounts and the treatment of amounts received from these entities.

Passive Activities

The tax applies to passive income, which is income from a trade or business that is a passive activity under Code Sec. 469. An activity is passive if it involves the conduct of a trade or business in which the taxpayer does not materially participate. Very generally, material participation exists if the taxpayer is involved in the operations of the activity on a regular, continuous, and substantial basis. Accordingly, if the individual materially participates in the entity’s business, the tax on net investment income does not apply to income from the entity. If the individual does not materially participate, the income is characterized as passive and may be subject to the tax under Code Sec. 1411(c)(2).

A sole proprietor by definition manages his or her business. Thus, the sole proprietor materially participates in his or her business and would not have to pay the 3.8-percent tax on income of the proprietorship.

Income from a partnership, S corporation, or LLC is often characterized as passive income if the individual does not materially participate in the business of the entity. In the past, passive income was seen as beneficial, because it could be used to offset passive losses. Thus, in the past, taxpayers have desired passive income and may even have planned for it. Now, because of the net investment income tax, certain taxpayers may prefer not to have income characterized as passive.

Social Security Taxes

Employees generally are subject to Social Security (FICA or SECA) taxes on their wage income, amounting to 7.65 percent contributed by the employee and the employer. This also applies to wages paid to partners. Self-employed individuals pay a similar tax (15.3 percent, which includes both the employee’s and the employer’s shares) on their business income. This income is characterized as net earnings from self employment.

The current payroll tax holiday has reduced an employee’s employment tax share to 5.65 percent (13.3 percent for self-employed). Absent further legislation, the rates will revert to their previous levels in 2013.

Net earnings from self-employment are specifically excluded from being characterized as net investment income (Code Sec. 1411(c)(6)). This eliminates the possibility of an individual being subject to Medicare taxes on both earnings and unearned income.

Partnership Income

Earnings or business income derived from a partnership, which flows through the entity to the general partners, is characterized as net earnings from self-employment. Therefore, it is subject to self-employment tax, and is not subject to the 3.8-percent tax on net investment income.

Income that flows through to the limited partners is not treated as net earnings from self-employment. It will be subject to the 3.8-percent net investment income tax, but not the Social Security tax.

If the same individual is both a general partner and a limited partner, the characterization of the income is not so clear and likely will be subject to greater examination by the IRS.

S Corporation Income

Unlike a partnership, an S corporation’s income that passes through to its owners (its shareholders) is not per se characterized as net earnings from self-employment, because dividends on shares of stock issued by the S corporation are excluded from this characterization. Similarly, normal distributions actually made by an S corporation to its shareholders are not treated as net earnings from self-employment. However, this contrasts with distributions that are payments of wages to shareholder-employees, which are subject to Social Security taxes.

Thus, shareholder-employees can avoid Social Security taxes by withdrawing funds from the S corporation as a distribution, rather than as wages. However, if the employee takes no salary or an unreasonably low salary, the courts generally have supported the IRS in recharacterizing at least a portion of the distributions as wages subject to Social Security taxes.

Income that passes through to S corporation shareholders, as well as distributions, will be subject to the 3.8-percent Medicare tax unless the shareholder materially participates in the business (i.e., the S corporation’s business is not a passive activity with respect to the shareholder). In the latter case, however, the income may successfully avoid both Social Security taxes and Medicare taxes. Furthermore, gain on the sale or redemption of the S corporation interest likewise should not be net investment income under this interpretation if the shareholder materially participates in the business.

Planning Strategies

With these consequences in mind, taxpayers may now be more inclined to establish an S corporation to run their business as long as they are materially involved in the operation of the business and pay reasonable salaries to shareholder-employees. This can be accomplished with a variety of structures.

The basic structure is to operate the business through an S corporation or through an LLC that elects to be taxed as an S corporation. The shareholder-owners must be materially involved in the business. Wages paid to shareholder-employees will be subject to Social Security taxes, but distributions, passthrough income, and net gains from the sale or redemption of the shareholder’s interest in the S corporation will not be subject to the net investment income tax.

If a shareholder does not materially participate in the business operations, the net investment income tax will apply to income items paid or distributed to the shareholder (other than wages).

Variations of this basic structure can be used, and the tax consequences should be the same. S corporations can only have one class of stock. An LLC with one class of interests and no preferred income allocations or distributions may elect S corporation treatment for tax purposes and secure this same treatment. Another variation can be used if there are varying interests. An S corporation owned by the business’s operators can become a member of an LLC with other investors who are not eligible to hold S corporation stock (e.g. foreign investors) becoming members of the LLC.

Another possible structure uses a corporation as the manager of an LLC. The corporate manager in this case would have the authority to bind the LLC. A member investing in the LLC as a limited partner would not be subject to self-employment taxes. If involved in the business, the limited partner would not be subject to the net investment income tax. It may not be so clear, however, how to treat an LLC member who is involved in the business for self-employment tax purposes. Finally, a limited partnership with an S corporation as the sole general partner could also obtain these benefits. Income would pass through and the limited partners would qualify for the limited partner exception to self-employment taxes.

The IRS has argued that LLCs should be treated as limited partnerships, but the courts generally have not accepted this analysis.

Under current law, it appears that investors may be able to use the S corporation structure to avoid most Social Security self-employment taxes and the net investment income tax. However, the IRS has yet to issue regulations on the 3.8-percent net investment income tax, and it remains to be seen whether potential IRS guidance on material participation in a business, or other interrelationships between the self-employment tax and net investment income tax provisions under the Code, will affect the use of these structures.

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Year-End Tax Planning for Business and the Fiscal Cliff

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As a taxpayer, you are facing what is perhaps an unprecedented set of circumstances – the expiration of the tax rates enacted in 2001, the expiration of more than 150 tax provisions and a tax increase of more than $500 billion overall – that could result in a much higher tax liability when you file your next return.

As we edge nearer to the “fiscal cliff,” as it’s being called, several changes are looming, including (but not limited to) a possible increase on long-term capital gains, restrictions on  itemized deductions, reinstatement of the full payroll tax, and an increase in both the estate tax rate and the number of estates that will be subject to the estate tax. In addition, a new 3.8% surtax on some investment income will become effective Jan. 1, 2013.

Many of these changes will have an impact on small businesses and call for tax planning and possible actions now to soften the potential burden [particularly if you operate as a pass-through entity as many tax increases will affect individuals]. For example, if you are planning to sell appreciated business assets, doing so before the end of 2012 may help avoid the higher capital gains tax. Please come in at your earliest convenience so we can discuss your tax situation and develop a strategy that makes sense for you.

Deductible Business Expenses – How Will You be Affected?

Under Section 179 of the tax code, small businesses can deduct the total cost of some qualifying property in the year it is placed in service, within certain limits, rather than depreciating it over time. The limit on the cost of property (including real property) that can be expensed is now $139,000. The total value of the equipment purchased cannot be higher than $560,000.

As of Jan. 1, 2013, the expensing limit is set to drop and real property, some of which is allowed now, will no longer be included. As a result, businesses may want to consider making equipment or property purchases before year-end to take advantage of the higher expense amount. What may be critical to taking advantage of section 179 election is whether the equipment can be put into service before Jan. 1, 2013.

Also, with the expiration of current 50% first-year bonus depreciation allowance, businesses will have to revert to the modified accelerated cost recovery system to calculate depreciation, meaning that more costs will have to be deducted over time rather than immediately.

Pass-Through Entities

As a pass-through entity, there are several other issues to consider since you pay your business taxes as an individual, including:

  • The return of the phase-out for itemized deductions for a taxpayer who has adjusted gross income over roughly $175,000 as well as a phase-out of personal exemptions for taxpayers with income over a certain level. Each one would limit the amount of allowable deductions and raise the taxpayer’s net taxable income.
  • The lowest individual income tax rate will rise from 10% to 15% and all other individual rates will also edge up.
  • Due to an expiring Bush-era tax cut, a broader marriage penalty will mean higher tax bills for married couples. Instead of the current 200%, the standard deduction for married couples filing jointly will fall to 167% of the standard deduction for single taxpayers.
  • The alternative minimum tax (AMT) will apply to 2012 income for many more Americans if not indexed for inflation. At the end of 2011, the AMT exemption was $74,450 for married taxpayers and $48,450 for singles. It is set to fall to $45,000 for joint filers and $33,750 for single filers. Taxpayers are also set to lose the ability to offset their AMT bite with personal tax credits.
  • The credit for Research and Experimentation Expenses, worth up to 20% of qualified costs, expired at the end of 2011 and has not been extended.

We also want to remind you that business owners and self-employed individuals need to:

  • Obtain tax identification numbers for all the individuals to whom they send Forms 1099-Misc
  • Closely review their estimated tax calculations in light of any tax changes that occur

Azran Financial can help you review those calculations to understand the effect these possible increases could have on your tax situation. Please contact us today at (310) 691-5040 or (818) 691-1234, or e-mail us at info@azran.mycloudserver.online to schedule an appointment to develop strategies to minimize the impact of this uncertain tax climate on your business.

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Arrangements that Recharacterize Taxable Wages as Nontaxable Reimbursements or Allowances

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The IRS has provided guidance which clarifies that an arrangement that recharacterizes taxable wages as nontaxable reimbursements or allowances does not satisfy the business connection requirement for accountable expense reimbursement plans.

In general, employee business expense reimbursements that are paid through an employer’s accountable expense reimbursement plan are excluded from the employee’s adjusted gross income. An accountable plan basically requires employees to submit receipts for expenses and repay any advances that exceed substantiated expenses. Amounts paid to employees through an accountable plan are not taxable compensation. Thus, they are not subject to federal or state income taxes or Social Security taxes, or employer payroll taxes and withholding.

On the other hand, business expense reimbursements paid through a system that does not meet the specific requirements for accountable plans are considered paid under a nonaccountable plan, and are treated as taxable compensation. An employer can have a reimbursement plan that is considered accountable in part and nonaccountable in part.

A reimbursement plan must meet three requirements in order to be considered an accountable expense allowance arrangement

  1. reimbursements must have a business connection;
  2. reimbursements must be substantiated; and
  3. employees must return reimbursements in excess of expenses incurred.

An arrangement satisfies the business connection requirement if it provides advances, allowances, or reimbursements only for business expenses that are allowable as deductions, and that are paid or incurred by the employee in connection with the performance of services as an employee of the employer. Therefore, not only must an employee actually pay or incur a deductible business expense, but the expense must arise in connection with the employment for that employer.

The business connection requirement will not be satisfied if a payor pays an amount to an employee regardless of whether the employee incurs or is reasonably expected to incur deductible business expenses. Failure to meet this reimbursement requirement of business connection is referred to as wage recharacterization because the amount being paid is not an expense reimbursement but rather a substitute for an amount that would otherwise be paid as wages.

The business connection requirement will not be satisfied if a payor pays an amount to an employee regardless of whether the employee incurs or is reasonably expected to incur deductible business expenses. Failure to meet this reimbursement requirement of business connection is referred to as wage recharacterization because the amount being paid is not an expense reimbursement but rather a substitute for an amount that would otherwise be paid as wages.

The IRS guidance includes four situations, three of which illustrate arrangements that impermissibly recharacterize wages such that the arrangements are not accountable plans. A fourth situation illustrates an arrangement that does not impermissibly recharacterize wages. In this arrangement, an employer prospectively altered its compensation structure to include a reimbursement arrangement.

Because of the difference in tax treatment of reimbursements under an accountable plan versus a nonaccountable plan, it is important to review your reimbursement policies. Please call our office for an appointment to discuss your options under this IRS guidance.

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IRS Guidance on Portability of Deceased Spousal Exclusion

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The IRS has recently issued guidance on the so-called portability election and the applicable estate and gift tax exclusion amount. As a surviving spouse, this guidance may impact your estate planning opportunities.

In general, the estate tax is imposed on a decedent’s gross estate as increased by the decedents’ taxable lifetime gifts, and reduced by any allowable estate tax deductions, such as the charitable or marital deduction.

In addition, the estate of every decedent is allowed a credit (the “applicable credit amount”) in determining the amount of estate tax due. The applicable credit amount effectively acts to exclude a certain amount of property from the estate tax (the “applicable exclusion amount”). With proper planning a married couple could take advantage of the applicable exclusion amount in each of their respective estates. However, prior to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) it was possible for a married couple to waste the applicable exclusion amount of the first spouse to die. Consequently, the 2010 Tax Relief act introduced the concept of “portability” with respect to the unused portion of the applicable exclusion amount of a predeceased spouse, referred to as the deceased spousal unused exclusion amount (DSUEA).

For estates of decedents dying after 2010, the applicable exclusion amount is equal to the sum of the basic exclusion amount and any available DSUEA, if previously elected. The basic exclusion amount is $5 million, which is adjusted for inflation beginning in 2012. A “portability election” passes along a decedent’s unused estate and gift tax exclusion amount to a surviving spouse.

The IRS guidance discusses the following:

  1. the estate and gift tax applicable exclusion amount, in general;
  1. the requirements for electing portability of any DSUEA to the surviving spouse; and
  1. the applicable rules for the use of the DSUEA by the surviving spouse.

It should be noted that as is the case for other changes made to the estate and gift tax rules by the Economic Growth and Tax Relief Reconciliation Act of 2001, and the 2010 Tax Relief Act, the concept of “portability” of a deceased spouse’s unused exclusion amount will end for the estates of decedents dying after December 31, 2012, unless Congress acts to extend this provision.

Regardless, the estate tax return on which the portability election is made must be filed within the time prescribed by law. In that way, the surviving spouse can take advantage of the DSUEA, should the portability provision be extended.

The IRS guidance explains the requirements for what is considered to be a “complete and properly-prepared return.” If the return is being filed only for the purpose of electing portability, the executor does not have to report the value of certain property qualifying for the marital or charitable deduction. The total value of the gross estate must be estimated based on a determination made with good faith and due diligence regarding the value of all assets includable in the gross estate.

If the executor does not wish to make the portability election, regulations require the executor to make an affirmative statement on the estate tax return indicating this to be the case. When no return is required to be filed for the decedent’s estate, not filing a timely filed return will be considered to be an affirmative statement of the decision not to make a portability election. With certain limited exceptions, only the executor of the estate is allowed to file the estate tax return and make the portability election.

IRS guidance also clarifies the computation of the DSUEA in certain circumstances and addresses the use of the DSUEA by the surviving spouse, including:

  1. the date the DSUEA may be taken into account by the surviving spouse;
  2. the last deceased spouse limitation on the DSUEA available to a surviving spouse; and
  3. the DSUEA available in the case of multiple spouses and previously applied DSUEA.

The portability election should be reviewed as part of your overall estate planning. We are available to discuss all of your options.

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2012 Planning: Tax Solutions for S-Corporations

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An S-corporation, such as yours, is a pass-through entity that is treated very much like a partnership for federal income tax purposes. As a result, all income is passed through to your shareholders and taxed at their individual tax rates. However, unlike a C corporation, an S corporation’s income is taxable to the shareholders when it is earned whether or not the corporation distributes the income. Because an S corporation has a unique tax structure that directly impacts shareholders, it is important for you to understand the S corporation distribution and loss limitations, as well as how and when items of income and expense are taxed, before developing your overall tax plan.

In addition, some S corporation income and expense items are subject to special rules and separate identification for tax purposes. Examples of separately stated items that could affect a shareholder’s tax liability include charitable contributions, capital gains, Sec. 179 expense deductions, foreign taxes, and net income or loss related to rental real estate activities.

These items, as well as income and losses, are passed through to the shareholder on a pro rata basis, which means that the amount passed through to each shareholder is dependent upon that shareholder’s stock ownership percentage. However, a shareholder’s portion of the losses and deductions may only be used to offset income from other sources to the extent that the total does not exceed the basis of the shareholder’s stock and the basis of any debt owed to the shareholder by the corporation. The S corporation losses and deductions are also subject to the passive-activity rules.

Other key points to consider when developing your comprehensive tax strategy include:

the availability of the Code Sec. 179 deduction at the corporate and shareholder level;

  1. reporting requirements for the domestic production activities deduction;
  2. the tax treatment of fringe benefits;
  3. below-market loans between shareholders and S corporations; and
  4. IRS scrutiny of distributions to shareholders who have not received compensation.

We can assist you in identifying and maximizing the potential tax savings. Please call our office at (310) 691-5040 or (818) 691-1234 or e-mail us at info@azran.mycloudserver.online to arrange an appointment.

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2012 Year-End Tax Planning For Businesses

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In recent years, end-of-the-year tax planning for businesses has been complicated by uncertainty over the future availability of many tax incentives. This year is no different.  In 2010, Congress extended many business tax incentives for one or two years. Now, those incentives have expired or are scheduled to expire. Whether they will be extended beyond 2012 is unclear as Congress debates with the fate of the fate of the Bush-era tax cuts and across-the-board spending cuts scheduled to take effect in 2013. In the meantime, you need to be aware of the expiring provisions and explore developing a multiyear tax strategy that takes into account various scenarios for the future of these incentives.

Code Sec. 179 expensing.  Code Sec. 179 gives businesses the option of claiming a deduction for the cost of qualified property all in its first year of use rather than claiming depreciation over a period of years. For 2010 and 2011, the Code Sec. 179 dollar limitation was $500,000 with a $2 million investment ceiling. For 2012, the amounts are less generous. The dollar limitation for 2012 is $139,000 with a $560,000 investment ceiling. Under current law, the Code Sec. 179 dollar limit is scheduled to drop to $25,000 for 2013 with a $200,000 investment ceiling.

Businesses should consider accelerating purchases into 2012 to take advantage of the still generous Code Sec. 179 expensing. Qualified property must be tangible personal property, which you actively use in your business, and for which a depreciation deduction would be allowed. Qualified property must be newly purchased new or used property, rather than property you previously owned but recently converted to business use. Examples of types of property that would qualify for Code Sec. 179 expensing are office equipment or equipment used in the manufacturing process. Additionally, Code Sec. 179 expensing is allowed for off-the-shelf computer software placed in service in tax years beginning before 2013.

If your equipment purchases for the year exceed the expensing dollar limit, you can decide to split your expensing election among the new assets any way you choose. If you have a choice, it may be more valuable to expense assets with the longest depreciation periods. As long as you start using your newly purchased business equipment before the end of the tax year, you get the entire expensing deduction for that year. The amount that can be expensed depends upon the date the qualified property is placed in service; not when the qualified property is purchased or paid for.

Congress could raise the Code Sec. 179 dollar limit and investment ceiling for 2013. In July 2012, the Senate voted to increase the Code Sec. 179 dollar amount to $250,000 with an $800,000 investment limitation for tax years beginning after December 31, 2012. The House voted to increase the Code Sec. 179 dollar amount to $100,000 with a $400,000 investment limitation for tax years beginning after December 31, 2012.

Bonus depreciation.  The 50 percent bonus first-year depreciation deduction is scheduled to expire after 2012 (2013 in the case of certain longer-production period property and certain transportation property). Unlike the Section 179 expense deduction, the bonus depreciation deduction is not limited to smaller companies or capped at a certain dollar level. To be eligible for bonus depreciation, qualified property must be depreciable under Modified Accelerated Cost Recovery System (MACRS) and have a recovery period of 20 years or less. The property must be new and placed in service before January 1, 2013 (January 1, 2014 for certain longer-production period property and certain transportation property).

Businesses also need to keep in mind the relationship of bonus depreciation and the vehicle depreciation dollar limits.  Code Sec. 280F(a) imposes dollar limitations on the depreciation deduction for the year a taxpayer places a passenger automobile in service within a business, and for each succeeding year. Code Sec. 168(k)(2)(F)(i) increases the first-year depreciation allowed for vehicles subject to the Code Sec. 280F luxury-vehicle limits, unless the taxpayer elects out, by $8,000, to which the additional first-year depreciation deduction applies.  The maximum depreciation limits under Code Sec. 280F for passenger automobiles first placed in service by the taxpayer during the 2012 calendar year are: $11,160 for the first tax year ($3,160 if bonus depreciation is not taken); $5,100 for the second tax year; $3,050 for the third tax year; and $1,875 for each tax year thereafter. The maximum depreciation limits under Code Sec. 280F for trucks and vans first placed in service during the 2012 calendar year are $11,360 for the first tax year ($3,360 if bonus depreciation is not taken); $5,300 for the second tax year; $3,150 for the third tax year; and $1,875 for each tax year thereafter. Sport utility vehicles and pickup trucks with a gross vehicle weight rating in excess of 6,000 pounds are exempt from the luxury vehicle depreciation caps.

New de minimis rule in repair regulations.  Comprehensive repair and capitalization regulations issued by the IRS in late 2011 open up a new planning opportunity. A new de minimis expensing rule allows a taxpayer to deduct certain amounts paid or incurred to acquire or produce a unit of tangible property if the taxpayer has an Applicable Financial Statement (AFS), written accounting procedures for expensing amounts paid or incurred for such property under certain dollar amounts, and treats the amounts as expenses on its AFS in accordance with its written accounting procedures. An overall ceiling limits the total expenses that a taxpayer may deduct under the de minimis rule. The de minimis expensing rule applies to amounts paid or incurred (to acquire or produce property) in tax years beginning on or after January 1, 2012.

Let’s look at an example. A taxpayer purchases 10 VoIP phones for its business at $200 each for a total cost of $2,000. Each phone is a unit of property and is not a material or supply. The taxpayer has an applicable financial statement and a written policy at the beginning of the tax year to expense amounts paid for property costing less than $500. The taxpayer treats the amounts paid for the phones as an expense on its applicable financial statement. Assume further that the total aggregate amount treated as de minimis and not capitalized, including the amounts paid for the phones, are less than or equal to the greater of 0.1 percent of total gross receipts or 2 percent of the taxpayer’s  total financial statement depreciation. The result: the de minimis rule applies and the taxpayer is not required to capitalize any portion of the $2,000 paid for the 10 phones.

Dividends.  Under current law, tax-favorable dividends tax rates are scheduled to expire after 2012. Qualified dividends are eligible for a maximum 20 percent tax rate for taxpayers in the 25 percent and higher brackets; zero percent for taxpayers in the 10 and 15 percent brackets. In July, the House voted to extend the current dividend tax treatment through 2013. The Senate, however, voted to extend the tax favorable rates only for individuals with incomes below $200,000 (families with incomes below $250,000). For income in excess of $200,000/$250,000 the tax rate on capital gains and dividends would be 20 percent.

If Congress taxes no action, qualified dividends will taxed at the ordinary income tax rates after 2012 (with the highest rate scheduled to be 39.6 percent not taking into account the 3.8 percent Medicare contribution tax for higher income individuals). Qualified corporations may want to explore declaring a special dividend to shareholders before January 1, 2013

Expired business tax incentives.  Many temporary business tax incentives expired at the end of 2011. In past years, Congress has routinely extended these incentives, often retroactively, but this year may be different. Confronted with the federal budget deficit and across-the-board spending cuts scheduled to take effect in 2013, lawmakers allow some of the business tax extenders to expire permanently. Certain extenders, however, have bipartisan support, and are likely to be extended.  They include the Code Sec. 41 research tax credit, the Work Opportunity Tax Credit (WOTC), and 15-year recovery period for leasehold, restaurant and retail improvement property.

Small employer health insurance credit.  A potentially valuable tax incentive has often been overlooked by small businesses, according to reports. Employers with 10 or fewer full-time employees (FTEs) paying average annual wages of not more than $25,000 may be eligible for a maximum tax credit of 35 percent on premiums paid for tax years beginning in 2010 through 2013. Tax-exempt employers may be eligible for a maximum tax credit of 25 percent for tax years beginning in 2010 through 2013.

The Code Sec. 45R credit is subject to phase-out rules. The credit is reduced by 6.667 percent for each FTE in excess of 10 employees. The credit is also reduced by four percent for each $1,000 that average annual compensation paid to the employees exceeds $25,000. This means that the credit completely phases out if an employer has 25 or more FTEs and pays $50,000 or more in average annual wages.

Let’s look at an example. A for-profit employer has 10 FTEs and pays average annual wages of $250,000 in tax year 2012. The employer’s qualified employee health care costs for tax year 2012 are $70,000. The employer’s Code Sec. 45R credit is $24,500 ($70,000 x 35 percent).

The credit is scheduled to climb to 50 percent of qualified premium costs paid by for-profit employers (35 percent for tax-exempt employers) for tax years beginning in 2014 and 2015. However, an employer may claim the tax credit after 2013 only if it offers one or more qualified health plans through a state insurance exchange.

Today’s uncertainty makes doing nothing or adopting a wait and see attitude very tempting. Instead, multi-year tax planning, which takes into account a variety of possible scenarios and outcomes, should be built into your approach. Please contact our office at (310) 691-5040 or (818) 691-1234 or at info@azran.mycloudserver.online for more details on developing a tax strategy in uncertain times that includes consideration of certain tax-advantaged step that may be taken before year-end 2012.

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2012 Year-End Tax Planning For Individuals

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As 2012 draws to a close, many taxpayers are asking how they can plan in light of the uncertainty surrounding the fate of the Bush-era tax cuts and other expiring tax incentives.

2012 began with great uncertainty over federal tax policy and now, with the end of the year approaching, that uncertainty appears to be far from any long-term resolution. A host of reduced tax rates, credits, deductions, and other incentives (collectively called the “Bush-era” tax cuts) are scheduled to expire after December 31, 2012. To further complicate planning, over 50 tax extenders are up for renewal, either having expired at the end of 2011 or scheduled to expire after 2012. At the same time, the federal government will be under sequestration, which imposes across-the-board spending cuts after 2012. The combination of all these events has many referring to 2013 as “taxmeggedon.”

Expiring incentives

Effective January 1, 2013, the individual income tax rates, without further Congressional action, are scheduled to increase across-the-board, with the highest rate jumping from 35 percent to 39.6 percent. The current 10 percent rate will expire and marriage penalty relief will sunset. Additionally, the current tax-favorable capital gains and dividends tax rates (15 percent for taxpayers in the 25 percent bracket rate and above and zero percent for all other taxpayers) are scheduled to expire. Higher income taxpayers will also be subject to revived limitations on itemized deductions and their personal exemptions. The child tax credit, one of the most popular incentives in the Tax Code, will be cut in half. Millions of taxpayers would be liable for the alternative minimum tax (AMT) because of expiration of the AMT “patch.” Countless other incentives for individuals would either disappear or be substantially reduced after 2012. While a divided Congress may indeed act to prevent some or all of these tax increases, a year-end planning strategy that protects against “worst-case” situations may be especially wise to consider this year.

Year-end planning

Income tax withholding. Expiration of the reduced individual tax rates will have an immediate impact. Income tax withholding on payrolls will immediately reflect the increased rates. One strategy to avoid being surprised in 2013 is to adjust your income tax withholding. Keep in mind that the current two percent payroll tax holiday is also scheduled to expire after 2012 so it is a good time to review if you are having too much or too little federal income tax withheld from your pay.

As mentioned, traditional year-end planning techniques should be considered along with some variations on those strategies. Instead of shifting income into a future year, taxpayers may want to recognize income in 2012, when lower tax rates are available, rather than shift income to 2013. Another valuable year-end strategy is to “run the numbers” for regular tax liability and AMT liability. Taxpayers may want to explore if certain deductions should be more evenly divided between 2012 and 2013, and which deductions may qualify, or will not be as valuable, for AMT purposes.

Harvesting losses. Now is also a good time to consider tax loss harvesting strategies to offset current gains or to accumulate losses to offset future gains (which may be taxed at a higher rate). The first consideration is to identify whether an investment qualifies for either a short-term or long-term capital gains status, because you must first balance short-term gains with short-term losses and long-term ones with long-term losses. Remember also that the “wash sale rule” generally prohibits you from claiming a tax-deductible loss on a security if you repurchase the same or a substantially identical asset within 30 days of the sale.

Education expenses. Taxpayers with higher educational expenses may want to consider the scheduled expiration of the American Opportunity Tax Credit (AOTC) after 2012 in their plans. The AOTC (an enhanced version of the HOPE education credit) reaches the sum of 100 percent of the first $2,000 of qualified expenses and 25 percent of the next $2,000 of qualified expenses, subject to income limits. If possible, pre-paying 2013 educational expenses before year-end 2012 could make the expenses eligible for the AOTC before it expires. Another popular education tax incentive, the Lifetime Learning Credit, is not scheduled to expire after 2012.

Job search expenses. Some expenses related to a job search may be tax deductible. There is one important limitation: the expenses must be spent on a job search in your current occupation. You may not deduct expenses you incur while looking for a job in a new occupation. Examples of job search expenses are unreimbursed employment and outplacement agency fees you pay while looking for a job in your present occupation. Travel expenses to look for a new job may be deductible. The amount of job search expenses that you can claim on your tax return is limited. You can claim the amount of expenses only to the extent that they, together with other “miscellaneous” deductions exceed two percent of your adjusted gross income.

Gifts. Gift-giving as a year-end tax strategy should not be overlooked. The annual gift tax exclusion per recipient for which no gift tax is due is $13,000 for 2012. Married couples may make combined tax-free gifts of $26,000 to each recipient. Use of the lifetime gift tax exclusion amount ($5.12 million for 2012) should also be considered. Without Congressional action, the exclusion amount drops to $1 million in 2013.

Charitable giving. For many individuals, charitable giving is also a part of their year-end tax strategy. Under current law, the so-called “Pease limitation” (named for the member of Congress who sponsored the law) is scheduled to be revived after 2012. The Pease limitation generally requires higher income individuals to reduce their tax deductions by certain amounts, including their charitable deduction. A special rule for contributing IRA assets to a charity by individuals age 70 ½ and older expired after 2011 but could be renewed for 2012.

New Medicare taxes

In 2013, two new taxes kick-in. The Patient Protection and Affordable Care Act (PPACA) imposes an additional 0.9 percent Medicare tax on wages and self-employment income and a 3.8 percent Medicare contribution tax. The 3.8 percent Medicare contribution tax will apply after 2012 to single individuals with a modified adjusted gross income (MAGI) in excess of $200,000 and married taxpayers with an MAGI in excess of $250,000. MAGI for purposes of the Medicare contribution tax includes wages, salaries, tips, and other compensation, dividend and interest income, business and farm income, realized capital gains, and income from a variety of other passive activities and certain foreign earned income. For individuals liable for the tax, the amount of tax owed will be equal to 3.8 percent multiplied by the lesser of (1) net investment income or (2) the amount by which their MAGI exceeds the $200,000/$250,000 thresholds. Taxpayers with MAGIs below the $200,000/$250,000 thresholds will not be subject to the 3.8 percent tax.

More changes for 2013

Many employers with health flexible spending arrangements (health FSAs) limit salary reduction contributions to between $2,500 and $5,000. Effective 2013, the PPACA requires health FSA’s under a cafeteria plan to limit contributions through salary reductions to $2,500. After 2013, the $2,500 limitation is scheduled to be adjusted for inflation. Individuals with unused health FSA dollars should consider spending them before year-end, or a 2 ½ month grace period if applicable, to avoid the “use it or lose it” rule. Keep in mind that health FSA dollars cannot be used for over-the-counter medications (except for insulin) after 2011.

Additionally, the threshold to claim an itemized deduction for unreimbursed medical expenses increases from 7.5 percent of adjusted gross income (AGI) to 10 percent of AGI after 2012. The PPACA provides a temporary exception for individuals (or their spouses) who are age 65 and older. This exception ends after 2017. While many medical expenses cannot be timed for tax-deduction purposes, batching expenses into 2012, when the threshold is 7.5 percent, may make it more likely that the expenses will exceed that threshold.

Looking ahead

In July 2012, the House and Senate passed competing bills to extend many of the expiring incentives one more year. Both bills would extend the current income tax rates (10, 15, 25, 28, 33, and 35 percent) through 2013. The House bill would extend the current capital gains and dividends treatment but the Senate bill would extend the tax favorable rates only for individuals with incomes below $200,000 (families with incomes below $250,000). For income in excess of $200,000/$250,000 the tax rate on capital gains and dividends would be 20 percent. Both bills would extend the $1,000 child tax credit through 2013 and provide for an AMT patch for 2012 (the House bill also provides an AMT patch for 2013).

At this time, it is increasingly likely that the fate of all the expiring tax provisions will be decided by the lame-duck Congress after the November elections. Although the House and Senate bills passed in July differ, they have many points in common; the most important being that lawmakers could agree on a one-year extension of the Bush-era tax cuts. However, some observers anticipate no resolution until January 2013 or beyond.

Today’s uncertainty makes doing nothing or adopting a wait and see attitude very tempting. Multi-year tax planning, which takes into account a variety of possible scenarios and outcomes, however, can provide a win-win combination irrespective of what happens. Please contact our office at (310) 691-5040 or (818) 691-1234 or by e-mail at info@azran.mycloudserver.online for more details on how we can customize a tax strategy for you in uncertain times.

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Repairs Versus Improvements: New Rules for Deductibility

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The IRS and Treasury have issued long-awaited, comprehensive regulations on the capitalization of amounts paid to acquire, produce or improve tangible property. The regulations, released at the end of 2011 and effective immediately for most taxpayers, provide the standards that businesses must now apply to determine whether expenditures can be deducted as repairs or must be capitalized and then recovered over a period of years.

The regulations are broad and far-reaching – they apply to every business taxpayer that uses tangible property, whether owned or leased, regardless of the form of entity that operates the business, and regardless of the entity’s foreign or domestic status. They apply to manufacturers, wholesalers, distributors, and retailers.

The new regulations have taken effect and steps must be taken to comply with them. They generally apply to amounts paid or incurred in tax years beginning on or after January 1, 2012. Thus, for calendar year taxpayers, the rules already apply. Some of the rules build upon rules already in place; other requirements, however, are completely new. The IRS will take comments and consider further changes, so any plans set forth to respond to these new regulations must themselves be ready for fine tuning. In the meantime, however, the new regulations must be followed precisely or the loss of tax benefits and imposition of penalties can ensue.

The regulations are generally beneficial to most businesses, but they also add complexity. They provide a more defined framework for determining capital expenditures, along with some clarifications of the law and some simplifying conventions. The regulations make significant and substantial changes to previous regulations issued by the government in 2008. In many cases, the tax treatment of an expenditure will vary from its treatment for book purposes, putting an additional burden on taxpayers to apply new tax accounting systems to track and collect data.

The regulations will require many decisions by taxpayers in determining the appropriate tax treatment. In some cases, taxpayers are given an explicit election to decide what type of tax treatment to follow, creating new opportunities as well as challenges. In other cases, taxpayers must make a de facto election. In either case, once the taxpayer adopts a particular method of accounting for particular assets, that business must continue to follow that method of accounting, and will not be able to change it without the IRS’s permission.

There will be more guidance from the IRS. Most taxpayers must now change their method of accounting for certain covered items to comply with the new regulations. The IRS has issued revenue procedures that provide transition rules for taxpayers changing their method of accounting. When changing accounting methods, however, the regulations require that taxpayers make so-called Code Section 481(a) adjustments to prevent duplicated or omitted tax benefits. Because of this requirement, taxpayers will in effect have to apply the new rules to costs incurred prior to the effective date of the regulations. As a result, some taxpayers may have to capitalize amounts they previously deducted, and recognize income based on the difference in treatment. Conversely, other taxpayers may be able to deduct amounts previously capitalized, and take a deduction for the difference. The retroactive impact of these changes can be significant for many businesses.

Our firm is here to help you determine how the regulations affect your business, what you must do to comply, what changes are necessary, what decisions must be made, and what opportunities are available.

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