The IRS has provided details clarifying the federal tax status involving special payments made by 21 states in 2022. Taxpayers in many states will not need to report these payments on their 2022 tax returns.

The IRS has provided details clarifying the federal tax status involving special payments made by 21 states in 2022. Taxpayers in many states will not need to report these payments on their 2022 tax returns.

General welfare and disaster relief payments

If a payment is made for the promotion of the general welfare or as a disaster relief payment, for example related to the COVID 19 pandemic, it may be excludable from income for federal tax purposes under the General Welfare Doctrine or as a Qualified Disaster Relief Payment. Payments from the following states fall in this category and the IRS will not challenge the treatment of these payments as excludable for federal income tax purposes in 2022:

• California,

• Colorado,

• Connecticut,

• Delaware,

• Florida,

• Hawaii,

• Idaho,

• Illinois,

• Indiana,

• Maine,

• New Jersey,

• New Mexico,

• New York,

• Oregon,

• Pennsylvania, and

• Rhode Island.

Alaska is in this group only for the supplemental Energy Relief Payment received in addition to the annual Permanent Fund Dividend. Illinois and New York issued multiple payments and in each case one of the payments was a refund of taxes to which the above treatment applies, and one of the payments is in the category of disaster relief payment. A list of payments to which the above treatment applies is available on the IRS website.

Refund of state taxes paid

If the payment is a refund of state taxes paid and recipients either claimed the standard deduction or itemized their deductions but did not receive a tax benefit (for example, because the $10,000 tax deduction limit applied) the payment is not included in income for federal tax purposes. Payments from the following states in 2022 fall in this category and will be excluded from income for federal tax purposes unless the recipient received a tax benefit in the year the taxes were deducted.

• Georgia,

• Massachusetts,

• South Carolina, and

• Virginia

Other Payments

Other payments that may have been made by states are generally includable in income for federal income tax purposes. This includes the annual payment of Alaska’s Permanent Fund Dividend and any payments from states provided as compensation to workers.

The IRS intends to change how it defines vans, sports utility vehicles (SUVs), pickup trucks and “other vehicles” for purposes of the Code Sec. 30D new clean vehicle credit. These changes are reflected in updated IRS Frequently Asked Questions (FAQs) for the new, previously owned and commercial clean vehicle credits.

The IRS intends to change how it defines vans, sports utility vehicles (SUVs), pickup trucks and “other vehicles” for purposes of the Code Sec. 30D new clean vehicle credit. These changes are reflected in updated IRS Frequently Asked Questions (FAQs) for the new, previously owned and commercial clean vehicle credits.

Clean Vehicle Classification Changes

For a vehicle to qualify for the new clean vehicle credit, its manufacturer’s suggested retail price (MSRP) cannot exceed:

• $80,000 for a van, SUV or pickup truck; or

• $55,000 for any other vehicle.

In December, the IRS announced that proposed regulations would define these vehicle types by reference to the general definitions provided in Environmental Protection Agency (EPA) regulations in 40 CFR 600.002 (Notice 2023-1).

However, the IRS has now determined that these vehicles should be defined by reference to the fuel economy labeling rules in 40 CFR 600.315-08. This change means that some vehicles that were formerly classified as “other vehicles” subject to the $55,000 price cap are now classified as SUVs subject to the $80,000 price cap.

Until the IRS releases proposed regulations for the new clean vehicle credit, taxpayers may rely on the definitions provided in Notice 2023-1, as modified by today’s guidance. These modified definitions are reflected in the Clean Vehicle Qualified Manufacturer Requirements page on the IRS website, which lists makes and models that may be eligible for the clean vehicle credits.

Expected Definitions of Vans, SUVs, Pickup Trucks and Other Vehicles

The EPA fuel economy standards establish a large category of nonpassenger vehicles called “light trucks.” Within this category, vehicles are defined largely by their gross vehicle weight ratings (GVWR) as follows:

• Vans, including minivans

• Pickup trucks, including small pickups with a GVWR below 6,000 pounds, and standard pickups with a GVWR between 6,000 and 8,500 pounds

• SUVs, including small SUVs with a GVWR below 6.000 pounds, and standard SUVs with a GVWR between 6,000 and 10,000 pounds

• Other vehicles (passenger automobiles) that, based on seating capacity of interior volume, are classified as two-seaters; mini-compact, subcompact, compact, midsize, or large cars; and small, midsize, or large station wagons.

However, the EPA may determine that a particular vehicle is more appropriately placed in a different category. In particular, the EPA may determine that automobiles with GVWR of up to 8,500 pounds and medium-duty passenger vehicles that possess special features are more appropriately classified as “special purpose vehicles.” These special features may include advanced technologies, such as battery electric vehicles, fuel cell vehicles, plug-in hybrid electric vehicles and vehicles equipped with hydrogen internal combustion engines.

FAQ Updates

The IRS also updated its frequently asked questions (FAQs) page for the Code Sec. 30D new clean vehicle credit, the Code Sec. 25E previously owned vehicle credit and the Code Sec. 45W qualified commercial clean vehicles credit. In addition to incorporating the new definitions discussed above, these updates:

• Define “original use” and "MSRP;"

• Describe the information a seller must provide to the taxpayer and the IRS;

• Clarify that the MSRP caps apply to a vehicle placed in service (delivered to the taxpayer) in 2023, even if the taxpayer purchased it in 2022; and

• Explain what constitutes a lease.

Effect on Other Documents

Notice 2023-1 is modified. Taxpayers may rely on the definitions provided in Notice 2023-1, as modified by Notice 2023-16, until the IRS releases proposed regulations for the new clean vehicle credit.

The IRS established the program to allocate environmental justice solar and wind capacity limitation (Capacity Limitation) to qualified solar and wind facilities eligible for the Low-Income Communities Bonus Credit Program component of the energy investment credit.

The IRS established the program to allocate environmental justice solar and wind capacity limitation (Capacity Limitation) to qualified solar and wind facilities eligible for the Low-Income Communities Bonus Credit Program component of the energy investment credit. The IRS also provided:

• initial guidance regarding the overall program design ,

• the application process, and

• additional criteria that will be considered in making the allocations.

After the 2023 allocation process begins, the Treasury Department and IRS will monitor and assess whether to implement any modifications to the Low-Income Communities Bonus Credit Program for calendar year 2024 allocations of Capacity Limitation.

Facility Categories, Capacity Limits, and Application Dates

The program establishes four facilities categories and the capacity limitation for each:

The IRS anticipates applications will be accepted for Category 3 and Category 4 facilities in the third quarter of 2023. Applications for Category 1 and Category 2 facilities will be accepted thereafter. The IRS will issue additional guidance regarding the application process and facility eligibility.

The program will also incorporate additional criteria in determining how to allocate the Capacity Limitation reserved for each facility category among eligible applicants. These may include a focus on facilities that are owned or developed by community-based organizations and mission-driven entities, have an impact on encouraging new market participants, provide substantial benefits to low-income communities and individuals marginalized from economic opportunities, and have a higher degree of commercial readiness.

Finally, only the owner of a facility may apply for an allocation of Capacity Limitation. Facilities placed in service prior to being awarded an allocation of Capacity Limitation are not eligible to receive an allocation. The Department of Energy (DOE) will provide administration services for the Low-Income Communities Bonus Credit Program. An allocation of an amount of capacity limitation is not a determination that the facility will qualify for the energy investment credit or the increase in the credit under the Low-Income Communities Bonus Credit Program.

The IRS announced a program to allocate $10 billion of credits for qualified investments in eligible qualifying advanced energy projects (the Code Sec. 48C(e) program). At least $4 billion of these credits may be allocated only to projects located in certain energy communities.

The IRS announced a program to allocate $10 billion of credits for qualified investments in eligible qualifying advanced energy projects (the Code Sec. 48C(e) program). At least $4 billion of these credits may be allocated only to projects located in certain energy communities.

The guidance announcing the program also:

• defines key terms, including qualifying advanced energy project, specified advanced energy property, eligible property, the placed in service date, industrial facility, manufacturing facilities, and recycling facility;

• describes the prevailing wage and apprenticeship requirements, along with remediation options; and

• sets forth the program timeline and the steps the taxpayer must follow.

Application and Certification Process

For Round 1 of the Section 48C(e) program, the application period begins on May 31, 2023. The IRS expects to allocate $4 billion in credit in this round, including $1.6 billion to projects in energy communities.

The taxpayer must submit a concept paper detailing the project by July 31, 2023. The taxpayer must also certify under penalties of perjury that it did not claim a credit under several other Code Sections for the same investment.

Within two years after the IRS accepts an allocation application, the taxpayer must submit evidence to the DOE to establish that it has met all requirements necessary to commence construction of the project. DOE then notifies the IRS, and the IRS certifies the project.

Taxpayers generally submit their papers through the Department of Energy (DOE) eXHANGE portal at https://infrastructure-exchange.energy.gov/. The DOE must recommend and rank the project to the IRS, and have a reasonable expectation of its commercial viability.

Energy Communities and Progress Expenditures

The guidance also provides additional procedures for energy communities and the credit for progress expenditures.

For purposes of the minimum $4 billion allocation for projects in energy communities, the DOE will determine which projects are in energy community census tracts. Additional guidance is expected to provide a mapping tool that applicants for allocations may use to determine if their projects are in energy communities.

Finally, the guidance explains how taxpayers may elect to claim the credit for progress expenditures paid or incurred during the tax year for construction of a qualifying advanced energy project. The taxpayer cannot make the election before receiving its certification letter.

The IRS has released new rules and conditions for implementing the real estate developer alternative cost method. This is an optional safe harbor method of accounting for real estate developers to determine when common improvement costs may be included in the basis of individual units of real property in a real property development project held for sale to determine the gain or loss from sales of those units.

The IRS has released new rules and conditions for implementing the real estate developer alternative cost method. This is an optional safe harbor method of accounting for real estate developers to determine when common improvement costs may be included in the basis of individual units of real property in a real property development project held for sale to determine the gain or loss from sales of those units.

Background

Under Code Sec. 461, developers cannot add common improvement costs to the basis of benefitted units until the costs are incurred under the Code Sec. 461(h) economic performance requirements. Thus, common improvement costs that have not been incurred under Code Sec. 461(h) when the units are sold cannot be included in the units' basis in determining the gain or loss resulting from the sales. Rev. Proc. 92-29, provided procedures under which the IRS would consent to developers including the estimated cost of common improvements in the basis of units sold without meeting the economic performance requirements of Code Sec. 461(h). In order to use the alternative cost method, the taxpayer had to meet certain conditions, provide an estimated completion date, and file an annual statement.

Rev. Proc. 2023-9 Alterative Cost Method

In releasing Rev. Proc. 2023-9, the IRS and Treasury stated that they recognized certain aspects of Rev. Proc. 92-29 are outdated, place additional administrative burdens on developers and the IRS, and that application of the method to contracts accounted for under the long-term contract method of Code Sec. 460 may be unclear.

The alternative cost method must be applied to all projects in a trade or business that meet the definition of a qualifying project. However, the alternative cost limitation of this revenue procedure is calculated on a project-by-project basis. Thus, common improvement costs incurred for one qualifying project may not be included in the alternative cost method calculations of a separate qualifying project.

The revenue procedure provides definitions including definitions of "qualifying project,""reasonable method," and "CCM contract" (related to the completed contract method). It provides rules for application of the alternative cost method for developers using the accrual method of accounting and the completed contract method of accounting, rules for allocating estimated common improvement costs, and a method for determining the alternative costs limitation. The revenue procedure also provides examples of how its rules are applied.

Accounting Method Change Required

Under Rev. Proc. 2023-9, the alternative cost method is a method of accounting. A change to this alternative cost method is a change in method of accounting to which Code Secs. 446(e) and 481 apply. An eligible taxpayer that wants to change to the Rev. Proc. 2023-9 alternative cost method or that wants to change from the Rev. Proc. 92-29 alternative cost method, must use the automatic change procedures in Rev. Proc. 2015-13 or its successor. In certain cases, taxpayers may use short Form 3115 in lieu of the standard Form 3115 to make the change.

Effective Date

This revenue procedure is effective for tax years beginning after December 31, 2022.

The IRS announced that taxpayers electronically filing their Form 1040-X, Amended U.S Individual Income Tax Return, will for the first time be able to select direct deposit for any resulting refund. 

The IRS announced that taxpayers electronically filing their Form 1040-X, Amended U.S Individual Income Tax Return, will for the first time be able to select direct deposit for any resulting refund. Previously, taxpayers had to wait for a paper check for any refund, a step that added time onto the amended return process. Following IRS system updates, taxpayers filing amended returns can now enjoy the same speed and security of direct deposit as those filing an original Form 1040 tax return. Taxpayers filing an original tax return using tax preparation software can file an electronic Form 1040-X if the software manufacturer offers that service. This is the latest step the IRS is taking to improve service this tax filing season.

Further, as part of funding for the Inflation Reduction Act, the IRS has hired over 5,000 new telephone assistors and is adding staff to IRS Taxpayer Assistance Centers (TACs). The IRS also plans special service hours at dozens of TACs across the country on four Saturdays between February and May. No matter how a taxpayer files the amended return, they can still use the "Where's My Amended Return?" online tool to check the status. Taxpayers still have the option to submit a paper version of Form 1040-X and receive a paper check. Direct deposit is not available on amended returns submitted on paper. Current processing time is more than 20 weeks for both paper and electronically filed amended returns.

"This is a big win for taxpayers and another achievement as we transform the IRS to improve taxpayer experiences," said IRS Acting Commissioner Doug O’Donnell. "This important update will cut refund time and reduce inconvenience for people who file amended returns. We always encourage directdeposit whenever possible. Getting tax refunds into taxpayers’ hands quickly without worry of a lost or stolen paper check just makes sense."

The OECD/G20 Inclusive Framework released a package of technical and administrative guidance that achieves clarity on the global minimum tax on multinational corporations known as Pillar Two. Further, it provides critical protections for important tax incentives, including green tax credit incentives established in the Inflation Reduction Act. 

The OECD/G20 Inclusive Framework released a package of technical and administrative guidance that achieves clarity on the global minimum tax on multinational corporations known as Pillar Two. Further, it provides critical protections for important tax incentives, including green tax credit incentives established in the Inflation Reduction Act. Pillar Two provides for a global minimum tax on the earnings of large multinational businesses, leveling the playing field for U.S. businesses and ending the race to the bottom in corporate income tax rates. This package follows the release of the Model Rules in December 2021, Commentary in March 2022 and rules for a transitional safe harbor in December 2022. The guidance will be incorporated into a revised version of the Commentary that will replace the prior version.

Additionally, the package includes guidance on over two dozen topics, addressing those issues that Inclusive Framework members identified are most pressing. This includes topics relating to the scope of companies that will be subject to the Global Anti-Base Erosion (GloBE) Rules and transition rules that will apply in the initial years that the global minimum tax applies. Additionally, it includes guidance on Qualified Domestic Minimum Top-up Taxes (QDMTTs) that countries may choose to adopt.

"The continued progress in implementing the globalminimum tax represents another step in leveling the playing field for U.S. businesses, while also protecting U.S. workers and middle-class families by ending the race to the bottom in corporate tax rates," said Assistant Secretary of the Treasury for Tax Policy Lily Batchelder. "We welcome this agreed guidance on key technical questions, which will deliver certainty for green energy tax incentives, support coordinated outcomes and provide additional clarity that stakeholders have asked for."

The Tax Code contains many taxpayer rights and protections. However, because the Tax Code is so large and complex, many taxpayers, who do not have the advice of a tax professional, are unaware of their rights. To clarify these protections, the IRS recently announced a Taxpayer Bill of Rights, describing 10 rights taxpayers have when dealing with the agency.

The Tax Code contains many taxpayer rights and protections. However, because the Tax Code is so large and complex, many taxpayers, who do not have the advice of a tax professional, are unaware of their rights. To clarify these protections, the IRS recently announced a Taxpayer Bill of Rights, describing 10 rights taxpayers have when dealing with the agency.

Taxpayer education

The idea for a Taxpayer Bill of Rights has been percolating for several years. One of the leading proponents has been National Taxpayer Advocate Nina Olson. In January 2014, Olson told Congress that a Taxpayer Bill of Rights was long overdue. Even though the rights already existed, many taxpayers did not know about them. More taxpayer education was needed, Olson emphasized. Olson proposed that either Congress pass legislation or the IRS take administrative action to set out a Taxpayer Bill of Rights.

Olson proposed that a Taxpayer Bill of Rights be based on the U.S. Bill of Rights. Olson also recommended that the IRS describe taxpayer rights in non-technical language. Olson's proposal won support from IRS Commissioner John Koskinen earlier this year.

Taxpayer Bill of Rights

In June, IRS Commissioner John Koskinen and Olson together unveiled a 10-point Taxpayer Bill of Rights.

The provisions in the Taxpayer Bill of Rights are:

1. The Right to Be Informed
2. The Right to Quality Service
3. The Right to Pay No More than the Correct Amount of Tax
4. The Right to Challenge the IRS's Position and Be Heard
5. The Right to Appeal an IRS Decision in an Independent Forum
6. The Right to Finality
7. The Right to Privacy
8. The Right to Confidentiality
9. The Right to Retain Representation
10. The Right to a Fair and Just Tax System

"The Taxpayer Bill of Rights contains fundamental information to help taxpayers," Koskinen said. "These are core concepts about which taxpayers should be aware. Respecting taxpayer rights continues to be a top priority for IRS employees, and the new Taxpayer Bill of Rights summarizes these important protections in a clearer, more understandable format than ever before."

As the IRS Commissioner noted, the Taxpayer Bill of Rights does not create new rights. Rather, the Taxpayer Bill of Rights is intended to serve an educational purpose to help taxpayers understand better their existing rights.

IRS Publication 1

The Taxpayer Bill of Rights is highlighted prominently in IRS Publication 1, Your Rights as a Taxpayer. The IRS reported that updated Publication 1 will be sent to taxpayers when they receive notices on issues ranging from audits to collections. Updated Publication 1 initially will be available in English and Spanish, and later in Chinese, Korean, Russian and Vietnamese.

Additionally, the IRS created a special page on its website to highlight the Taxpayer Bill of Rights. The Taxpayer Bill of Rights will be displayed in all IRS offices.

If you have any questions about the IRS Taxpayer Bill of Rights, please contact our office.

IR-2014-72

Taxpayers who are self-employed must pay self-employment tax on their income from self-employment. The self-employment tax applies in lieu of Federal Insurance Contributions Act (FICA) taxes paid by employees and employers on compensation from employment. Like FICA taxes, the self-employment tax consists of taxes collected for Social Security and for Medicare (hospital insurance or HI).

Taxpayers who are self-employed must pay self-employment tax on their income from self-employment. The self-employment tax applies in lieu of Federal Insurance Contributions Act (FICA) taxes paid by employees and employers on compensation from employment. Like FICA taxes, the self-employment tax consists of taxes collected for Social Security and for Medicare (hospital insurance or HI).

The self-employment tax is levied and collected as part of the income tax. The tax must be taken into account in determining an individual's estimated taxes. The self-employed taxpayer is responsible for the self-employment tax, in effect paying both the employer's and the employee's share of the tax. The tax is calculated on Schedule SE, filed with the individual's income tax return, and is then reported on the Form 1040.

Self-Employment Tax Rate

The self-employment tax rate is 15.3 percent of self-employment income. This is the same overall percentage that applies to an employee's compensation. The rate combines the 12.4 percent Social Security tax and the 2.9 percent Medicare tax. Self-employed individuals can deduct one-half of the self-employment tax. (For 2011 and 2012, the Social Security tax rate was reduced from 12.4 to 10.4 percent.) If the individual's net earnings from self-employment are less than $400 (or $100 for a church employee), the individual does not owe self-employment tax.

Like FICA taxes, the 12.4 percent Social Security tax only applies to earning up to a specified threshold. For 2013, this threshold was $113,700; for 2014, the threshold is $117,000. There is no ceiling for applying the 2.9 percent Medicare tax.

Self-Employment

The tax applies to net earnings from self-employment. This is the taxpayer's gross income for the year from operating a trade or business, minus the deductions allowable to the trade or business, plus the taxpayer's distributive share of income or loss from a partnership.

A person is self-employed if he or she carries on a trade or business as a sole proprietor or independent contractor. A general partner of a partnership that carries on a trade or business is also considered to be self-employed. Self-employment does not include the performance of services by an employee. However, an employee who also carries on a separate business part-time can be self-employed with respect to the business.

Additional Medicare Tax

Effective for 2013 and subsequent years, both employees and self-employed individuals must pay an additional 0.9 percent Medicare tax if their FICA wages or self-employment income exceeds specified thresholds $250,000 for joint filers; $125,000 for married filing separately; and $200,000 for all other taxpayers. This tax is determined on Form 8959.

The simple concept of depreciation can get complicated very quickly when one is trying to determining the proper depreciation deduction for any particular asset. Here’s only a summary of some of what’s involved.

The simple concept of depreciation can get complicated very quickly when one is trying to determine the proper depreciation deduction for any particular asset. Here’s only a summary of some of what’s involved.

Identifying the asset

The modified accelerated cost recovery system (MACRS) is generally, but not always, used to depreciate tangible depreciable property placed in service after 1986. The MACRS deduction is computed on Form 4562, Depreciation and Amortization.

Intangible property may not be depreciated under MACRS, but it may be amortized in certain situations. Real estate may not be depreciated, but buildings situated on it may. Sound recordings, films, and videotapes are specifically excluded from MACRS, but may be depreciated using the income forecast method. Deprecation for financial accounting book purposes is generally not the same as tax depreciation. Under MACRS, property placed in service and disposed of in the same tax year is not depreciable. Property converted from business use to personal use in the tax year of acquisition is not depreciable.

The cost of tangible depreciable property also may be deducted immediately if the business and the asset qualifies for Code Section 179 expensing. Bonus depreciation, in years that Congress makes it available, is also available, taken first before the asset’s remaining value is depreciated under MACRS.

Computing depreciation under MACRS

In order to compute depreciation under MACRS, the asset's MACRS property class must be determined. The asset's recovery period (i.e., its depreciation period), applicable depreciation method, and applicable convention depend on the asset's property class. Under MACRS, an asset's property class is based on either the type of asset or the business activity in which the asset is primarily used. The key resource for determining an asset's property class is the asset classification table contained in Revenue Procedure 87-56.

The cost of property in the 3-, 5-, 7-, and 10-year classes is recovered using the 200-percent declining-balance method (i.e., the applicable depreciation method) over three, five, seven, and ten years, respectively (i.e., the applicable recovery period), and the half-year convention (unless the mid-quarter convention applies), with a switch to the straight-line method in the year that maximizes the deduction.

The cost of 15- and 20-year property is generally recovered using the 150-percent declining-balance method over 15 and 20 years, respectively, and the half-year convention, with a switch to the straight-line method to maximize the deduction. The cost of residential rental and nonresidential real property is recovered using the straight-line method and the mid-month convention over 27.5-  and 39-year recovery periods, respectively.

For more specific information on the amount of depreciation you may take for any business asset you own or plan to purchase, please feel free to contact this office.

Nearly half-way into the year, tax legislation has been hotly debated in Congress but lawmakers have failed to move many bills. Only one bill, legislation to make permanent the research tax credit, has been approved by the House; its fate in the Senate still remains uncertain. Other bills, including legislation to extend many of the now-expired extenders before the 2015 filing season, have stalled. Tax measures could also be attached to other bills, especially as the days wind down to Congress' August recess.

Nearly half-way into the year, tax legislation has been hotly debated in Congress but lawmakers have failed to move many bills. Only one bill, legislation to make permanent the research tax credit, has been approved by the House; its fate in the Senate still remains uncertain. Other bills, including legislation to extend many of the now-expired extenders before the 2015 filing season, have stalled. Tax measures could also be attached to other bills, especially as the days wind down to Congress' August recess.

Tax extenders

Legislation to extend nearly all of the extenders seemed to be almost assured of passage in the Senate after the Senate Finance Committee (SFC) approved the EXPIRE Act in April. The EXPIRE Act would extend through 2015 many of the popular but temporary tax incentives, including the higher education tuition deduction, the state and local sales tax deduction, the deduction for mortgage premiums, research tax credit, Work Opportunity Tax Credit (WOTC), and more. In May, the EXPIRE Act became bogged down in procedural votes in the Senate. Democrats and Republicans could not agree whether amendments would be allowed and if so, how many amendments.

In the meantime, individual lawmakers have introduced bills to extend some of the extenders. The bills must be referred to committees (the SFC or the House Ways and Means Committee) for action. Committee chairs ultimately determine if the bills will be brought before the committee. SFC Chair Ron Wyden, D-Ore., has signaled that the EXPIRE Act is likely his best attempt to move an extenders bill. Wyden has also said that he will not promote another extenders bill after 2015 (hence the name, EXPIRE Act). Ways and Means Chair Dave Camp, R-Mich., has largely kept the committee's focus on the proposals outlined in his proposed Tax Reform Act of 2014.

Lawmakers have roughly eight weeks before their month-long August recess to act on the extenders. Our office will keep you posted of developments.

Research tax credit

The research tax credit is a very popular business tax incentive. Its popularity has pushed it to the front of the line in the House for renewal. One drawback is the credit's cost: estimated at $155 billion over 10 years.

In May, the House approved the American Research and Competitiveness Act of 2014. The bill attracted support from both Democrats and Republicans. The bill makes permanent and enhances the research tax credit. The bill is not offset, which is a stumbling block to winning support from Senate Democrats. In fact, President Obama has said he would veto the bill in its present form if it reaches his desk. There is a possibility, albeit slight, that the Senate could pass its own version of the research tax credit and the House and Senate would try to reach a compromise in conference.

Corporate taxation

President Obama, lawmakers from both parties and many taxpayers agree that the U.S. corporate tax rate should be reduced. They disagree on how to pay, or if to offset, any reduction. President Obama continues to promote the elimination of some business tax preferences, particularly tax incentives for oil, gas and fossil fuel producers, as the way to pay for a corporate tax rate cut. The President also has called for using some of the revenues to fund road and bridge construction.

Democrats in the House and Senate have also honed in on so-called "corporate inversions." These occur when U.S. companies merge with foreign ones for tax purposes. The merged entity is often located in a low-tax jurisdiction, such as Ireland with a corporate tax rate of 12.5 percent, compared to the U.S. corporate tax rate of 35 percent. House and Senate Democrats have introduced companion bills (Stop Corporate Inversions Act of 2014) to curb these mergers. Under current law, a corporate inversion will not be respected for U.S. tax purposes if 80 percent or more of the new combined corporation (incorporated offshore) is owned by historic shareholders of the U.S. corporation. The bill would reduce the threshold to 50 percent. House and Senate Republicans are not expected to support the bill.

Other bills

On July 1, the interest rate on federal subsidized Stafford loans is set to increase from 3.4 to 6.8 percent. Legislation introduced in the Senate, the Bank on Students Loan Fairness Act, would provide a one-year "fix" by setting the rate at the primary interest rate offered through the Federal Reserve discount window. The bill would be paid for by the so-called "Buffett Rule," which generally would disallow certain tax preferences to higher income individuals. Along with the student loan bill, lawmakers have on their agenda legislation to renew federal highway spending, as discussed above. A final highway bill with tax-related provisions could be approved before the August recess. Some lawmakers have proposed a hike in the federal gasoline tax but it is unlikely to be approved.

If you have any questions about tax legislation, please contact our office.

Transit incentives are a popular transportation fringe benefit for many employees. Although the costs of commuting to and from work are not tax-deductible (except in certain relatively rare cases), transportation fringe benefits help to offset some of the costs, including the expenses of riding mass transit or taking a van pool to work. Under current law, the value of qualified transportation fringe benefits provided to an employee is excluded from the employee's gross income and wages for income and payroll tax purposes.

Transit incentives are a popular transportation fringe benefit for many employees. Although the costs of commuting to and from work are not tax-deductible (except in certain relatively rare cases), transportation fringe benefits help to offset some of the costs, including the expenses of riding mass transit or taking a van pool to work. Under current law, the value of qualified transportation fringe benefits provided to an employee is excluded from the employee's gross income and wages for income and payroll tax purposes.

Qualified benefits

Only certain transit benefits qualify for this special tax treatment. They are:

• Transportation in a commuter highway vehicle if the transportation is in connection with travel between the employee's residence and place of employment (for example, van pooling),
• Transit passes,
• Qualified parking, and
• Qualified bicycle commuting reimbursements.

Employers have some latitude regarding which, if any, transit benefits they want to offer. An employer may simultaneously provide an employee with any one or more of the first three qualified transportation fringes. However, an employee may not exclude a bicycle commuting reimbursement for any month in which he or she receives any of the other incentives.

Excluded from gross income

As long as the amount of the transit pass, qualified parking or other benefit does not exceed the statutory monthly limits, the amounts are not wages for purposes of Social Security and Medicare, the Federal Unemployment Tax Act (FUTA), and federal income tax withholding. However, if the amounts do exceed the statutory limits, the excess must be included in the employee's gross income.

Amounts

For 2014, the maximum that may be excluded is $250 per month for qualified parking, but only $130 for transit passes and van pooling. The exclusion for qualified bicycle commuting reimbursement is limited to a per employee limitation of $20 per month multiplied by the number of qualified bicycle commuting months during the calendar year.

At the end of 2013, the monthly cap on the transit passes and van pools of the commuter benefit dropped to $130 per month-from $240 per month-because transit benefits parity expired. The amount of qualified parking, however, increased to $250 per month, from $240 per month, because of an adjustment for inflation required under the Tax Code.

Pending legislation

Parity could be restored and made retroactive to January 1, 2014. In April, the Senate Finance Committee approved the EXPIRE Act, which would restore parity by increasing the transit pass and van pool benefits to $250 per month - the same amount as parking. The EXPIRE Act is not a permanent fix. The bill would extend parity through the end of 2015. On January 1, 2016, parity would again expire.

The EXPIRE Act also includes special treatment for bikeshare costs. In 2013, the IRS announced that bikeshare arrangements would not be treated as a transportation fringe benefit unless Congress makes them so. The EXPIRE Act modifies the definition of qualified bicycle commuting reimbursement to include expenses associated with the use of a bikesharing arrangement.

Both the House and Senate must pass legislation in order to extend transit benefits parity. At this time, transit benefits parity has not moved in the House. One deterrent is the cost of extending parity. According to the Joint Committee on Taxation, a two-year extension of parity (through 2015) would cost $180 million over 10 years.

Retroactive extension

Retroactive extension of transit benefit parity would create some administrative challenges for employers. The last time there was a retroactive extension, the IRS provided special guidance to employers on how to account for the retroactive change when filing employment tax returns and Forms W-2. The IRS would likely do the same if there is a retroactive extension of transit benefit parity to January 1, 2014.

Please contact our office if you have any questions about transportation fringe benefits. Our office will keep you posted of developments.

With the April 15th filing season deadline now behind us, it’s not too early to turn your attention to next year’s deadline for filing your 2014 return. That refocus requires among other things an awareness of the direct impact that many "ordinary," as well as one-time, transactions and events will have on the tax you will eventually be obligated to pay April 15, 2015. To gain this forward-looking perspective, however, taking a moment to look back … at the filing season that has just ended, is particularly worthwhile. This generally involves a two-step process: (1) a look-back at your 2013 tax return to pinpoint new opportunities as well as "lessons learned;" and (2) a look-back at what has happened in the tax world since January 1st that may indicate new challenges to be faced for the first time on your 2014 return.

Your 2013 Form 1040

Examining your 2013 Form 1040 individual tax return can help you identify certain changes that you might want to consider this year, as well encourage you to continue what you’re doing right. These "key ingredients" to your 2014 return may include, among many others considerations, a fresh look at:

Your refund or balance due. While it is nice to get a big refund check from the IRS, it often indicates unnecessary overpayments over the course of the year that has provided the federal government with an interest-free loan in the form of your money. Now’s the time to investigate the reasons behind a refund and whether you need to take steps to lower wage withholding and/or quarterly estimated tax payments.

If on the other hand you had to pay the IRS when filing your return (or requesting an extension), you should consider whether it was due to a sudden windfall of income that will not repeat itself; or because you no longer have the same itemized deductions, you had a change in marital status, or you claimed a one-time tax credit such as for energy savings or education. Likewise, examining anticipated changes between your 2013 and 2014 tax years—marriage, the birth of a child, becoming a homeowner, retiring, etc.—can help warn you whether your're headed for an underpayment or overpayment of your 2014 tax liability.

Investment income. One area that blindsided many taxpayers on their 2013 returns was the increased tax bill applicable to investment income. Because of the "great recession," many investors had carryforward losses that could offset gains realized for a number of years as markets gradually improved. For many, however, 2013 saw not only a significant rise in investment income but also a rise in realized taxable investment gains that were no longer covered by carryforward losses used up during the 2010–2012 period.

Furthermore, dividends and long-term capital gains for the first time in 2013 were taxed at a new, higher 20 percent rate for higher income taxpayers and an additional 3.8 percent net investment income tax surtax for those in the higher income brackets. Short-term capital gains saw the highest rate jump, from 35 percent to 43.4 percent rate, which reflected a new 39.6 percent regular rate and the new 3.8 percent net investment income tax rate. This tax structure remains in place for 2014.

Personal exemption/itemized deductions. Effective January 1, 2013, the American Taxpayer Relief Act (ATRA) revived the personal exemption phaseout (PEP). The applicable threshold levels are $250,000 for unmarried taxpayers; $275,000 for heads of households; $300,000 for married couples filing a joint return (and surviving spouses); and $150,000 for married couples filing separate returns (adjusted for inflation after 2013). Likewise, for it revived the limitation on itemized deductions (known as the "Pease" limitation after the member of Congress who sponsored the original legislation) for those same taxpayers.

Medical and dental expenses. Starting in 2013, the Affordable Care Act (ACA) increased the threshold to claim an itemized deduction for unreimbursed medical expenses from 7.5 percent of adjusted gross income (AGI) to 10 percent of AGI. However, there is a temporary exemption for individuals age 65 and older until December 31, 2016. Qualified individuals may continue to deduct total medical expenses that exceed 7.5 percent of adjusted gross income through 2016. If the qualified individual is married and only one spouse is age 65 or older, the taxpayer may still deduct total medical expenses that exceed 7.5 percent of adjusted gross income.

Recordkeeping. If you cannot find the paperwork necessary to prove your right to a deduction or credit, you cannot claim it. An organized tax recordkeeping system—whether on paper or computerized–therefore is an essential component to maximizing tax savings.

Filing Season Developments

So far this year, the IRS, other federal agencies and the courts have issued guidance on individual and business taxation, retirement savings, foreign accounts, the ACA, and much more. Congress has also been busy working up a "tax extenders" bill as well as tax reform proposals. All these developments can impact how you plan to maximize benefits on your 2014 income tax return.

Tax reform. President Obama, the chairs of the House and Senate tax writing committees, and individual lawmakers all made tax reform proposals in early 2014. The proposals range from comprehensive tax reform to more piece-meal approaches. Although only small, piecemeal proposals have the most promising chances for passage this year, taxpayers should not ignore the broader push toward tax reform that will be taking shape in 2015 and 2016.

Tax extenders. The Senate Finance Committee (SFC) approved legislation (EXPIRE Act) in April that would extend nearly all of the tax extenders that expired after 2013. Included in the EXPIRE Act are individual incentives such as the state and local sales tax deduction, the higher education tuition deduction, transit benefits parity, and the classroom teacher’s deduction; along with business incentives such as enhanced Code 179 small business expensing, bonus depreciation, the research tax credit, and more. Congress may now move quickly on an extenders bill or it may not come up with a compromise until after the November mid-term elections. Many of these tax benefits are significant and will directly impact the 2014 tax that taxpayers will pay.

Individual mandate. The Affordable Care Act’s individual mandate took effect January 1, 2014. Individuals failing to carry minimum essential coverage after January 1, 2014 and who are not exempt from the requirement will make an individual shared responsibility payment when they file their 2014 federal income tax returns in 2015. There are some exemptions, including a hardship exemption if the taxpayer experienced problems in signing up with a Health Insurance Marketplace before March 31, 2014. Further guidance is expected before 2014 tax year returns need to be filed, especially on how to calculate the payment and how to report to the IRS that an individual has minimum essential coverage.

Employer mandate. The ACA’s shared responsibility provision for employers (also known as the “employer mandate”) will generally apply to large employers starting in 2015, rather than the original 2014 launch date. Transition relief provided in February final regulations provides additional time to mid-size employers with 50 or more but fewer than 100 employees, generally delaying implementation until 2016. Employers that employ fewer than 50 full-time or full time equivalent employees are permanently exempt from the employer mandate. The final regulations do not change this treatment under the statute.

Other recent tax developments to be aware of for 2014 planning purposes include:

• IRA rollovers. The IRS announced that, starting in 2015, it intends to follow a one-rollover-per-year limitation on Individual Retirement Account (IRA) rollovers as an aggregate limit.
• myRAs. In January, President Obama directed the Treasury Department to create a new retirement savings vehicle, “myRA,” to be rolled out before 2015.
• Same-sex married couples. In April, the IRS released guidance on how the Supreme Court’s Windsor decision, which struck down Section 3 of the Defense of Marriage Act (DOMA), applies to qualified retirement plans, opting not to require recognition before June 26, 2013.
• Passive activity losses. The Tax Court found in March that a trust owning rental real estate could qualify for the rental real estate exception to passive activity loss treatment.
• FATCA deadline. The IRS has indicated that it is holding firm on the July 1, 2014, deadline for foreign financial institutions (FFIs) to comply with the FATCA information reporting requirements or withhold 30 percent from payments of U.S.-source income to their U.S. account holders.
• Vehicle depreciation. The IRS announced that inflation-adjusted limitations on depreciation deductions for business use passenger autos, light trucks and vans first placed in service during calendar year 2014 are relatively unchanged from 2013 (except for first year $8,000 bonus depreciation that may be removed if Congress does not act in time.
• Severance payments. In March, the U.S. Supreme Court held that supplemental unemployment benefits (SUB) payments made to terminated employees and not tied to the receipt of state unemployment benefits are wages for FICA tax purposes.
• Virtual currency. The IRS announced that convertible virtual currencies, such as Bitcoin, would be treated as property and not as currency, thus creating immediate tax consequences for those using Bitcoins to pay for goods.

Please contact this office if you’d like further information on how an examination of your 2013 return, and examination of recent tax developments, may point to revised strategies for lowering your eventual tax bill for 2014.

A new tax applies to certain taxpayers, beginning in 2013—the 3.8 percent Net Investment Income (NII) Tax. This is a surtax that certain higher-income taxpayers may owe in addition to their income tax or alternative minimum tax. The tax applies to individuals, estates, and trusts (but not to corporations). Individuals are subject to the tax if they have NII, and their adjusted gross income exceeds a specified threshold—$250,000 for married taxpayers filing jointly; $200,000 for unmarried individuals.

For trusts, the NII tax applies at a much lower income level—the amount at which the highest tax bracket for a trust begins. This may sound high, but in fact, it is not. For 2014, this bracket begins at $12,150. A trust subject to the NII tax may lower or eliminate its potential liability by distributing NII to its beneficiaries, because the tax applies only to the undistributed NII for the year. The tax may then apply to the recipient, but based on the recipient’s income level.

Exempt and nonexempt trusts

Some trusts are exempt from the NII tax: cemetery perpetual care funds; Alaska Native Settlement Trusts electing to be taxed under Code Sec. 646; wholly charitable trusts; and foreign trusts. However, other trusts are not exempt. These include pooled income funds (where individuals donate remainder interests to charity while retaining an income interest); qualified funeral trusts; electing small business trusts; and charitable remainder trusts.

Passive activity

For individuals, trusts, and estates, the tax applies to income from a trade or business that is a passive activity with respect to the taxpayer. A trade or business is not passive if the taxpayer materially participates in the activity (as determined under Code Sec. 469). There is IRS guidance for determining whether an individual materially participates in an activity.

Material participation

The IRS has never provided guidance on how to determine whether a trust or estate materially participates in a trade or business. When the IRS issued final regulations on the NII tax, it said that the issue was under study, but the IRS has not indicated whether it will issue guidance on the issue.

The IRS regulations conclude that the application of the material participation requirements to trust income potentially subject to the NII tax must be determined at the trust level. The treatment of the income as passive or nonpassive, once determined for the trust, flows through to trust beneficiaries who receive a distribution of NII. Thus, if the trust materially participates in the activity that generated the income, the income is nonpassive to both the trust and its beneficiaries, regardless of the age or involvement of the beneficiaries. If the trust did not materially participate, the income is passive to both the trust and its beneficiaries, even if a beneficiary materially participated in the activity.

As virtual currencies such as Bitcoin rise in prominence and use, the IRS has for the first time described how virtual currency will be treated for tax purposes. The agency concluded in new guidance (Notice 2014–21) that Bitcoin and other virtual currencies like it are not to be treated as currency, but as property.

Definition of virtual currency

Actual (or "real") currency is commonly defined as a system of money in general use in a particular country. The U.S. dollar is an example of actual currency. A single definition of virtual currency, on the other hand, has not yet achieved widespread acceptance. Virtual currency (sometimes referred to as "cryptocurrency") is a medium of exchange that operates like actual currency under some circumstances. Currently, virtual currency does not have legal tender status in any jurisdiction.

How virtual currency works

Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as "convertible" virtual currency. Currently, the most prominent example of a convertible virtual currency is Bitcoin, which can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real currencies.

A Bitcoin is created, or "mined," electronically, according to a purely mathematical process. A complex computer algorithm is applied. As more and more Bitcoins are mined, the difficulty of doing so will increase, as it becomes computationally more difficult to create them. This process was designed to mimic the production rate of a commodity such as gold.

Companies like BitPay or Coinbase act as intermediaries in Bitcoin transactions. According to Adam White, the Director of Business Development and Sales at Coinbase, over a million customers use Coinbase as their "Bitcoin wallet," allowing Coinbase to accept Bitcoin payments on their behalf using its payment tools. This includes over 28,000 merchants.

Fees associated with virtual currency transactions are relatively small in contrast with higher fees charged to businesses accepting credit cards. Credit card companies generally charge businesses a fee per swipe of the card, plus two to four percent of the total transaction. On the other hand, businesses that use a merchant processor pay fees of one percent, or less, for Bitcoin transactions. However, virtual currencies are volatile and involve high risk. For example, the value of a Bitcoin went from pennies to $1,200 in a five-year period, and then back down to around $500, where it rested as on April 22, 2014.

U.S. tax treatment

The IRS acknowledged that virtual currency may be used to pay for goods or services, or held for investment. The IRS issued guidance providing answers to frequently asked questions (FAQs) about virtual currency, offering Bitcoin as an example. The FAQs at present provide only basic information on the tax implications of transactions in, or using, virtual currency.

Property. Notice 2014–21 states that virtual currency will be treated as property for U.S. federal tax purposes. As such, it is governed by the same general principles that apply to property transactions generally. The sale or exchange of convertible virtual currency, or its use to pay for goods or services in a real-world economy transaction, has immediate tax consequences that would not apply if it were considered pure "legal tender."

Conversion required. A taxpayer who receives virtual currency in payment for goods or services is required to include the fair market value of the virtual currency in computing gross income. This value must be measured in U.S. dollars as of the date the virtual currency was received. The basis in virtual currency is its fair market value on the date of receipt, determined by converting the virtual currency to U.S. dollars (or another real currency which can be converted into U.S. dollars) at the applicable exchange rate in a reasonable manner that is consistently applied.

Capital gain or ordinary income. The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer. If the virtual currency is held as inventory, for example, for sale to customers in a trade or business, gain or loss on its disposition will be ordinary gain or loss. If the virtual currency is held as an investment, gain or loss on its disposition will be capital in nature.

It remains unclear whether Bitcoins will be treated as "coins" for purposes of the 28 percent capital gains rate on collectibles; or whether they will be considered a permitted investment within individual retirement accounts or in other, similar circumstances.

A taxpayer who creates, or mines, virtual currency realizes gross income on receipt of the virtual currency resulting from that activity. The fair market value of the virtual currency as of that date is includible in gross income.

Information reporting. A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. Thus, a person who makes a payment of fixed and determinable income using virtual currency with a value in excess of $600 to a U.S. non-exempt recipient is required to report the payment to the IRS and to the payee. This includes payment of rent, salaries, wages, premiums, annuities, and compensation.

Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W–2, and are subject to federal income tax withholding. Also, payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply to such payments. Payers using virtual currency must normally issue Form 1099 to the payee.

Penalties. Taxpayers who fail to report their income from virtual currency may potentially be subject to tax penalties. At the April 2 House Committee’s Bitcoin hearing, L. Michael Couvillion, Professor, Plymouth State University, New Hampshire, pointed out that taxpayers who treated virtual currencies inconsistently with IRS Notice 2014–21 before it was issued will not receive penalty relief unless they can establish that their underpayment or failure to properly file information returns was due to reasonable cause. This will require many businesses and individuals to go back and determine the existence of gain or loss on transactions that occurred in the past, perhaps several years in the past.

The applicable federal rates (AFRs) are used for a number of federal tax provisions. For example, Code Sec. 1274 uses AFRs to determine whether a debt instrument has original issue discount (OID or imputed interest). This determination requires the calculation of the present value of payments made on the debt instrument; present value is calculated using a discount rate equal to the AFR, compounded semi-annually.

Determining AFRs

AFRs are based on the average market yield on outstanding marketable obligations of the United States government. Under Code Sec. 1274(d), the AFR includes the federal short-term rate (based on the interest rates for debt instruments of three years or less); the federal mid-term rate (based on the rates for debt instruments of three to nine years); and the federal long-term rate (based on the rates for debt instruments exceeding nine years).

The IRS computes AFRs for each calendar month and publishes them in a revenue ruling. As an example, Rev. Rul. 2014–1, published January 6, 2014, provided the AFRs for January 2014. AFRs may be compounded (and therefore applied) monthly, quarterly, semiannually, or annually. In addition, some amounts are calculated using a higher percentage of the basic AFR. The monthly revenue rulings provide AFRs equal to 110 percent of the base AFR, 120 percent, 130 percent, 150 percent, and 175 percent.

Applying AFRs

The Tax Code uses AFRs to determine appropriate amounts under a multitude of provisions. These include:

• The present value of an annuity, life interest, term of years interest, remainder interest, or reversionary interest under Code Sec. 7520;
• Loans with below-market interest rates, under Code Sec. 7872 (the applicable rate depending on the term of the loan);
• Insurance reserves under Code Sec. 807, as well as insurance provisions under Code Secs. 811 and 812;
• The present value of golden parachute payments under Code Sec. 280G (120 percent of the AFR, compounded semiannually);
• Payments for the use of property or services under Code Sec. 467;
• Unrelated business income and debt-financed income under Code Sec. 514; and
• The recharacterization of gain from straddles under Code Sec. 1058.

The AFR revenue rulings also provide adjusted AFRs, which are used to determine the Code Sec. 382 limits on NOLs following ownership changes, and to determine OID on tax-exempt obligations under Code Sec. 1288.

Code Sec. 162 permits a business to deduct its ordinary and necessary expenses for carrying on the business. However, Code Sec. 274 restricts the deduction of entertainment expenses incurred for business by disallowing expenses of entertainment activities and entertainment facilities. Many expenses are totally disallowed; other amounts, if allowed under Code Sec. 274, are limited to 50 percent of the expense.

The income tax regulations define entertainment as any activity of a type generally considered to be entertainment, amusement, or recreation, such as entertaining at night clubs, lounges, theaters, country clubs, golf and athletic clubs, and sports events, as well as hunting, fishing, vacation and similar trips. There are special rules for the costs of facilities used to entertain the customer, such as a boat or a country club membership. Dues or fees for any social, athletic or sporting club or organization are treated as items involving facilities.

Deduction allowed

Expenses are allowed if the expense was either "directly related" to the active conduct of the taxpayer’s trade or business, or "associated with" the conduct of the trade or business. An activity is "associated with" business if the activity directly precedes or follows a substantial and bona fide business discussion.

Entertainment expenses are not directly related to the business if the activity occurred under circumstances with little or no possibility of engaging in the active conduct of the trade or business. These circumstances include an activity where the distractions are substantial, such as a meeting or discussion at a night club, theater, or sporting event. However, taking a customer to a meal at a restaurant or for drinks at a bar can be considered conducive to a business discussion, if there are no substantial distractions to a discussion.

Substantial business discussion

For expenses that are either directly related to or associated with business, the taxpayer must establish that the he or she conducted a substantial and bona fide business discussion with the customer. The IRS has said that there is no specified length for a discussion to be substantial; all facts and circumstances will be considered. The discussion is substantial if the active conduct of the business was the principal character of the combined business and entertainment activity, but it is not necessary that more time be devoted to business than to entertainment.

For an activity that is associated with, the discussion can directly precede or follow the activity. For a discussion to be directly before or after the activity, it generally must be on the same day as the activity. However, facts and circumstances may allow the entertainment and the discussion to be on consecutive days, for example if the customer is from out of town.

Season tickets

The special rules for facilities do not apply to season tickets. Instead, the taxpayer must allocate the cost of the season tickets to each separate entertainment event. The amount deductible is limited to the face value of the ticket. For a "skybox" or other area leased and used exclusively by the taxpayer and guests, the amount deductible is limited to the face value of non-luxury seats for the area covered by the lease.

Under these rules, it appears that the deductible costs of baseball season tickets must be determined separately for each baseball game. Attendance at a baseball game would involve a "distracting" activity that is not conducive to a business discussion, so the cost of the game would not be directly related to the conduct of the trade or business. However, attendance at a game before or after the conduct of a substantial business discussion could qualify as being associated with the business; in these circumstances, the cost of the event would be deductible.

If the taxpayer provided food to the customer at the baseball game, the cost of the food would be deductible as part of the cost of the event. Some "luxury" seats include food provided by the baseball team to the ticket user. It appears that the taxpayer would have to determine the fair market value of the ticket and the food separately, although the costs of food actually provided to the customer may still be deductible.

The current likelihood that your business will become involved in an employment tax audit or an employment-related income tax audit has increased: the IRS is aggressively attempting to reduce the "tax gap" of uncollected revenues in a time of increasing budget austerity. Employment tax noncompliance is estimated by the IRS to account for approximately $54 billion of the tax gap. Under-reporting of FICA makes up $14 billion; under-reporting of self-employment tax accounts for $39 billion; and under-reporting of unemployment tax accounts for $1 billion in lost revenue. Add to that total amount over $50 billion in estimated employment-associated income tax lost that is the result of missteps in withholding obligations, tip reporting, and proper fringe benefit classification . . . and employers are forewarned. The IRS is stepping up its auditing in these areas and has been conducting studies to maximize the best use of its agents' time to do so.

Latest audit survey

The IRS is conducting an intensive audit of 6,000 employment tax returns to obtain an up-to-date picture of taxpayers' employment tax practices. This will enable the IRS to better devote its compliance resources to the most important areas of noncompliance and to the taxpayers most likely not to be in compliance.

Based on these audits, the IRS's Chief of Employment Tax Policy has spotlighted several areas of concern that the IRS will focus on. These areas include backup withholding, tip reporting, worker classification, and fringe benefit reporting.

Backup withholding. Backup withholding is the number one problem uncovered in the audits. The IRS can impose backup withholding on income reported on Forms 1099 that is not ordinarily subject to withholding, such as interest, dividends, and nonemployee compensation. Failure to provide a taxpayer identification number (TIN) on the Form 1099, an incorrect TIN, or a TIN that does not match the name on the form can trigger backup withholding. A taxpayer's failure to report the income can also trigger backup withholding.

Tip reporting. Tip reporting is a major concern of the IRS. The IRS considers noncompliance a widespread problem, especially for small businesses that are not aware of the issues. The IRS has been focusing on educating employers, and is not auditing employment tax returns filed before 2014. An important issue is the failure to differentiate between service charges and tips. A payment that is automatically added to a bill may be a service charge. A service charge is characterized as Social Security wages, rather than Social Security tips. The distinction is important, because employers can claim a Social Security credit for FICA obligations attributable to tips that exceed the minimum wage, but cannot claim a credit for taxes paid on service charges.

Worker misclassification. To avoid FICA and FUTA taxes and income tax withholding, some employers intentionally classify employees as independent contractors. This has been a longstanding concern for the IRS, and the recent audits have shown that the problem continues. The agency regularly conducts employment tax audits to reclassify workers as employees. To facilitate reclassification to employee status, the IRS has two settlement programs for employers: the Classification Settlement Program (CSP) for taxpayers under audit, and the Voluntary Classification Settlement Program (VCSP) for companies that are not under an employment tax audit and meet other requirements. The IRS has received 1,550 applications under the VCSP and has reclassified approximately 25,000 workers. Companies that agree to prospectively treat workers as employees generally pay reduced taxes and may get audit protection for past years.

Fringe benefit reporting. Fringe benefits can be cash or noncash benefits provided in addition to regular wages. As a compliance matter, fringe benefits are taxable and must be included in the recipient's income, unless the Tax Code specifically excludes the benefit from taxable income. Moreover, if the recipient is an employee, the value of the benefit is additional compensation subject to employment taxes. Fringe benefits can be a particular problem for small companies, where owners seek to reduce their taxable income by taking noncash benefits, such as the use of company vehicles. A bargain sale of a house to an employee could also generate taxable income subject to employment taxes.

Conclusions

Employment taxes present an increasing risk to employers as the IRS steps up focuses on what it suspects is a heretofore largely untapped source of revenue. The IRS is certain to use the data now being harvested through its latest audit surveys. Many employers may do well to review how their employment tax compliance now measures up to this new degree of scrutiny.

In response to the economic downturn that has affected the retirement portfolios of millions of individuals across the country, Congress has been considering a variety of alternatives to offer relief to those who face financial emergencies and need immediate access to their funds. Two of the most significant proposals that have been recommended include: (1) significant broadening of the suspension of the 10 percent penalty tax on early withdrawals from IRAs and defined contribution plans, and (2) extending the temporary suspension of the penalty tax imposed on individuals age 70 1/2 or older who do not take required minimum distributions (RMDs) from certain retirement plans.

Early withdrawal penalty

To discourage individuals from using money set aside in retirement accounts for expenses incurred outside of retirement, a 10 percent tax is imposed on the amount that is withdrawn, in addition to this amount being included in the individual's gross income and subject to federal (and often, state) income tax. The 10 percent penalty will not apply to distributions made in the following circumstances:

• After the individual has reached age 59 1/2;
• The distribution is made to an individual who is a beneficiary of a deceased IRA owner;
• The individual is disabled;
• For higher education expenses (from IRAs only);
• The distributions are made as part of substantially equal payments over the account holder's life expectancy;
• The individual retires after age 55;
• For unreimbursed medical expenses exceeding 7.5 percent of the individual's adjusted gross income (AGI);
• For medical insurance premiums in the case of unemployment;
• To buy, build, or rebuild a first home (from IRAs only, and subject to a $10,000 withdrawal limit); and
• If the individual is a reservist called to active duty after September 11, 2001.

Caution: The extent to which a withdrawal may be made from an employer-sponsored qualified retirement plan, even with respect to amounts that you contributed, depends upon what is allowed under the written plan itself. Some plans only allow you to withdraw after retirement. Others allow withdrawals for "hardships," which may include medical expenses or other financial crisis. Still other withdrawals, such as withdrawals for higher education or a first home purchase, are never allowed under IRS rules from an employer-sponsored plan.

The 10 percent penalty and, for that matter, the underlying taxable income generated from a withdrawal, do not apply if the funds are properly rolled over within a 60-day period from an employer-sponsored plan to an IRA or from one qualified plan or IRA to another.

Hardship withdrawals. Individuals who take a hardship withdrawal from their defined contribution plan must also pay the 10 percent penalty tax. A hardship is defined as an immediate and heavy financial need. Certain expenses are deemed to meet this definition, but even so, the penalty still applies.

Proposals to suspend the 10 percent penalty

Several proposals have been advanced by policymakers to eliminate or suspend the 10 percent early withdrawal penalty in certain situations. The proposals would generally add a paragraph to Internal Revenue Code Sec. 72(t) to eliminate the penalty in specific circumstances. Proposals include eliminating or suspending the 10 percent early withdrawal penalty for:

• Public safety employees who retire before the age of 55;
• Workers who are unemployed;
• Individuals affected by natural disasters;
• Homeowners at risk of having their mortgage foreclosed;
• Individuals who receive a hardship distribution from a retirement plan; and
• Individuals who have qualified adoption expenses.

RMDs

Individuals with certain qualified retirement plans, as well as traditional IRAs and 403(b) plans, are required to withdraw a certain amount ( a "required minimum distribution" or RMD) from the account each year after reaching age 70 1/2 (Roth IRAs are not subject to the RMD rules). The annual RMD is based on the account balance as of December 31 of the prior year and the account holder's life expectancy. Generally, RMDs must begin no later than April 1 of the year after you reach age 70 1/2.

Proposals to suspend RMDs

RMDs were suspended for 2009 only. RMDs must be taken for 2010 and beyond, unless Congress acts to suspend the RMD rules again. However policymakers have put forth various proposals to eliminate or suspend altogether the RMD requirements. The proposals include:

• Suspending the RMD requirement through 2010;
• Suspending the RMD requirement through 2012;
• Eliminating the RMD requirement; or
• Postponing the required starting date, which would raise the age at which individuals must start taking their RMDs.

When contemplating whether to implement any of these proposals, Congress and Treasury officials must balance a number of considerations, including the immediate financial needs of individuals with the policies behind the penalty taxes; namely, providing funds for retirement and not allowing the money to be used for pre-retirement expenses.

Our office will keep you posted on any legislative proposals that may affect your retirement planning. We also can help you navigate the current rules that would apply should you need to make a withdrawal soon from your retirement savings.