In Congress

IN CONGRESS

Return for a moment to Congress’ unfinished business on tax relief. Legislative battles over taxes will be particularly acrimonious in 2010, with the midterm congressional elections looming. Democrats will be attempting to maintain the Bush tax cuts, but only for middle and low incomers. And Obama has said 2010 is the year for tax code overhaul. With so many contentious issues already on their plate for next year, lawmakers did themselves no favors by punting on expiring breaks and the estate tax. Although Congress adopted the old slogan of the Brooklyn Dodgers and decided to wait until next year, lawmakers are certain to discover that their differences will be even harder to resolve in an election year.

JUST REMEMBER…MIRACLES HAPPEN ON ELECTION YEARS ... POLITICIANS LIVE BY THE 4 YEAR RULE: 3 FOR THEM AND 1 FOR US.

If you are fed up, let’s clean house this November.

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Payroll Taxes: Correcting Errors

PAYROLL TAXES

Firms can correct most employment tax underreporting errors interest free, according to the IRS. There are some exceptions to this rule, such as cases where the employer fails to pay the additional FICA tax due when it files Form 941-X, or when it agrees on Form 2504 to changes IRS made on audit (Rev. Rul. 2009-39).

IRS will waive estimated tax penalties due to the Making Work Pay Credit...the 6.2% credit on earned income, capped at $400 for singles and $800 for couples. IRS changed its income tax withholding tables to approximate the value of the credit. But many filers will be under withheld because the drop in income tax withholding exceeds the amount of the credit they’re entitled to. This includes working couples and pensioners with no earned income whose tax withholding was calculated under the new tables. Details on the waiver are in the instructions for Form 2210.

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Gift Taxes

GIFT TAXES

When splitting a gift between individuals and charitable organizations... It’s OK to let the charities get more if IRS revalues the gift to individuals, the Tax Court says. A mother set up an LLC and gave away $907,000 worth of units in it to trusts for her kids. That used up her remaining gift tax exemption. A portion of her gift went to charities. Under the gift’s terms, if IRS found that the LLC units were worth more than she thought, the trusts were required to give the charities any amount over $907,000. On audit, IRS said the LLC units had a higher value. But no additional gift tax was due because the extra amount went to the charities. The Service balked at the formula clause, but the Court OK’d it because the trusts still got the dollar amount the mother intended (Est. of Petter, TC Memo. 2009-280).

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Business Taxes

BUSINESS TAXES

Corporations with NOL carry backs should receive their refunds promptly, the IRS says. Even though Congress extended the five-year NOL carry back to firms with average annual gross receipts of $15 million or more, the Service says it has enough staff to turn around those refund claims in the normal 90-day period.

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The Clergy: Tax Breaks Under Attack

THE CLERGY

Two tax breaks for members of the clergy are under attack in court. A group wants a court to void the tax exclusion for parsonage allowances and the deduction for real estate taxes and mortgage interest that is available to recipients of these allowances. In its view, preferential tax benefits for ministers that cannot be claimed by other taxpayers are unconstitutional. Seven years ago, an Appeals Court questioned the legality of the breaks in a case concerning the cap on the housing allowance, but IRS swept the issue under the rug, conceding the case after Congress tightened the cap. The current case will require the district court to uphold or nix the breaks (Freedom From Religion Found. v. Geithner, D.C., Calif.).

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Losses

LOSSES

A major tax break for securities traders cannot be elected retroactively, the Tax Court says. Traders who want to treat their holdings as if sold at the end of the year can claim any losses from the deemed sale as ordinary losses for tax purposes, without regard to the $3,000 annual ceiling on net capital losses. But to make an election for a year, they must do so by mid-April...the filing deadline for the previous year. A late filed election won’t fly if the trader is using hindsight to benefit from the election, in the Court’s view (Kohli, TC Memo. 2009-287).

Casualty losses on rental property aren’t passive losses, the Tax Court says. Losses from fire, storm, theft or similar events don’t count toward the $25,000 limit on deductible passive losses (Agosto, TC Summ. Op. 2009-191). On the flip side, however, any gain resulting from the insurance proceeds will not be passive income. Drinking and driving can mix for tax purposes, according to the Tax Court. A drunk driver who totaled his pickup can claim a casualty loss deduction, in its view, because his actions weren’t grossly negligent. Although he had arranged to be driven home from a party where he’d been drinking, he later thought he was OK to drive elsewhere. His vehicle slid off the road and rolled over, and he was arrested for drunken driving because his blood alcohol reading was just over the legal limit.

His insurer denied his claim because of the arrest. The Court let him deduct the loss because it said that he had tried to act reasonably (Rohrs, TC Summ. Op. 2009-190). The Court would have nixed the deduction if he had driven right home from the party with a high blood alcohol level and had an accident. That would be gross negligence.

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Brokers: Basis Reporting Regulations

BROKERS

Brokers have just over a year to gear up for a new reporting rule:

They must list on 1099-B forms the tax basis of stock sold by customers. The first reports are due on sales of stocks purchased after 2010. Form 1099-B will be revised to reflect the new requirement. Under newly proposed regulations, for sales of stocks bought after 2010, brokers also will have to report if the gain or loss on the sale is long term or short term and if the wash-sale rule applies to disallow a loss. A loss barred by the wash-sale rule increases the tax basis of the replacement stock. And when customers move stock bought after 2010 to another broker, the transferring broker must report the basis to the new broker.

The basis reporting rules are phased in for other types of securities. They’ll apply to sales of mutual fund shares purchased after 2011 or stock received after 2011 in connection with a dividend reinvestment plan. And for the first time, S firms will get 1099-Bs for sales of stock and other securities bought after 2011.

A reminder on the deadline for brokers to issue 2009 tax statements:

The due date is Feb. 16, 2010. In 2008, Congress changed the deadline from Jan. 31 to Feb. 15 for several forms: 1099-Bs, 1099-S’s and any 1099-MISCsthat show payments of lawyer fees or payments by brokers of substitute dividends or tax-exempt interest. This also applies to annual composite reporting statements that brokers send to clients, including 1099-DIV and 1099-INT forms that normally are part of those statements. Issuers get an extra day because Feb. 15 is a holiday.

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State Taxes: Military Spouses’ Break

STATE TAXES

Congress has OK’d a new tax break for spouses of armed forces members. They can keep their home state domicile for state income tax purposes if they live with a soldier whose duty station is in another state. The new law applies only to their wages and personal service income, and is retroactive to Jan. 1, 2009.

This helps spouses who hail from states with no income tax or a low rate income tax who wind up moving on account of military orders to a state with a high tax rate. This is causing problems for states, which now must amend their tax forms and withholding forms to handle the late change in the law. Spouses who are eligible for this relief will have to file returns with the state they reside in to get a refund of withheld or estimated taxes as well as
in their home state if it has an income tax.

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Estate Taxes: Family Partnerships

ESTATE TAXES

Family limited partnerships can be used to reduce estate taxes. But they need to be established for reasons other than the tax savings to work for tax purposes, the Tax Court says. A father who set up one with his son and trusts for his grandkids passed that test. All of the parties transferred stock in the father’s employer to an LLC and took back proportionate interests in it.

Although estate tax savings via a discount for a partial LLC interest were discussed, the main reasons for the transfers were to keep the grandkids from selling their stock and to keep the shares at bay from the son’s spouse, whom the son later divorced. Keeping the block of stock intact let's the family maintain a seat on the firm’s board. The IRS’ attempt to tax the stock’s full value fails (Est. of Black, 133 TC No. 15).

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Observations: Congress’ Mess

Congress is leaving behind a big tax mess:

Many key issues remain unresolved for now. Although the House approved extensions for a group of expiring tax breaks, the Senate got bogged down in debate over health care overhaul, preventing it from tackling other must-do bills before year-end. The gridlock could lead to a train wreck on taxes in 2010. Not only will unfinished business have to be taken care of, but Congress will be staring at another major deadline because the Bush tax
cuts will expire at the end of the year if nothing is done.

This session’s biggest failure: Inaction on the estate tax. With no change in current law, the tax will disappear in 2010, then reappear in 2011 with a top rate of 60% and a low $1-million exemption. The generation-skipping tax will also end for a year, and the gift tax lives on, but the top rate falls to 35%. Also, some heirs of people who die in 2010 will owe capital gains tax when they sell inherited assets.

Current law, which steps up the basis for inherited assets to the date-of-death value, is replaced by a convoluted system that starts with the decedent’s income tax basis. Executors are allowed to increase the basis of inherited assets by up to $1.3 million, with an extra $3 million for assets left to a surviving spouse. Taxwriters realize this is a nightmare, so they’ll push for some kind of estate tax solution next year.

Also stuck in limbo: A bunch of tax provisions that will sunset Dec. 31. Among them: The R&D credit and write-offs for college tuition, teachers’ supplies and state sales tax, as well as the break for donating IRA distributions to charity.

Plus raising the AMT exemptions so they don’t fall to pre-2001 levels. These breaks will be renewed, retroactive to Jan. 1, 2010, but that may not occur until late 2010.

The waiver for 2009 of mandatory payouts from IRAs and plans will not be revived. Senior citizens were left in the lurch as well. Their Social Security checks will shrink in 2010 because there won’t be a cost-of-living increase to offset a hike in Medicare Part D premiums. Lawmakers failed to OK a bill for a onetime payment of up to $250 for these folks. And Congress didn’t stop a 2010 increase in premiums for about 25% of Medicare Part B recipients…singles with adjusted gross incomes of more than $85,000, couples with AGIs over $170,000 and new Medicare enrollees.

Those folks will see their basic 2010 Part B premium jump to $110.50 from $96.40. Congress did manage to renew one break before heading home for the year: The COBRA health coverage subsidy law, which originally allowed workers terminated after Aug. 31, 2008 and before Jan. 1, 2010 to get a nine-month subsidy for 65% of the premiums they paid to continue their coverage. That assistance has been extended to workers let go through Feb. 28, 2010. Anyone who is eligible for the subsidy can now receive it for
up to 15 months, up from nine months before. This also includes former employees whose subsidy payments ran out after November. Firms will have to notify those eligible for the longer subsidy about the extension.

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Qualified Plans: Audits of 401(k)s

QUALIFIED PLANS

Recent audits of small 401(k) plans have borne fruit. Examiners looked at 50 “top heavy” plans, which are subject to special rules because the bulk of the plans’ benefits go to highly paid employees. Among the problems: Failing to make required minimum contributions for low paids; excluding eligible workers from the plan. And not depositing employee contributions in a timely manner. Look for IRS to broaden its reach and order up more audits of these small plans. Employers get an extra year to amend plans to reflect pension law changes approved by Congress over the past few years. The new deadline is Dec. 31, 2010.

Among the changes requiring amendments; Quicker vesting for cash balance plans, Curbs on benefit accruals for underfunded pensions, And rules allowing participants in 401(k) s to diversify out of employer stock. Announcement of the new deadline just three weeks before the original due date may come too late to provide relief for many plans, because amendments generally have been in the works for months. And IRS is giving itself more time to set procedures for OKing 403(b) plans.

Major new rules for these plans took effect Jan. 1, 2009, including a requirement that these plans must be in writing by the end of this year. The Revenue Service expects to have 403(b) plan approval procedures in place within a few months. The bottom line for sponsors: No need to petition IRS for the time being to get approval of a plan’s tax qualified status. The Service will announce sometime in 2010 when it will be ready to accept determination letter requests. Until then, employers using a prototype plan developed by IRS can assume that they are OK as long as they follow the procedures that the Service will announce next year.

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Fringe Benefits

FRINGE BENEFITS

Firms get an extra year to switch to debit cards to pay commuting benefits. Earlier, IRS had said that beginning Jan. 1, 2010, employers in localities with transit card systems would no longer be allowed to pay those benefits in cash. Now the Service says employers will still have the option of using cash or debit cards until 2011. The additional time is needed because many local
mass transit systems still need more time to make changes to conform to IRS rules for debit card usage. With debit cards, workers can get transit benefits without substantiating expenses, but the card must be one they can use only in a transit system or parking facility.

Companies can’t avoid unrelated business tax on earnings in VEBAs ... voluntary employees’ beneficiary associations. Employers use VEBAs to pay claims for health and accident benefits of employees, their spouses and dependents.

In this case, a firm’s fully funded VEBA earned over $2.5 million
on its investments and paid out more than $7 million in benefit claims. The company tried to argue that the investment earnings were exempt because they were used to pay benefits, but that was rejected by an Appeals Court. The income tax exemption is allowed only in cases when the VEBA is underfunded and the earnings on the investments are used to help pay claims (CNG Transmission Management VEBA, Fed. Cir.).

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