Amid a growing number of scams and fraudulent activity surrounding the Employee Retention Credit, the Internal Revenue Service will stop processing new claims, effective immediately, at least through the end of the year.

Amid a growing number of scams and fraudulent activity surrounding the Employee Retention Credit, the Internal Revenue Service will stop processing new claims, effective immediately, at least through the end of the year.

"We are deeply concerned that this program is not operating in a way that was intended today, far from the height of the pandemic in 2020 and 2021," IRS Commissioner Daniel Werfel said during a September 14, 2023, conference call with reporters. "We believe we should see only a trickle of employee retention claims coming in. Instead, we are seeing a tsunami."

Werfel said the agency has received about 3.6 million claims by taxpayers taking advantage of the program and there are more than 600,000 that have yet to be processed, "virtually all of which were received within the last 90 days. That means about 15 percent of all ERCclaims received since the start of the program three and half years ago have been received in the last 90 days. That’s an incredibly large number to have so far beyond the pandemic and nearly two years after the time periods covered by the program."

He attributed the spike in claims to emergence and prevalence of so-called ERC mills.

"This great program to help small businesses has been overtaken by aggressive promoters," Werfel said. "The ads are everywhere. The program has become the centerpiece for unscrupulous marketing and profits from pushing taxpayers to claim a credit that they would not be eligible for."

The agency said in a September 14, 2023, press release that it will process claims already received, but as of today, there will be no new claims processed for the pandemic-era relief program aimed to help small businesses remain in operation while dealing with potential economic hardships due to the COVID-19 pandemic.

However, for those who have filed claims, they can expect longer wait times for the financial relief offered by the credit as the agency conducts more detailed compliance reviews of the claims that have been filed.

And that compliance work as already begun. Werfel stated that as of July 31, 2023, the IRS Criminal Investigation Division has initiated 252 investigations involving more than $2.8 billion worth of potentially fraudulent ERC claims. Fifteen of those cases have resulted in federal charges, with six cases resulting in convictions, and an average sentence of 21 months for those reaching the sentencing phase. He also stated that the agency has referred thousands of claims for audit.

"With the stricter compliance reviews in place during this period, existing ERCclaims will go from a standard processing goal of 90 day to 180 days – and much longer if the claim faces further review or audit," the agency stated in the press release. "The IRS may also seek additional documentation from the taxpayer to ensure it is a legitimate claim."

To help taxpayers who may have fallen victim to an ERC mill, the IRS will be introducing programs in the coming weeks and months to help taxpayers. First, the agency will be providing a process under which taxpayers with unprocessed claims can withdraw those claims. To help taxpayers in self-reviewing their already submitted claims or who may be thinking about submitting claims when the IRS begins processing new claims again, the agency on September 14, 2023, released an updated eligibility checklist. The process to withdraw a claim will be finalized soon.

For those who have had their claims processed, received money and then later received a determination that they were in fact ineligible for the credit, the IRS will be offering a settlement program to help taxpayers pay back funds they should not have received due to eligibility reasons. Details on the settlement program will be released in coming months.

This help may be needed because the IRS recognizes that a business or tax-exempt group c"ould find itself in a much worse financial position if you have to pay back the credit than if the credit was never claimed in the first place," Werfel said.

Werfel is encouraging those who have submitted claims to do an independent verification of eligibility with a trusted tax professional to ensure they were in fact eligible for the credit and if they were not, be ready to take the steps to withdraw the claim if it hasn’t been paid or to look for the settlement program if necessary.

By Gregory Twachtman, Washington News Editor

The Department of the Treasury is reaching out to Congress to get the appropriate tools to combat the wave of Employee Retention Credit fraud and other future issues.

The Department of the Treasury is reaching out to Congress to get the appropriate tools to combat the wave of Employee Retention Credit fraud and other future issues.

In a September 14, 2023, letter to Senate Finance Committee Chairman Ron Wyden, the agency made two specific requests. First, the IRS asked for authority to regulate paid preparers, which it sated "could help protect taxpayers from penalties, interest, or avoidable costs of litigation that result from the poor-quality advice they receive."

Second, the IRS asked for legislation specific to the ERC, but it was more vague in what it wants, asking Congress "to consider other ways to help reduce fraud and abuse associated with the ERC, while protecting honest taxpayers. For example, legislating targeting contingency fee practices would help prevent overzealous promoters from profiting off small businesses."

During a September 14, 2023, conference call with reporters, Laurel Blatchford, chief implementation officer of the Inflation Reduction Act at the Treasury Department, said that having the ability to regulate paid preparers would make it easier to target ERC mills that have popped up in recent months.

"Congress should pass legislation making clear these mills have to play by the same rules as other professionals who prepare returns for taxpayers," Blatchford said. "These mills may claim they aren’t paid preparers, but they receive compensation for their advice."

And while the IRS and Treasury could promulgate regulations for something like banning contingency fees that would prevent mills from collecting a portion of the money refunding through the credit,"a legislative prohibition takes effect far more quickly."

By Gregory Twachtman, Washington News Editor

The Internal Revenue Service detailed plans on some of the high-income taxpayers that will be targeted for more compliance efforts in the coming fiscal year.

The Internal Revenue Service detailed plans on some of the high-income taxpayers that will be targeted for more compliance efforts in the coming fiscal year.

IRS Commissioner Daniel Werfel, during a September 7, 2023, teleconference with reporters, said that the new compliance push "makes good on the promise of the Inflation Reduction Act to ensure the IRS holds our wealthiest filers accountable to pay the full amount of what they owe,"adding that the agency will simply be enforcing already-existing laws.

Werfel stated that the IRS will be "pursuing 1,600 millionaires who owe at least $250,000. … The IRS will have dozens of revenue officers focused on these high-end collection cases in fiscal year 2024,"which begins on October 1, 2023. "This group of millionaires owes hundreds of millions of dollars in taxes, and we will use Inflation Reduction Act resources to get those funds back."

He also said that the agency will be making a “dramatic shift” on large partnerships.

"These are some of the most complex cases the IRS faces, and it involves a wide range of activities and industries where it’s been far too easy for tax evaders to cut corners,"Werfel said.

To help with this effort, Werfel highlighted that the agency will be using expanded artificial intelligence programs and additional Inflation Reduction Act resources to help with the audit process for large complex partnerships.

"The selection of these partnership returns for review is the result of groundbreaking collaboration among experts in data sciences and tax enforcement," Werfel said. "They have been working side-by-side to apply cutting-edge machine learning technology to identify potential compliance risks in the area of partnership tax, general income tax, and accounting and international tax in a segment that historically has been subject to limited examination coverage."

The AI will be used to help spot trends that might not be obvious and help the agency determine which partnerships are at the greatest risk of noncompliance, starting with 75 specific partnerships with assets of more than $10 million.

"These are some of the largest [partnerships] in the U.S. that the AI tool helped us identify," Werfel said. "These organizations will be notified of the audit in the coming weeks. These 75 organizations represent a cross section of industries, including hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms, and other industries."

Werfel also noted that starting in October, "hundreds of partnerships will receive a special compliance alert from us in the mail. The alert relates to what we have identified as an ongoing discrepancy on balance sheets involving partnerships with over $10 million in assets," adding that taxpayers filing partnership returns are showing more and more discrepancies in recent years. Approximately 500 partnerships will be receiving this mailing.

"We will need to do more in the partnership arena," Werfel said. "But this is historic. And these are examples of how the Inflation Reduction Act funding will make a difference and help ensure fairness in the tax system."

Other areas that will get compliance attention in the coming fiscal year include those with digital assets, high-income taxpayers who use foreign banks to avoid disclosure and related tax obligations, as well as a previously announced effort to target the construction industry where companies are using subcontractors, which are shell corporations, to engage in tax fraud. The agency will also be targeting scammers such as the current trend of Employee Retention Credit mills.

Werfel also noted that there are ongoing efforts to keep hiring people to conduct these enforcement actions.

"We know we need to make more progress in our hiring efforts, as we will be accelerating these," Werfel said. "This is particularly important given our aging workforce and the relatively high attrition rate among IRS employees."

By Gregory Twachtman, Washington News Editor

The Treasury Inspector General for Tax Administration is calling on the Internal Revenue Service to improve its training of revenue agents that will be focused on auditing high-income taxpayers.

The Treasury Inspector General for Tax Administration is calling on the Internal Revenue Service to improve its training of revenue agents that will be focused on auditing high-income taxpayers.

In an August 31, 2023, report, the Treasury Department watchdog noted that despite receiving supplemental funding from the Inflation Reduction Act that has been earmarked, in part, to increase examination of high-income taxpayers, the "IRS’s efforts to train new hires do not appear to be fully leveraging" the expertise it has within the Large Business and International Division.

"The IRS treats this training as specialized and only offers it when necessary for employees auditing in this specialized area," that current continued, recommending that with the new IRA funding, "the IRS should revise its training paradigm and expose new hires to the types of issues associated with high-incometaxpayer returns."

TIGTA also criticized the agency for not having"a unified or updated definition for individual high-incometaxpayers," noting that"current examination activity code schema still uses $200,000 as the main threshold" as established in the Tax Reform Act of 1976. This threshold exists even as the IRS continually uses $400,000 as the income threshold, with the population underneath it not expecting to see a rise in audit rates against historical levels from a decade ago.

"The IRS’s Inflation Reduction Act Strategic Operating Plan sets forth leveraging data analytics to improve the IRS’s understanding of the tax filings of high-wealth individuals and to address potential noncompliance," the report states. "Consequently, the IRS needs to update its high-incometaxpayer definition to better identify and track examination results and manage examination priorities."

IRS in its response to the TIGTA findings, published in the report, did not agree with the recommendation related to the definition of high-income taxpayers, stating that "a static and overly proscriptive definition of high-incometaxpayers for the purposes of focusing on income levels above which taxpayers have unique and varied opportunities for tax would serve to deprive the IRS of the agility to address emerging issues and trends."

By Gregory Twachtman, Washington News Editor

The IRS has provided additional interim guidance in Notice 2023-64 for the application of the new corporate alternative minimum tax (CAMT). This guidance clarifies and supplements the CAMT guidance provided in Notice 2023-7, I.R.B. 2023-3, 390, and Notice 2023-20, I.R.B. 2023-10, 523, which were issued earlier this year. The IRS anticipates that the forthcoming proposed regulations on the CAMT will be consistent with this interim guidance and that they will apply for tax years beginning on or after January 1, 2024. Taxpayers may rely on the interim guidance for tax years ending on or before the date the forthcoming proposed regulations are published, and for any tax year that begins before January 1, 2024.

The IRS has provided additional interim guidance in Notice 2023-64 for the application of the new corporate alternative minimum tax (CAMT). This guidance clarifies and supplements the CAMT guidance provided in Notice 2023-7, I.R.B. 2023-3, 390, and Notice 2023-20, I.R.B. 2023-10, 523, which were issued earlier this year. The IRS anticipates that the forthcoming proposed regulations on the CAMT will be consistent with this interim guidance and that they will apply for tax years beginning on or after January 1, 2024. Taxpayers may rely on the interim guidance for tax years ending on or before the date the forthcoming proposed regulations are published, and for any tax year that begins before January 1, 2024.

CAMT and Prior CAMT Guidance

For tax years beginning after 2022, a 15-percent CAMT is imposed on the adjusted financial statement income (AFSI) of an applicable corporation (generally, a corporation with a three-year average annual AFSI in excess of $1 billion) (Code Secs. 55(a) and (b), and 59(k)). To determine if the threshold is met, corporations under common control are generally aggregated and special rules apply in the case of foreign-parented multinational groups. The CAMT does not apply to S corporations, regulated investment companies (RICs), and real estate investment trusts (REITs).

A corporation’s AFSI is the net income or loss reported on the corporation’s applicable financial statement (AFS) with adjustments for certain items, as provided in Code Sec. 56A. Special rules apply in the case of related corporations included on a consolidated financial statement or filing a consolidated return. Applicable corporations are allowed to deduct financial statement net operating losses (FSNOLs), subject to limitation, and can reduce their minimum tax by the CAMT foreign tax credit (CAMT FTC) and the base erosion and anti-abuse tax (BEAT). They can also utilize a minimum tax credit against their regular tax and the general business credit.

Notice 2023-7 announced that the IRS intends to issue proposed regulations (forthcoming proposed regulations) addressing the application of the CAMT, and provided interim guidance regarding time-sensitive CAMT issues that taxpayers may rely on until the forthcoming proposed regulations are issued.

Notice 2023-20 provided additional interim guidance that taxpayers may rely on until the issuance of the forthcoming proposed regulations, including interim guidance intended to help avoid substantial unintended adverse consequences to the insurance industry arising from the application of the CAMT.

Considering the challenges of determining the CAMT liability, Notice 2023-42, 2023-26 I.R.B. 1085, provided relief from the addition to tax under Code Sec. 6655 in connection with the application of the CAMT (specifically, the IRS will waive the penalty for a corporation’s estimated income tax with respect to its CAMT for a tax year that begins after December 31, 2022, and before January 1, 2024).

Additional Interim Guidance Provided in Notice 2023-64

The IRS intends to propose rules in the forthcoming proposed regulations consistent with the interim guidance in Notice 2023-64, which provides taxpayers with additional clarity in applying the CAMT before the issuance of the forthcoming proposed regulations. Specifically, Notice 2023-64 sets forth the following guidance:

• Definition of a taxpayer for purposes of the guidance - a taxpayer includes any entity identified in Code Sec. 7701 and its regulations, including a disregarded entity, regardless of whether the entity meets the definition of a taxpayer under Code Sec. 7701(a)(14).
• Determining a taxpayer’s AFS - the guidance provides a definition of an AFS, a list of financial statements that meet the AFS definition, priority rules for identifying a taxpayer’s AFS; rules for certified financial statements, restatements, annual and periodic financial statements; and special rules for an AFS covering a group of entities.
• Determining a taxpayer's AFSI - the guidance provides definitions of financial statement income (FSI) and AFSI; general rules for determining FSI and AFSI, including federal tax treatment not relevant for FSI or AFSI; and rules for determining FSI from a consolidated AFS.
• Determining the FSI, AFSI, and CAMT of tax consolidated groups – rules are provided for priority of consolidated AFS; calculation of FSI of a consolidated group; and calculation of the CAMT of a tax consolidated group.
• Determining AFSI with respect to certain foreign corporations – special rules are provided for the application of Code Sec. 56A(c) to certain foreign corporations.
• Determining the AFSI adjustment for certain taxes under Code Sec. 56A(c)(5).
• Determining the AFSI adjustment for depreciation – the new guidance modifies and clarifies the guidance for the AFSI depreciation adjustments provided in Notice 2023-7, and provides other AFSI rules for Section 168 property. Taxpayers that choose to rely on the interim guidance in section 4 of Notice 2023-7 on or after September 12, must apply the guidance in section 4 of Notice 2023-7, as modified and clarified by Notice 2023-64.
• Determining the AFSI adjustment for qualified wireless spectrum.
• Determining adjustments to prevent certain duplications and omissions of AFSI – rules are provided for adjustments resulting from a change in financial accounting principle or restatement of a prior year’s AFS; and adjustments for amounts disclosed in an auditor’s opinion.
• Determining the use of financial statement NOL (FSNOL) carryovers - the amount of an FSNOL carried forward to the first tax year a corporation is an applicable corporation (and subsequent tax years) is determined without regard to whether the taxpayer was an applicable corporation for any prior tax year.
• Determining an applicable corporation status – specific rules are provided for the application of the aggregation rules under Code Sec. 59(k)(1)(D); for determining an applicable corporation status of members of a foreign-parented multinational group; and for disregarding the distributive share adjustment.
• Determining the CAMT foreign tax credit (CAMT FTC) - generally, a foreign income tax is eligible to be claimed as a CAMT FTC in the tax year in which it is paid or accrued for federal income tax purposes by either an applicable corporation or a CFC with respect to which the applicable corporation is a U.S. shareholder, provided the foreign income tax has been taken into account on the AFS of the applicable corporation or CFC.

Applicability Dates, Request for Comments, and Effect on Other Documents

The IRS intends to publish forthcoming proposed regulations regarding the application of the CAMT that would include proposed rules consistent with the interim guidance provided in Notice 2023-7, as modified and clarified by Notice 2023-64, Notice 2023-20, and Notice 2023-64. It is anticipated that the forthcoming proposed regulations would apply for tax years beginning on or after January 1, 2024. Taxpayers may rely on the interim guidance provided in these Notices for tax years ending on or before the date forthcoming proposed regulations are published. However, in any event, a taxpayer may rely on such interim guidance for any tax year that begins before January 1, 2024.

The IRS has requested comments on any questions arising from the interim guidance provided in Notice 2023-64 as well as comments addressing specific questions listed in the guidance.

Sections 3, 4, and 7 of Notice 2023-7 are modified and clarified.

Taxpayers may rely on a notice that describes proposed regulations that will address the amortization of qualified research and experimentation (R&E) expenses. Before 2022, R&E expenses were currently deductible, but the Tax Cuts and Jobs Act (P.L. 115-97) replaced the deduction with a five-year amortization period (15 years for foreign research).

Taxpayers may rely on a notice that describes proposed regulations that will address the amortization of qualified research and experimentation (R&E) expenses. Before 2022, R&E expenses were currently deductible, but the Tax Cuts and Jobs Act (P.L. 115-97) replaced the deduction with a five-year amortization period (15 years for foreign research).

The notice provides guidance on:

• the capitalization and amortization of specified research or experimental expenditures;
• the definition of specified research or experimental (SRE) expenditures and software expenditures;
• the treatment of SRE expenditures performed under contract with a third party, including long term contracts under Code Sec. 460;
• the application of Code Sec. 482 to cost sharing arrangements involving SRE expenditures; and
• the disposition or abandonment of SRE expenditures.

The guidance generally applies to tax years ending after September 8, 2023. The notice is not intended to change the rules for determining eligibility for or computation of the Code Sec. 41 research credit, including rules for "research with respect to computer software," and the definitions of "qualified research" and "qualified researchexpenses."

The notice obsoletes section 5 of Rev. Proc. 2000-50. Comments are requested.

Capitalization of SRE Expenditures

The notice requires taxpayers to capitalize SRE expenditures and amortize them ratably over the applicable amortization period beginning with the midpoint of the tax year. The midpoint is the first day of the seventh month of the tax year in which the SRE expenditures are paid or incurred.

However, the midpoint of a short tax year is the first day of the midpoint month. If the short tax year has an even number of months, the midpoint month is determined by dividing the number of months in the short tax year by two and then adding one. For example, for a short tax year with ten months, the midpoint month is the sixth month ((10 / 2) + 1 = 6)). If the short tax year has an odd number of months, the midpoint month is the month that has an equal number of months before and after it. For example, for a short tax year with seven months, the mid-point month is the fourth month.

If a short tax year includes part of a month, the entire month is included in the number of months in the tax year, but the same month may not be counted more than once. If a taxpayer has two successive short tax years and the first short tax year ends in the same month that the second short tax year begins, the taxpayer should include that month in the first short ta year and not in the second short year.

For purposes of the 15-year amortization period, foreign research is any research conducted outside the United States, the Commonwealth of Puerto Rico, or any U.S. territory or other possession of the United States.

SRE Expenditures and Activities

The notice clarifies the scope of Code Sec. 174 by defining SRE expenditures and SRE activities. Otherwise, the notice adopts the definitions provided in Reg. §1.174-2.

SRE expenditures for tax years beginning after 2021 are research or experimental (R&E) expenditures that are paid or incurred by the taxpayer during the tax year in connection with the taxpayer’s trade or business. R&E expenditures must

• satisfy the Reg. §1.174-2 requirements, or
• be paid or incurred in connection with the development of computer software (defined below), regardless of whether they satisfy Reg. §1.174-2.

SRE activities are software development costs (defined below), or research or experimental activities defined in Reg. §1.174-2.

Costs that may be SRE expenditures include labor costs, materials and supplies costs, cost recovery allowances, operation and management costs and travel costs that are used in the performance or direct support of SRE activities, as well as patent costs. Costs that are not SRE expenditures include general and administrative costs, interest on debt, costs to input content into a website, website hosting and registration costs, amounts representing amortization of SRE expenditures, and expenses listed in Reg. § 1.174-2(a)(6).

Costs are allocated to SRE expenditures on the basis of a cause-and-effect relationship between the costs and the SRE activities or another method that reasonably related the costs to benefits provided to SRE activities. A taxpayer may use different allocation method for different types of costs, but must apply each method consistently. SRE expenditures must also be treated consistently for all provisions under subtitle A of the Code.

Computer Software Development

The notice defines computer software as a computer program or routine (that is, any sequence of code) that is designed to cause a computer to perform a desired function or set of functions, and the documentation required to describe and maintain that program or routine. The code may be stored on a computing device, affixed to a tangible medium (for example, a disk or DVD), or accessed remotely via a private computer network or the Internet (for example, via cloud computing).

Software includes a computer program, a group of programs, and upgrades and enhancements, which are modifications to existing software that result in additional functionality (enabling the software to perform tasks that it was previously incapable of performing), or materially increase the software’s speed or efficiency. Computer software can include upgrades and enhancements to purchased software.

The notice provides several examples of activities that constitute software development, such as planning the development, designing, building a model, and testing the software or updates and enhancements; and writing and converting source code.

As mentioned above, computer software may include upgrades and enhancements to purchased software. However, software development does not include the purchase and installation of purchased computer software, including the configuration of pre-coded parameters to make the software compatible with the business and reengineering the business to make it compatible with the software, and any planning, designing, modeling, testing, or deployment activities with respect to the purchase and installation of such software.

Contract Research

The notice also provides clarity in the treatment of costs paid or incurred for research performed under contract. For purposes of these rules, a research provider is the party that contracts to perform research services or develop an SRE product for a research recipient. An SRE product is a pilot model, process, formula, invention, technique, patent, computer software, or similar property (or a component thereof) that is subject to protection under applicable domestic or foreign law. For example, mere know-how gained by the research provider that is not subject to legal protection is not an SRE product.

Costs incurred by the research recipient are governed by Reg. §1.174-2(a)(10) and (b)(3). A provider may incur SRE expenditures under the contract if the provider:

• bears financial risk sunder the terms of the contract (that is, the provider may suffer a financial loss related to the contract research); or
• has a right to use any resulting SRE product in its own trade or business or otherwise exploit through sale, lease or license. The provider does not have such rights if it must obtain approval from another party to the research arrangement that is not related to the provider.

Disposition, Retirement or Abandonment of Property

The notice provides clarity in the treatment of unamortized SRE expenditures if the related property is disposed of, retired, or abandoned in certain transactions during the applicable amortization period. The disposition, retirement or abandonment generally does not accelerate the recovery of unamortized SRE expenditures (that is, the amortized SRE expenditures that have not yet been recovered). Thus, the taxpayer must continue to amortize the expenditures over the remainder of the applicable amortization period.

If a corporation ceases to exist in a Code Sec.381(a) transaction or series of transactions, the acquiring corporation will continue to amortize the distributor or transferor corporation’s unamortized SRE expenditures over the remainder of the distributor or transferor corporation’s applicable amortization period beginning with the month of transfer.

However, a corporation that ceases to exist in any other transaction or series of transactions may generally deduct the unamortized SRE expenditures in its final tax year, unless a principal purpose of the transaction(s) is to allow the corporation to deduct the expenses.

Taxpayers may not rely on these rules for SRE expenditures paid or incurred with respect to property that is contributed to, distributed from, or transferred from a partnership.

Long-Term Contracts and Cost-Sharing Regs

The notice provides that costs allocable to a long-term contract accounted for using the percentage-of-completion method (PCM) include amortization of SRE expenditures under Code Sec. 174(a)(2)(B), rather than the capitalized amount of such expenditures. This amortization is treated as incurred for purposes of determining the percentage of contract completion as deducted.

The notice also makes changes to regulations for cost sharing transaction payments (CST payments) between controlled participants in a cost sharing arrangement (CSA) that are made to ensure that each controlled participant’s share of intangible development costs (IDCs) is in proportion to its share of reasonably anticipated benefits from exploitation of the developed intangibles (RAB share).

Accounting Method Changes

The IRS intends to issue additional guidance for taxpayers to obtain automatic consent to change methods of accounting to comply with this notice. Until the issuance of such procedural guidance, taxpayers may rely on section 7.02 of Rev. Proc. 2023-24 to change their methods of accounting under Code Sec. 174 to comply with this notice. Unless specifically authorized by the IRS or by statutes, a taxpayer may not request or make a retroactive change in accounting method by filing an amended return.

Comments Requested

The IRS request comments on issues arising from the interim guidance provided in the notice, as well as issued that are not addressed. Written comments should be submitted by November 24, 2023; however, the IRS will consider late comments if doing so will not delay the issuance of the forthcoming proposed regulations. Comments may be submitted by mail or electronically via the Federal eRulemaking Portal at www.regulations.gov. The subject line for the comments should include a reference to Notice 2023-63.

Taxpayers may rely on proposed regulations that detail how to satisfy the prevailing wage and apprenticeship (PWA) requirements for bonus amounts that may apply to several energy and business credits. The regs also explain the correction and penalty provisions that allow taxpayers to claim the bonus credits even if they failed to satisfy the PWA tests. Comments are requested.

Taxpayers may rely on proposed regulations that detail how to satisfy the prevailing wage and apprenticeship (PWA) requirements for bonus amounts that may apply to several energy and business credits. The regs also explain the correction and penalty provisions that allow taxpayers to claim the bonus credits even if they failed to satisfy the PWA tests. Comments are requested.

PWA Requirements

The Inflation Reduction Act of 2022 (P.L. 117-169) provided bonus credits as part of several new and existing components of the general business credit. The initial credit amount is increased for taxpayers that satisfy the PWA requirements during the construction, alteration and repair of a credit facility.

The bonus credits apply to the following 11 credits, plus one deduction:

• the business credit component of the Code Sec. 30C Alternative Fuel Vehicle Refueling Property Credit
• the Code Sec. 45 renewable electricity production credit
• the Code Sec. 45L New Energy Efficient Home Credit (prevailing wage test only)
• the Code Sec. 45Q carbon sequestration credit
• the Code Sec. 45U Zero-Emission Nuclear Power Production Credit (prevailing wage test only)
• the Code Sec. 45V Credit for Production of Clean Hydrogen
• the Code Sec. 45Y Clean Electricity Production Credit
• the Code Sec. 45Z Clean Fuel Production Credit
• the Code Sec. 48 energy investment credit
• the Code Sec. 48C Advanced Energy Project Credit
• the Code Sec. 48E clean energy investment credit and
• the Code Sec. 179D Energy Efficient Commercial Buildings Deduction (increased deduction).

The IRS previewed these proposed regs in Notice 2022-61 (TAXDAY, I.1, 11/30/2022).

Prevailing Wage Requirements in General

In determining prevailing wages, the proposed regs largely incorporate the Davis-Bacon Act (DBA), as administered by the Wage and Hours Division of the Department of Labor (DOL), to the extent it is relevant and consistent with sound tax administration. However, the regs do not adopt the DBA’s federal contracting provisions, or its exemptions for Tribal governments and the Tennessee Valley Authority. The definition of “employed” is also broader for the PWA tests than it is for other purposes of the Code.

Under the proposed regs, the taxpayer that claims the increased credit would be solely responsible for:

• making sure the PWA requirements are satisfied,
• keeping appropriate records, and
• the correction and penalty provisions and the good faith effort exception.

“Taxpayer” includes an applicable entity that elects to treat the credit as a federal tax payment under Code Sec. 6417, and an eligible taxpayer that elects to transfer the credit to an unrelated person under Code Sec. 6418. Thus, the PWA requirements apply to the eligible taxpayer, not the transferee taxpayer.

The proposed regs define several relevant terms, including applicable wage determination, laborer, mechanic, construction, alteration, repair, locality or geographic area (including DOL site of work definitions), and prevailing wage rate. The proposed regs generally adopt DOL rules that allow lower prevailing wage rates for apprentices.

Prevailing Wage Determinations

The proposed regs would require taxpayers to use the general wage determination in effect when the construction of the facility begins, but would not require taxpayers to update those rates during construction. However, consistent with DOL guidance under the DBA, a new general wage determination would be required when a contract is changed to include additional, substantial construction, alteration, or repair work, or to require work to be performed for an additional time period. Taxpayers would also need to update wage rates for alteration or repairs after the facility has been placed in service.

A general wage determination would be one issued and published by the DOL that includes a list of wage and bona fide fringe benefit rates determined to be prevailing for laborers and mechanics for the various classifications of work performed with respect to a specified type of construction in a geographic area. The proposed regulations would largely incorporate the definition of “wages” from 29 CFR 5.2 for the Prevailing Wage Requirements. This definition is not relevant in determining wages or compensation for other federal tax purposes.

The proposed regs would provide special procedures when a general wage determination does not provide applicable wage rates; as, for example, when no general wage determination has been issued for the geographic area, for the specified type of construction, or for a labor classification. According to the DOL, these situations should be rare. The taxpayer, contractor, or subcontractor would need to request a supplemental wage determination or prevailing wage rate for an additional classification from the DOL. However, taxpayers could not use these requests to split, subdivide, or otherwise avoid classifications in a general wage determination.

A request for a supplemental wage determination or a prevailing wage rate for an additional classification would need to include information consistent with the information that must be provided by a contracting agency when requesting a project wage determination or a conformance for purposes of the DBA. After review, the Wage and Hour Division will notify the taxpayer as to the labor classifications and wage rates to be used. The proposed regulations would also adopt the review and appeal procedures available to any interested party under the DBA with respect to wage determinations generally.

If construction of a credit facility spans adjacent geographic areas, the prevailing wage rate would the highest rate for each classification. For an offshore facility, taxpayers could rely on the general wage determinations in the geographic area closest to the area where the qualified facility will be located.

Prevailing Wage Correction and Penalty Provisions

A taxpayer that fails to satisfy the PWA requirements may still qualify for the increased credit or deduction by satisfying correction and penalty provisions. The proposed regulations would provide that the obligation to make correction payments and pay the penalty would not become binding until the taxpayer files a return claiming the increased credit. The taxpayer generally would have to make correction payments to the underpaid workers before filing the return, and pay any penalty when the return is field.

In addition, the taxpayer would have to make the correction and penalty payments within 180 days after the IRS makes a final determination that a taxpayer failed to satisfy the Prevailing Wage Requirements, which would come in the form of a notice sent by the IRS. Although deficiency procedures would not apply to the penalty payment, deficiency procedures would apply to any IRS disallowance of the increased credit.

Taxpayers that cannot locate the underpaid workers are not excused from the correction requirements. The IRS expect that taxpayers will be able to establish correction payments by using existing state and tax withholding procedures. Taxpayers that underpay workers while waiting for a supplemental wage or additional classification determination would have 30 days after the determination to make correction payments. For purposes of credit transfers under Code Sec. 6418, the correction and penalty requirements would continue to apply to the eligible taxpayer, not the credit transferee.

For purposes of the increased correction and penalty amounts for intentional disregard of the PWA requirements, the proposed regs would provide that failures would be due to intentional disregard if they are knowing or willful, based on all relevant facts and circumstances. There would be a rebuttable presumption against intentional disregard if the taxpayer makes the correction and penalty payments before receiving a notice of an examination.

The proposed regs would provide limited penalty waivers when PWA failures are small in amount or occur in a limited number of pay periods. The penalty also would not apply with respect to a laborer or mechanic employed under a project labor agreement that meets certain requirements, if correction payments are made by the time the taxpayer claims the increased credit. The proposed regs would use the IRS’s general enforcement discretion to allow taxpayers to correct limited failures to pay prevailing wages if the taxpayers pay the mechanics and laborers back wages and interest in a timely manner before claiming the increased credit.

Apprenticeship Requirements

To satisfy the apprenticeship requirement, taxpayers must satisfy:

The proposed regs explain that the Labor Hours Requirement generally is subject to the Ratio Requirement, and the Participation Requirement applies in addition to those two requirements.

Failure to Satisfy Apprenticeship Requirements

The proposed regs provide addition guidance regarding the good faith effort exception to the apprenticeship requirements when a taxpayer’s request for a qualified apprentices is denied. The taxpayer may need to submit requests to multiple apprenticeship programs, and each request must include prescribed information. A taxpayer would have to submit a second request within 120 days of a first denial. The good faith exception would apply only to a particular denied request. A taxpayer that does not qualify for the good faith exception may be treated as satisfying the apprenticeship requirements by paying a penalty to the IRS. The proposed regs spell out how taxpayers determine correction amounts are determined.

Failures to meet the Apprenticeship Requirements would be due to intentional disregard if they are knowing or willful under all relevant facts and circumstances. The proposed regulations provide a non-exhaustive list of relevant facts and circumstances.

The proposed regulations would also provide the penalty payment requirement for failures to meet the Labor Hours or Participation Requirement would not apply if a project labor agreement that meets certain requirements is in place. In addition, there would be a rebuttable presumption against intentional disregard if the taxpayer makes the penalty payments before receiving a notice of an examination.

As with the prevailing wage requirements, the proposed regulations would provide that a penalty payment would remain the responsibility of the eligible taxpayer that transfers the increased credit under Code Sec. 6418. The obligation to meet the Apprenticeship Requirements would not be binding until the eligible taxpayer files its return for the year the credit is determined or, if earlier, the transferee taxpayer files its return taking the transferred credit into account.

Recordkeeping Requirements

The proposed regulations would require taxpayers to establish compliance with the Prevailing Wage Requirements at the time a return claiming the increased credit is filed. These requirements are generally consistent with the recordkeeping requirements under the DBA regime. Taxpayers would also have to maintain and preserve sufficient payroll records to establish compliance.

Similarly, the proposed regulations would require taxpayers subject to the Apprenticeship Requirements to maintain sufficient records to establish compliance with the Labor Hours, Ratio and Participation Requirements. It would be the responsibility of the taxpayer to maintain the relevant records for each apprentice engaged in the construction, alteration, or repair on the qualified facility, regardless of whether the apprentice is employed by the taxpayer, a contractor, or a subcontractor.

Finally, if an eligible taxpayer transfers any portion of a credit that includes the increased amount for satisfying the PWA requirements, these recordkeeping requirements would remain with an eligible taxpayer.

Effect on Other Documents

The provisions of sections 3 and 4 of Notice 2022-61 would be obsoleted for facilities, property, projects, or equipment the construction, or installation of which begins after the date these regulations are published as final.

Proposed Applicability Date

The regulations are proposed to apply to facilities, property, projects, or equipment placed in service in tax years ending after the date they are published as final, and the construction or installation of which begins after hat date. However, taxpayers may rely on the proposed regulations with respect to construction or installation of a facility, property, project, or equipment beginning on or after January 29, 2023, and on or before the date the regulations are published as final, provided that beginning after October 30, 2023, the taxpayer follows the proposed regulations in their entirety and in a consistent manner.

Comments Requested

The IRS requests comments on the proposed regs, and a public hearing is scheduled for November 21, 2023, at 10 am EST. Comments and requests to speak at the hearing must be received by October 30, 2023, and requests to attend the hearing must be received by November 17, 2023. Comments and requests may be mailed to the IRS, or they may be submitted electronically via the Federal eRulemaking Portal at https://www.regulations (indicate IRS and REG-100908-23).

The IRS has provided guidance on the income tax treatment of payments made by states in 2023 and later years. In IRS News Release 2023-23, February 10, 2023, the IRS clarified the federal tax status of special payments made by 21 states in 2022 that were mainly related to the COVID-19 pandemic, with varying terms in the types of payments, payment amounts, and eligibility rules.

The IRS has provided guidance on the income tax treatment of payments made by states in 2023 and later years. In IRS News Release 2023-23, February 10, 2023, the IRS clarified the federal tax status of special payments made by 21 states in 2022 that were mainly related to the COVID-19 pandemic, with varying terms in the types of payments, payment amounts, and eligibility rules.

State Tax Refunds

The exclusion of state income tax refunds is largely dependent on whether an individual itemized deductions and deducted the amount of state income tax paid. A state income tax refund will be excluded from an individual's gross income if the person claimed the standard deduction for the tax year in which the state income tax was paid. On the other hand, an individual who itemized deductions and deducted the amount of state income tax paid will include a state income tax refund to the extent that the individual received a federal income tax benefit from the prior federal income tax deduction.

A similar rule applies to state property tax refunds.

2022 Payments Covered by IR-2023-23

IR-2023-23 described some 2022 programs that intended to make payments in early 2023. To the extent an individual could exclude such a payment received in 2022 pursuant to the news release, an individual may exclude a state payment received in 2023 under a 2022 program from federal income tax.

General Welfare Payments

Payments that are made under a state program for the promotion of the general welfare are not includible in federal income tax. To be excluded as a payment for the general welfare, the payment must: (1) be made from a governmental fund; (2) be for the promotion of the general welfare, meaning based on individual or family need; and (3) not represent compensation for services.

Comments Requested

The IRS requests comments on the application of these rules and on specific aspects of state payment programs or additional situations where federal guidance would be helpful. Comments should be submitted on or before October 16, 2023. Comments may be mailed to the IRS or submitted electronically via the Federal eRulemaking Portal at https://www.regulations.gov.

National Taxpayer Advocate Erin Collins is calling on the Internal Revenue Service to alter how it deals with supervisory review of penalties.

National Taxpayer Advocate Erin Collins is calling on the Internal Revenue Service to alter how it deals with supervisory review of penalties.

"The IRS’s approach to supervisoryreview of penalties is heavy-handed and burdensome on taxpayers," Collins wrote in an August 29, 2023, blog post.

She noted that the while some penalties require supervisory approval before they can be assessed, the statue providing authority "is vague regarding the point at which this approval must occur," which has led to conflicting decisions in tax court about how they should be treated.

Collins noted that the IRS is currently working on the problem and has issued proposed regulations on the subject. A public hearing on this issue will be held on September 11, 2023.

"The proposed regulations succeeded in providing clarity, but it would be nice if they did so in a way that helps taxpayers rather than harming them."

According to Collins, the proposed regulations set up a process by which a supervisory approval can be obtained anytime before the statutory notice of deficiency is issued for pre-assessment penalties subject to Tax Court review. For those penalties not subject to pre-assessment Tax Court review, they can be approved up until the time of assessment itself.

"The IRS’s proposed approach is problematic because the ability to raise potential penalties with taxpayers in the absence of oversight could lend itself to the improper assertion of penalties," Collins wrote. "Practitioners and Congress expressed concerns that some IRS examiners may be tempted to propose a penalty with no real intention of actually imposing it. Rather, the penalty is put forth as a bargaining chip to be negotiated away as part of the case resolution process. The IRS is quick to point out that this practice is unauthorized and is strongly discouraged. Nevertheless, the structure perpetuated in the proposed regulations does nothing to protect taxpayers from potential abuse."

Collins stated that supervisory review "should occur before applicable penalties are communicated to the taxpayer in writing," adding that the proposed regulations "provide the IRS with an excellent chance to reconsider its approach to supervisoryreview. This is an opportunity that the IRS has so far declined to embrace, but there is still time. I urge the IRS to reexamine its policy and I request that Congress consider clarifying the law to protect taxpayers’ rights."

By Gregory Twachtman, Washington News Editor

Taxpayers, and the accounting and legal professionals who represent them, need to be prepared as the Internal Revenue Service has begun compliance work on those who own and trade in cryptocurrencies.

Taxpayers, and the accounting and legal professionals who represent them, need to be prepared as the Internal Revenue Service has begun compliance work on those who own and trade in cryptocurrencies.

"A CPA needs to advise their clients that the IRS is looking into this," Paul Miller, CPA and managing partner at Queens, N.Y.-based Miller and Company LLP, said in interview. He recalled that one of his clients was recently audited for his crypto transactions going all the way back to 2018.

Miller suggested that the tip off that the agency would be more closely examining taxpayers’ crypto transactions was the simple question added to Form 1040 asking whether the taxpayer engaged in any transactions.

He also suggested that the IRS could be showing some level of leniency for these early taxpayers who are getting their crypto transactions audited.

"The IRS was pretty reasonable with this man," Miller said. "He wasn’t assessed the fraud penalty. He wasn’t assessed the 25 percent penalty. He just had to amend three or four years of his tax returns for failing to report crypto."

Miller also pointed out that the IRS gave the taxpayer"the benefit of the doubt," recognizing both that he might night have thought about the tax ramifications of his crypto transactions as well as recognizing the fact that he was unable to recover transaction data from 2018.

To that end, Miller stressed that it is very important to keep accurate records and to not necessarily rely on transaction platforms for providing that information.

"If you use Coinbase, Coinbase is pretty good because they give you a 1099," he said, adding that other trading platforms might not provide that information. "Regardless, we tell all our of our clients to keep records, keep track of it" just like they would keep track of information about money in foreign bank accounts.

On the IRS side, Miller suggested that crypto compliance could be a part of the agency’s push to utilizing artificial intelligence as part of the compliance process, noting that with everything else on the agency’s plate, the IRS "literally doesn’t have the manpower." This could make AI a tool for crypto compliance.

Miller also recommended that CPAs be sure to include very specific questions on crypto in their engagement letters.

"It’s all about getting the client to take responsibility off of me and putting it on them," he said. "Because at the end of the day, I’m just preparing the tax return."

He stressed that it does not mean the goal of a CPA is not to give their clients the best advice.

"The goal is that you have a responsibility to pay your taxes," he said. "You have a responsibility to report the information, If you disagree or if you deviate from that, you have to deal with the consequences, not me."

By Gregory Twachtman, Washington News Editor

One morning you reach into your mailbox or bin to find the dreaded letter from the IRS announcing that you owe unpaid taxes. As if that wasn't enough to induce panic, you may discover there are add-on charges for interest and penalties. Penalties for what, you may ask?

One morning you reach into your mailbox or bin to find the dreaded letter from the IRS announcing that you owe unpaid taxes. As if that wasn't enough to induce panic, you may discover there are add-on charges for interest and penalties. Penalties for what, you may ask?

If you violate the Tax Code, the IRS may impose civil and/or criminal penalties, depending on the type of infraction committed. Civil penalties are commonly imposed for a failure to pay taxes when due, failure to report the correct amount of tax owed, a failure to deposit federal tax deposits, filing late, or even failing to pay because of a bounced check. There are more than 100 kinds of civil penalties in the Tax Code, ranging in severity. For example, a penalty for failure to file (separate and apart from a failure to pay) carries a minimum $100 fine, while a penalty for valuation overstatement can result in a 30 percent penalty on the amount of tax owed as a result. Criminal penalties can be even more severe, and may include terms of imprisonment as well as fines.

Taxpayers, return preparers, and third parties with some connection to the tax return in question may all become subject to penalties. Common civil penalties include failure to file tax returns, failure to pay taxes due, underpaying tax due to negligence, and valuation misstatements that result in inaccurate reporting of income (and therefore an incorrect amount of tax owed).

Criminal penalties are imposed for violations of federal Tax Code and Criminal Code, which include the willful (or intentional) attempt to evade or defeat any federal tax, the failure to collect or truthfully account for and pay any federal tax as required, or the failure to keep required records, supply required information or make required returns. Generally the IRS Criminal Investigations Division will conduct investigations into allegations of criminal tax violations, and if it recommends that the government prosecuted, the case could be referred to the IRS Office of Chief Counsel, the Department of Justice, the U.S. Attorney's Office, or some combination of the three.

Hopefully you will never receive a letter from the IRS about either civil or criminal penalties. But if you do, please call our offices with any questions.

When starting a business or changing an existing one there are several types of business entities to choose from, each of which offers its own advantages and disadvantages. Depending on the size of your business, one form may be more suitable than another. For example, a software firm consisting of one principal founder and several part time contractors and employees would be more suited to a sole proprietorship than a corporate or partnership form. But where there are multiple business members, the decision can become more complicated. One form of business that has become increasingly popular is called a limited liability company, or LLC.

When starting a business or changing an existing one there are several types of business entities to choose from, each of which offers its own advantages and disadvantages. Depending on the size of your business, one form may be more suitable than another. For example, a software firm consisting of one principal founder and several part time contractors and employees would be more suited to a sole proprietorship than a corporate or partnership form. But where there are multiple business members, the decision can become more complicated. One form of business that has become increasingly popular is called a limited liability company, or LLC.

The LLC combines several favorable characteristics of a traditional partnership, in which all members are entitled to participate in the management and operation of the business, with those of a corporation, in which the owners, directors, and shareholders are generally shielded from liability for the corporation's debts. The means that in an LLC, just as in a corporation, the personal assets of the business owners' would generally be protected if the business failed, lost a lawsuit, or faced some other catastrophe. Members are only liable to the extent of their capital contribution to the business. In addition, members can fully participate in the management of the business without endangering their limited liability status.

When filing season begins, the profits (or losses) from the LLC pass through to its members, who pay tax on any income when filing their individual returns. In other words, income from the LLC is taxed at the individual tax rates. Income from corporations, on the other hand is taxed twice, once at the corporate entity level and again when distributed to shareholders. Because of this, more tax savings often results if a business formed as an LLC rather than a corporation.

Taxpayers should note, however, that Congress recently increased the top marginal individual income tax rate to 39.6 percent, has placed a .09 percent additional Medicare tax on wages over $200,000 (single taxpayers), and has imposed a 3.8 percent net investment income tax on higher-income taxpayers. At the same time, there is strong talk among members of both political parties of lowering the corporate rate from the current 35 percent to something around 28 or 25 percent to make the United States more competitive with foreign nations. If this happens, many highly profitable LLC businesses may need to rethink their situation and consider switching to a corporate form.

Forming an LLC involves many requirements, but the benefits can be substantial. Please call our offices if you have any questions.

The IRS has announced a new optional safe harbor method, effective for tax years beginning on or after January 1, 2013, for individuals to determine the amount of their deductible home office expenses (IR-2013-5, Rev. Proc. 2013-13). Being hailed by many as a long-overdue simplification option, taxpayers may now elect to determine their home office deduction by simply multiplying a prescribed rate by the square footage of the portion of the taxpayer's residence used for business purposes.

The IRS has announced a new optional safe harbor method, effective for tax years beginning on or after January 1, 2013, for individuals to determine the amount of their deductible home office expenses (IR-2013-5, Rev. Proc. 2013-13). Being hailed by many as a long-overdue simplification option, taxpayers may now elect to determine their home office deduction by simply multiplying a prescribed rate by the square footage of the portion of the taxpayer's residence used for business purposes.

The IRS cites that over three million taxpayers in recent tax years have claimed deductions for business use of a home, which normally requires the taxpayer to fill out the 43-line Form 8829. Under the new procedure, a significantly simplified form is used. The new method is expected to reduce paperwork and recordkeeping for small businesses by an estimated 1.6 million hours annually, according to the IRS. The new optional deduction is limited to $1,500 per year, based on $5 per square foot for up to 300 square feet.

The simplified method is not effective for 2012 tax year returns being filed during the current 2013 filing season, but it will become effective for 2013 tax year returns filed in 2014. Taxpayers may want to investigate now whether they could benefit from the election for the 2013 tax year. Acting IRS Commissioner Steven Miller advised upon announcement of the safe harbor that "The IRS … encourages people to look at this option as they consider tax planning in 2013."  A final decision on the election need not be made until 2014, when 2013 returns are filed.

Basic home office deduction rule

Under Code 280A, which governs the home office deduction rules on the simplified method election, a taxpayer may deduct expenses that are allocable to a portion of the dwelling unit that is exclusively used on a regular basis. This generally means usage as:

• The taxpayer's principal place of business for any trade or business
• A place to meet with the taxpayer's patients, clients, or customers in the normal course of the taxpayer's trade or business, or
• In the case of a separate structure that is not attached to the dwelling unit, in connection with the taxpayer's trade or business.

The new simplified method does not remove the requirement to keep records that prove exclusive use, on a regular basis, for one of the three designated uses listed above. It does help, however, in other ways.

Simplified safe harbor

Using the new simplified safe harbor method, a taxpayer determines the amount of deductible expenses for qualified business use of the home for the tax year by multiplying the allowable square footage by the prescribed rate. The allowable square footage is the portion of a home used in a qualified business use of the home, but not to exceed 300 square feet. The prescribed rate is $5.00 per square foot.

Taxpayers who itemize their returns and use the safe harbor method may also deduct, to the extent allowed by the Tax Code and regs, any expense related to the home that is deductible without regard to whether there is a qualified business use of the home for that tax year, the IRS explained. As a result, they will be able to claim allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A of Form 1040. These deductions do not need to be allocated between personal and business use, as is required under the regular method.

Depreciation

Taxpayers using the safe harbor cannot deduct any depreciation for the portion of the home that is used in a qualified business use of the home for that tax year. For many taxpayers, depreciation is the largest component of the home office deduction under the regular method that must be sacrificed if the new safe harbor method is used.  Depending upon the value of your home and the space devoted to an office at home, using the regular method may prove to be the far better choice than electing the simplified method.

Election

Taxpayers may elect from tax year to tax year whether to use the safe harbor method or actual expense method. Once made, an election for the tax year is irrevocable.  The IRS has provided rules for calculating the depreciation deduction if a taxpayer uses the safe harbor for one year and actual expenses for a subsequent year. The deduction of expenses that are not related to the home, such as wages and supplies, is unaffected and those deductions are still available to those using the new method.

Limitations

The IRS set various limits on the safe harbor, including:

• Taxpayers with more than one qualified business use of the same home for a tax year and who elect the safe harbor must use the safe harbor for each qualified business use of the home.
• Taxpayers with qualified business uses of more than one home for a tax year may use the safe harbor for only one home for that tax year.
• A taxpayer who has a qualified business use of a home and a rental use of the same home cannot use the safe harbor for the rental use.

If you are currently claiming a home office deduction, or if you have considered taking the deduction in the past but were discouraged by all of the paperwork and calculations required, you should consider whether the new, simplified safe harbor method is right for you. Please feel free to contact this office for further details.

Under the new health care law, starting in 2014, "large" employers with more than 50 full-time employees will be subject to stiff monetary penalties if they do not provide affordable and minimum essential health coverage. With less than eleven months before this "play or pay" provision is fully effective, the IRS continues to release critical details on what constitutes an "applicable large employer," "full-time employee," "affordable coverage," and "minimum health coverage."  Most recently, the IRS issued proposed reliance regulations that provide employers with the most comprehensive explanation of their obligations and options to date.

Under the new health care law, starting in 2014, "large" employers with more than 50 full-time employees will be subject to stiff monetary penalties if they do not provide affordable and minimum essential health coverage. With less than eleven months before this "play or pay" provision is fully effective, the IRS continues to release critical details on what constitutes an "applicable large employer," "full-time employee," "affordable coverage," and "minimum health coverage."  Most recently, the IRS issued proposed reliance regulations that provide employers with the most comprehensive explanation of their obligations and options to date.

Background

Under the Patient Protection and Affordable Care Act (PPACA) the federal government has made it possible for certain workers who do not otherwise have access to affordable health insurance coverage to obtain a tax credit that would help them pay the costs of their health care premiums. This credit applies to low-income workers whether employed by a small, mid-size or large employer or self-employed.  Under Code Sec. 4980H as added by the PPACA, however, an "applicable large employer" is subject to a shared responsibility payment (an assessable payment) after December 31, 2013 if any of its full-time employees are certified to receive an applicable premium tax credit or cost-sharing reduction and either:

• The employer does not offer to its full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan (Code Sec. 4980H(a)); or
• The employer offers its full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan that with respect to a full-time employee who has been certified for the advance payment of an applicable premium tax credit or cost-sharing reduction either is unaffordable relative to an employee's household income or does not provide minimum value (Code Sec. 4980H(b)).

The Code Sec. 4980H(b) penalty applies to coverage that is "unaffordable," meaning that the coverage costs more than 9.5 percent of the employee's household income. Since employers may not be able to determine household income, the proposed regs provide three affordability safe harbors: the Form W-2 safe harbor (based on employee wages); the rate of pay safe harbor (based on hourly or monthly pay rates); and the federal poverty line safe harbor, the IRS explained.

The employer cannot be liable under both Code Secs. 4980H(a) and 4980H(b). Furthermore, the penalty cannot exceed the payment amount that would have been imposed under Code Sec. 4980H(a) if the employee had failed to offer coverage to its full-time employees.

Proposed reliance regs

The proposed reliance regs further clarify what employees are considered "full-time employees" for the purpose of the statute. This distinction is important because the number of full-time employees determines who is an applicable large employer, subject to the affordable coverage requirements and, potentially, the per-employee shared responsibility payment. The proposed reliance regs provide additional guidance on who is a full-time employee, and covers gray areas such as the treatment of seasonal employees.

Other guidance under the regs covers whether employers who have only become applicable large employers in the current year are exempt from the shared responsibility payment. (Generally, they are not.) The proposed reliance regulations also provide certain relief to employers who inadvertently miss some employees.

Finally, the proposed reliance regs provide several transition rules. A major rule allows employers with plans on a fiscal year to wait to apply the standards until the first day of the first plan year that begins in 2014. Another rule exempts employers from penalties in 2014 if they must add dependent coverage to their health plans. Other transition rules apply to health plans offered through cafeteria plans and multiemployer plans. In addition, there are many notification responsibilities that will be placed upon the shoulders of all employers regarding access by their employees to health insurance.

If you have questions about the health care requirements for employers, the shared responsibility payment under Code Sec. 4980H, or anything related to the tax provisions of the new health care law, please contact our offices.

Beginning in 2013, the capital gains rates, as amended by the American Taxpayer Relief Act of 2012, are as follows for individuals:

Beginning in 2013, the capital gains rates, as amended by the American Taxpayer Relief Act of 2012, are as follows for individuals:

• A capital gains rate of 0 percent applies to the adjusted net capital gains if the gain would otherwise be subject to the 10 or 15 percent ordinary income tax rate.
• A capital gains rate of 15 percent applies to adjusted net capital gains if the gain would otherwise be subject to the 25, 28, 33, or 35 percent ordinary income tax rate.
• A capital gains rate of 20 percent applies to adjusted net capital gains if the gain would otherwise be subject to the 39.6 percent ordinary income tax rate beginning after December 31, 2012.

Individuals are subject to the 39.6 percent ordinary income tax rate beginning in 2013 to the extent their taxable income exceeds the applicable threshold amount of $450,000 for married individuals filing joint returns and surviving spouses, $425,000 for heads of households, $400,000 for single individuals, and $225,000 for married individuals filing separate returns.

Comment:  The only change from 2012 rates is the 20 percent rate, applied as described, above.  Prior to 2013, the highest tax rate on net capital gain was 15 percent.

Comment: Adjusted net capital gain is net capital gain from capital assets held for more than one year other than unrecaptured Code Sec. 1250 gain (25 percent); collectibles gain (28 percent) or gain from qualified small business stock (varying rates).

Examples

Following the rules outlined above, computations for higher-income taxpayers (those whose taxable income together with net capital gains exceed the 39.6 percent tax bracket threshold amounts, which are also the threshold amounts for the 20 percent capital gain rate) are illustrated under three scenarios:

Example 1: Assume in 2013, joint filers with $475K in net capital gain and $200K in ordinary income:

• $200K ordinary income will be taxed under the regular income tax tables, which for 2013 indicate a $43,465.50 tax.
• $475K capital gain is taxed:
  • $250K of $475 net capital gain at 15 percent ($450K threshold less $200K ordinary income) = $37,500
  • The remainder of the net capital gain $225K ($475K less $250K that was taxed at 15 percent) is taxed at 20 percent = $45,000

Total tax liability: $43,465.50 on $200K ordinary income and $82,500 on $475K net capital gain.

Example 2: Assume in 2013, joint filers with $200K in net capital gain and $475K in ordinary income:

• $475K ordinary income will be taxed under the regular income tax tables, which for 2013 indicate a $135,746 tax.
• $200K capital gain is taxed:
  • All of $200K net capital gain at 20 percent ($450K threshold already exceeded by $475K in ordinary income) = $40,000.

Total tax liability: $135,746 on $475K ordinary income and $40,000 on $200K net capital gain.

Example 3: Assume in 2013, joint filers with $50K ordinary income and $425K in net capital gain:

• $50K ordinary income will be taxed under the regular income tax tables, which for 2013 indicate a $4,845
• $425K net capital gain is taxed:
  • $20,700 at zero percent ($70,700, which is the top of the 15 percent bracket less $50K ordinary income) = $0
  • $379,300 at 15 percent ($450,000 less $70,700) = $56,895
  • $25,000 at 20 percent (balance of ordinary income plus capital gain over $450K threshold) = $5,000.

Total tax liability: $4,845 on $50K ordinary income and $40,000 on $200K net capital gain.

In recent years, the IRS has been cracking down on abuses of the tax deduction for donations to charity and contributions of used vehicles have been especially scrutinized. The charitable contribution rules, however, are far from being easy to understand. Many taxpayers genuinely are confused by the rules and unintentionally value their contributions to charity at amounts higher than appropriate.

In recent years, the IRS has been cracking down on abuses of the tax deduction for donations to charity and contributions of used vehicles have been especially scrutinized. The charitable contribution rules, however, are far from being easy to understand. Many taxpayers genuinely are confused by the rules and unintentionally value their contributions to charity at amounts higher than appropriate.

Vehicle donations

According to the U.S. Department of Transportation (DOT), there are approximately 250 million registered passenger motor vehicles in the United States. The U.S. is the largest passenger vehicle market in the world.  Potentially, each one of these vehicles could be a charitable donation and that is why the IRS takes such a sharp look at contributions of used vehicles and claims for tax deductions. The possibility for abuse of the charitable contribution rules is large.

Bona fide charities

Before looking at the tax rules, there is an important starting point.  To claim a tax deduction, your contribution must be to a bona fide charitable organization. Only certain categories of exempt organizations are eligible to receive tax-deductible charitable contributions. 

Many charitable organizations are so-called “501(c)(3)” organizations (named after the section of the Tax Code that governs charities. The IRS maintains a list of qualified Code Sec. 501(c)(3) organizations. Not all charitable organizations are Code Sec. 501(c)(3)s. Churches, synagogues, temples, and mosques, for example, are not required to file for Code Sec. 501(c)(3) status. Special rules also apply to fraternal organizations, volunteer fire departments and veterans organizations. If you have any questions about a charitable organization, please contact our office.

Tax rules

In past years, many taxpayers would value the amount of their used vehicle donation based on information in a buyer’s guide. Today, the value of your used vehicle donation depends on what the charitable organization does with the vehicle.

In many cases, the charitable organization will sell your used vehicle. If the charity sells the vehicle, your tax deduction is limited to the gross proceeds that the charity receives from the sale. The charitable organization must certify that the vehicle was sold in an arm’s length transaction between unrelated parties and identify the date the vehicle was sold by the charity and the amount of the gross proceeds. 

There are exceptions to the rule that your tax deduction is limited to the gross proceeds that the charity receives from the sale of your used vehicle. You may be able to deduct the vehicle’s fair market value if the charity intends to make a significant intervening use of the vehicle, a material improvement to the vehicle, or give or sell the vehicle to a qualified needy individual. If you have any questions about what a charity intends to do with your vehicle, please contact our office.

Written acknowledgment

The charitable organization must give you a written acknowledgment of your used vehicle donation. The rules differ depending on the amount of your donation.  If you claim a deduction of more than $500 but not more than $5,000 for your vehicle donation, the written acknowledgment from the charity must:

• Identify the charity’s name, the date and location of the donation
• Describe the vehicle
• Include a statement as to whether the charity provided any goods or services in return for the car other than intangible religious benefits and, if so, a description and good faith estimate of the value of the goods and services
• Identify your name and taxpayer identification number
• Provide the vehicle identification number

The written acknowledgement generally must be provided to you within 30 days of the sale of the vehicle.  Alternatively, the charitable organization may in certain cases, provide you a completed Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, that contains the same information.

The written acknowledgment requirements for claiming a deduction under $500 or over $5,000 are similar to the ones described above but there are some differences. For example, if your deduction is expected to be more than $5,000 and not limited to the gross proceeds from the sale of your used vehicle, you must obtain a written appraisal of the vehicle. Our office can help guide you through the many steps of donating a vehicle valued at more than $5,000.

If you are planning to donate a used vehicle, please contact our office and we can discuss the tax rules in more detail.

Lawmakers have departed Washington to campaign before the November 6 elections and left undone is a long list of unfinished tax business.  In many ways, the last quarter of 2012 is similar to 2010, when Congress and the White House waited until the eleventh hour to extend expiring tax cuts. Like 2010, a host of individual and business tax incentives are scheduled to expire.  Unlike 2010, lawmakers are confronted with massive across-the-board spending cuts scheduled to take effect in 2013.

Lawmakers have departed Washington to campaign before the November 6 elections and left undone is a long list of unfinished tax business.  In many ways, the last quarter of 2012 is similar to 2010, when Congress and the White House waited until the eleventh hour to extend expiring tax cuts. Like 2010, a host of individual and business tax incentives are scheduled to expire.  Unlike 2010, lawmakers are confronted with massive across-the-board spending cuts scheduled to take effect in 2013.

Unfinished business

Since the start of 2012, the list of tax measures waiting for Congressional action has remained unchanged. Among the individual tax provisions scheduled to expire after 2012 are:

• Reduced individual income tax rates
• Reduced capital gains and dividend tax rates
• Temporary repeal of the limitation on itemized deductions and the personal exemption phaseout for higher income taxpayers
• Reduced estate, gift and generation-skipping transfer tax rates
• Enhancements to many education tax incentives, such as the American Opportunity Tax Credit, Coverdell education savings accounts, and more.

Also scheduled to expire at the end of 2012 is the payroll tax holiday.  The employee share of Social Security taxes is 4.2 percent rather than 6.2 percent, up to the Social Security earnings cap of $110,100 for 2012.  Self-employed individuals benefit from a similar reduction.

Additionally, many so-called tax extenders for individuals expired after 2011.  They include the state and local sales tax deduction, the teachers' classroom expense deduction, and more.  The most recent alternative minimum tax (AMT) "patch" expired after 2011.

The list of expiring or expired tax incentives for businesses is just as long.  They include:

• Enhanced Code Sec. 179 expensing (after 2012)
• 100 percent bonus depreciation (generally after 2011)
• 50 percent bonus depreciation (generally after 2012)
• Research tax credit (after 2011)
• Production tax credit for wind energy (after 2012)
• Enhanced Work Opportunity Tax Credit (WOTC) for veterans (after 2012)
• Regular WOTC (after 2011)
• A lengthy laundry list of business tax extenders, such as special expensing rules for television and film productions, the Indian employment credit, and more (after 2011).

Along with all of the expiring provisions are even more pending proposals. They include proposals by the White House to enact tax incentives to encourage employers to hire long-term unemployed individuals, impose a minimum tax on overseas profits and more. The likelihood of any of these proposals being enacted before year-end is slim, but they could be revisited in 2013 depending on the outcome of the November elections. Comprehensive tax reform, including any reduction in the individual tax rates below their 2012 levels and a reduction in the corporate tax rate, is also expected to wait until 2013 or beyond.

Behind the scenes talks

The lame-duck Congress, which will meet after the November elections, may tackle some or all of the expiring tax incentives, or it could do nothing and punt them to the next Congress.  Behind the scenes, some Democrats and Republicans in Congress are reportedly talking about a short-term extension of the expiring/expired provisions, for six months or one year, which would give lawmakers and the White House more time to reach an overall agreement.  However, the dynamic could and likely will change if the GOP takes the White House and wins control of the Senate.

In the Senate, Sen. Kent Conrad, D-ND, has told reporters that he and several other senators from both parties have been discussing whether or not to extend the expiring tax cuts. Conrad, who is retiring at the end of 2012, has acknowledged that Democrats and Republicans are far apart on revenue raisers and spending cuts.  Reports of informal talks among the members of the House Ways and Means Committee have also circulated but no concrete proposals have so far been revealed.

Sequestration

The imminent spending cuts (called sequestration) are the result of the Budget Control Act of 2011.  The 2011 Act imposes approximately $110 billion in spending cuts, impacting defense and non-defense spending, for 2013.  Almost every area of federal spending, including tax enforcement, will be affected. 

In recent months, some lawmakers have proposed to mitigate the spending cuts by raising revenues elsewhere.  One area targeted for tax increases is the oil and gas industry.  However, several attempts to repeal tax preferences for the oil and gas industry failed in Congress in 2012. 

Any extension of the expiring tax breaks will have to take into account the looming across-the-board spending cuts. Tax reform and debt reduction will go hand-in-hand.  However, it is unclear if debt reduction will drive tax reform or vice-versa.  Our office will keep you posted of developments.

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

In 2013, a new and unique tax will take effect—a 3.8 percent "unearned income Medicare contribution" tax as part of the structure in place to pay for health care reform. The tax will be imposed on the "net investment income" (NII) of individuals, estates, and trusts that exceeds specified thresholds. The tax will generally fall on passive income, but will also apply generally to capital gains from the disposition of property.

In 2013, a new and unique tax will take effect—a 3.8 percent "unearned income Medicare contribution" tax as part of the structure in place to pay for health care reform. The tax will be imposed on the "net investment income" (NII) of individuals, estates, and trusts that exceeds specified thresholds. The tax will generally fall on passive income, but will also apply generally to capital gains from the disposition of property.

Specified thresholds

For an individual, the tax will apply to the lesser of the taxpayer's NII, or the amount of "modified" adjusted gross income (AGI with foreign income added back) above a specified threshold, which is:

• $250,000 for married taxpayers filing jointly and a surviving spouse;
• $125,000 for married taxpayers filing separately;
• $200,000 for single and head of household taxpayers.

Examples. A single taxpayer has modified AGI of $220,000, including NII of $30,000. The tax applies to the lesser of $30,000 or ($220,000 minus $200,000), the specified threshold for single taxpayers. Thus, the tax applies to $20,000.

A single taxpayer has modified AGI of $150,000, including $60,000 of NII. Because the taxpayer's income is below the $200,000 threshold, the taxpayer does not owe the tax, despite having substantial NII.

For an estate or trust, the tax applies to the lesser of undistributed net income, or the excess of AGI over the dollar amount for the highest tax rate bracket for estates and trusts ($11,950 for 2013). Thus, the tax applies to a much lower amount for trusts and estates.

Application of tax

The tax applies to interest, dividends, annuities, royalties, and rents, and capital gains, unless derived from a trade or business. The tax also applies to income and gains from a passive trade or business.

Other items are excluded from NII and from the tax:  distributions from IRAs, pensions, 401(k) plans, tax-sheltered annuities, and eligible 457 plans, for example. Items that are totally excluded from gross income, such as  distributions from a Roth IRA and interest on tax-exempt bonds, are excluded both from NII and from modified AGI.

The tax does not apply to nonresident aliens, charitable trusts, or corporations.

Tax planning techniques

Taxpayers are concerned about having to pay the tax. One technique for avoiding the tax is to sell off capital gain property in 2012, before the tax applies. This can be particularly useful if the taxpayer is facing a large capital gain from the sale of a principal residence (after taking the $250,000/$500,000 exclusion from income). Older taxpayers who do not want to sell their property may want to consider holding on to appreciated property until death, when the property gets a fair market value basis without being subject to income tax.

The technique of "gain harvesting" may be even more attractive if tax rates increase on dividends, capital gains, and AGI in 2013, with the potential expiration of the Bush-era tax cuts. However, the status of these tax rates will not be determined until after the election, potentially in a lame-duck Congressional session. It is also possible that Congress will simply extend existing tax rates for another year and "punt" the decision until 2013, as tax reform discussions heat up.

Taxpayers may also want to change the source of their income. Investing in tax-exempt bonds will be more attractive, since the interest income does not enter into AGI or NII. Converting a 401(k) account or traditional IRA to a Roth IRA will accomplish the same purpose. Income from a Roth conversion is not net investment income, although the income will increase modified AGI, which may put other income in danger of being subject to the 3.8 percent tax. Increasing deductible or pre-tax contributions to existing retirement plans can also lower income and help the taxpayer stay below the applicable threshold.

Trusts and estates should make a point of distributing their income to their beneficiaries. A trust's NII will be taxed at a low threshold (less than $12,000), while the income received by a beneficiary is taxed only if the much higher $200,000/$250,000 thresholds are exceeded.

Uncertainty

There was some uncertainty about the tax taking effect because of litigation challenging the health care law providing the tax, but a June 2012 Supreme Court decision upheld the law. The application of the tax is also uncertain because the Republican leadership has vowed to pursue repeal of the health care law if the Republicans win the presidency and take control of both houses of Congress in the November 2012 elections. But this is speculative. In the meantime, the Supreme Court decision guarantees that the tax will take effect on January 1, 2013.

These can be difficult decisions. While economic considerations for managing assets and income are important, it also makes sense for a taxpayer to look at the tax impact if the certain asset sales or shifts in investment portfolios are otherwise being considered.

Taxpayers recovering from the current economic downturn will get at least some relief in 2013 by way of the mandatory upward inflation-adjustments called for under the tax code, according to CCH, a Wolters Kluwer business. CCH has released estimated income ranges for each 2013 tax bracket as well as a growing number of other inflation-sensitive tax figures, such as the personal exemption and the standard deduction.

Taxpayers recovering from the current economic downturn will get at least some relief in 2013 by way of the mandatory upward inflation-adjustments called for under the tax code, according to CCH, a Wolters Kluwer business. CCH has released estimated income ranges for each 2013 tax bracket as well as a growing number of other inflation-sensitive tax figures, such as the personal exemption and the standard deduction.

Projections this year, however, are clouded by the uncertainty of expiring provisions in the tax code. If Congress allows the so-called Bush-era tax cuts to expire at the end of 2012, many taxpayers could lose more ground than they will otherwise gain. These tax cuts, first enacted within Economic Growth Tax Recovery and Reconciliation Act of 2001 (EGTRRA) with a ten-year life, were last extended by the 2010 Tax Relief Act, but only for two years through 2012.

When there is inflation, indexing of brackets lowers tax bills by including more of taxpayers' incomes in lower brackets – in the existing 15-percent rather than the existing 25-percent bracket, for example. The formula used in indexing showed an average amount of inflation this year of about 2.5 percent – the highest in several years. Most 2013 figures therefore have moved higher.

Tax Rates

The current 10, 15, 25, 33 and 35-percent rates are now officially scheduled to sunset to the pre-EGTRRA rate structure of 15, 28, 31, 36 and 39.6-percent. While no one in Washington is calling for a full sunset of all the current tax rates, congressional gridlock might produce a cliffhanger on what will happen until after the November elections, and perhaps not even before January when the new, 113th Congress convenes. In the meantime, there are three possible alternative scenarios being debated by lawmakers:

• Extend the current tax bracket structure in its entirety;
• As proposed by President Obama, keep the current rate structure except revive the 36 and 39.6-percent rates, starting at a higher-income bracket level of $200,000 for single filers, $250,000 for joint filers, $225,000 for head-of-households and $125,000 for married taxpayers filing separately, also indexed for inflation since initially proposed in 2009 but keyed to adjusted gross income (AGI) rather than taxable income (indexed 2013 projections for those AGI levels, based on the Administration's FY 2013 Budget, are $213,200 / $266,500 / $239,850 / and $133,250, respectively); or
• As proposed by certain Senate Democrats, raise the top tax rate only for individuals making more than $1 million.

Tax Brackets

Here is a sample of how inflation will raise rate brackets in 2013, assuming a full extension of tax rates:

• Joint returns. For married taxpayers filing jointly and surviving spouses, the maximum taxable income subject to the 10-percent bracket will rise from $17,400 in 2012, to $17,850 in 2013; the top of the 15-percent tax bracket will increase from $70,700 to $72,500. The bracket amounts for the remaining tax rates will show similarly proportionate increases: $146,400 as the maximum for the 25-percent bracket (up $3,700 from 2012); $223,050 for the 28-percent bracket (up $5,600 from 2012); and $398,350 for the 33-percent bracket (up $10,000 from 2012). Amounts above the $398,350 level will be taxed at the 35-percent rate.

• Single filers. For single taxpayers, the maximum taxable income for the 10-percent bracket will increase to $8,925 for 2012 (up from $8,700 in 2012). The remainder of the rate brackets show inflation increases of: $900 for the top of the 15-percent bracket (to $36,250); $2,200 for the 25-percent bracket (to $87,850); $4,600 for the 28-percent bracket (to $183,250); and $10,000 for the top of the 33-percent bracket (to $398,350).

Standard Deductions

The 2013 standard deduction will increase for all taxpayers. The standard deduction amounts for 2013 is projected to be $6,100 for single taxpayers; $8,950 for heads of households; $12,200 for married taxpayers filing jointly and surviving spouses; and $6,100 for married taxpayers filing separately. The standard deduction for dependents rises $50 to $1,000 (or earned income plus $350). The additional standard deduction for those have reached 65 or are blind will rise to $1,200 for married taxpayers; $1,500 for unmarried individuals.

Personal Exemptions

The amount of personal and dependency exemptions for 2013 will increase to $3,900 from the 2012 level of $3,800.

Gift Tax Exclusion

The gift tax annual exclusion, which rose from a base of $10,000 to $11,000 in 2002; $12,000 in 2006, and $13,000 in 2009, once again will rise in 2013 to $14,000. Pursuant to the IRC, the exemption can rise only when the inflation adjustment produces an increase of $1,000 or more.

Some individuals must pay estimated taxes or face a penalty in the form of interest on the amount underpaid. Self-employed persons, retirees, and nonworking individuals most often must pay estimated taxes to avoid the penalty. But an employee may need to pay them if the amount of tax withheld from wages is insufficient to cover the tax owed on other income. The potential tax owed on investment income also may increase the need for paying estimated tax, even among wage earners.

Some individuals must pay estimated taxes or face a penalty in the form of interest on the amount underpaid. Self-employed persons, retirees, and nonworking individuals most often must pay estimated taxes to avoid the penalty. But an employee may need to pay them if the amount of tax withheld from wages is insufficient to cover the tax owed on other income. The potential tax owed on investment income also may increase the need for paying estimated tax, even among wage earners.

The trick with estimated taxes is to pay a sufficient amount of estimated tax to avoid a penalty but not to overpay. The IRS will refund the overpayment when you file your return, but it will not pay interest on it. In other words, by overpaying tax to the IRS, you are in essence choosing to give the government an interest-free loan rather than invest your money somewhere else and make a profit.

When do I make estimated tax payments?

Individual estimated tax payments are generally made in four installments accompanying a completed Form 1040-ES, Estimated Tax for Individuals. For the typical individual who uses a calendar tax year, payments generally are due on April 15, June 15, and September 15 of the tax year, and January 15 of the following year (or the following business day when it falls on a weekend or other holiday).

Am I required to make estimated tax payments?

Generally, you must pay estimated taxes in 2012 if (1) you expect to owe at least $1,000 in tax after subtracting tax withholding (if you have any) and (2) you expect your withholding and credits to be less than the smaller of 90 percent of your 2012 taxes or 100 percent of the tax on your 2011 return.  There are special rules for higher income individuals.

Usually, there is no penalty if your estimated tax payments plus other tax payments, such as wage withholding, equal either 100 percent of your prior year's tax liability or 90 percent of your current year's tax liability. However, if your adjusted gross income for your prior year exceeded $150,000, you must pay either 110 percent of the prior year tax or 90 percent of the current year tax to avoid the estimated tax penalty. For married filing separately, the higher payments apply at $75,000.

Estimated tax is not limited to income tax. In figuring your installments, you must also take into account other taxes such as the alternative minimum tax, penalties for early withdrawals from an IRA or other retirement plan, and self-employment tax, which is the equivalent of Social Security taxes for the self-employed.

Suppose I owe only a relatively small amount of tax?

There is no penalty if the tax underpayment for the year is less than $1,000. However, once an underpayment exceeds $1,000, the penalty applies to the full amount of the underpayment.

What if I realize I have miscalculated my tax before the year ends?

An employee may be able to avoid the penalty by getting the employer to increase withholding in an amount needed to cover the shortfall. The IRS will treat the withheld tax as being paid proportionately over the course of the year, even though a greater amount was withheld at year-end. The proportionate treatment could prevent penalties on installments paid earlier in the year.

What else can I do?

If you receive income unevenly over the course of the year, you may benefit from using the annualized income installment method of paying estimated tax. Under this method, your adjusted gross income, self-employment income and alternative minimum taxable income at the end of each quarterly tax payment period are projected forward for the entire year. Estimated tax is paid based on these annualized amounts if the payment is lower than the regular estimated payment. Any decrease in the amount of an estimated tax payment caused by using the annualized installment method must be added back to the next regular estimated tax payment.

Determining estimated taxes can be complicated, but the penalty can be avoided with proper attention. This office stands ready to assist you with this determination. Please contact us if we can help you determine whether you owe estimated taxes.

In light of the IRS’s new Voluntary Worker Classification Settlement Program (VCSP), which it announced this fall, the distinction between independent contractors and employees has become a “hot issue” for many businesses. The IRS has devoted considerable effort to rectifying worker misclassification in the past, and continues the trend with this new program.  It is available to employers that have misclassified employees as independent contractors and wish to voluntarily rectify the situation before the IRS or Department of Labor initiates an examination.

The distinction between independent contractors and employees is significant for employers, especially when they file their federal tax returns. While employers owe only the payment to independent contractors, employers owe employees a series of federal payroll taxes, including Social Security, Medicare, Unemployment, and federal tax withholding. Thus, it is often tempting for employers to avoid these taxes by classifying their workers as independent contractors rather than employees.

If, however, the IRS discovers this misclassification, the consequences might include not only the requirement that the employer pay all owed payroll taxes, but also hefty penalties. It is important that employers be aware of the risk they take by classifying a worker who should or could be an employee as an independent contractor.

“All the facts and circumstances”

The IRS considers all the facts and circumstances of the parties in determining whether a worker is an employee or an independent contractor. These are numerous and sometimes confusing, but in short summary, the IRS traditionally considers 20 factors, which can be categorized according to three aspects: (1) behavioral control; (2) financial control; (3) and the relationship of the parties.

Examples of behavioral and financial factors that tend to indicate a worker is an employee include:

• The worker is required to comply with instructions about when, where, and how to work;
• The worker is trained by an experienced employee, indicating the employer wants services performed in a particular manner;
• The worker’s hours are set by the employer;
• The worker must submit regular oral or written reports to the employer;
• The worker is paid by the hour, week, or month;
• The worker receives payment or reimbursement from the employer for his or her business and traveling expenses; and
• The worker has the right to end the employment relationship at any time without incurring liability.

In other words, any existing facts or circumstances that point to an employer’s having more behavioral and/or financial control over the worker tip the balance towards classifying that worker as an employee rather than a contractor. The IRS’s factors do not always apply, however; and if one or several factors indicate independent contractor status, but more indicate the worker is an employee, the IRS may still determine the worker is an employee.

Finally, in examining the relationship of the parties, benefits, permanency of the employment term, and issuance of a Form W-2 rather than a Form 1099 are some indicators that the relationship is that of an employer–employee.

Conclusion

Worker classification is fact-sensitive, and the IRS may see a worker you may label an independent contractor in a very different light. One key point to remember is that the IRS generally frowns on independent contractors and actively looks for factors that indicate employee status.

Please do not hesitate to call our offices if you would like a reassessment of how you are currently classifying workers in your business, as well as an evaluation of whether IRS’s new Voluntary Classification Program may be worth investigating.

Job-hunting expenses are generally deductible as long as you are not searching for a job in a new field. This tax benefit can be particularly useful in a tough job market. It does not matter whether your job hunt is successful, or whether you are employed or unemployed when you are looking.

Expenses directly connected with a job search are deductible as a miscellaneous itemized deduction. You can deduct job-hunting expenses if the amount of all your so-called miscellaneous itemized deductions exceeds two percent of your adjusted gross income. However, if you claim the standard deduction, you cannot deduct job-hunting expenses. Therefore, as a practical matter for many job seekers, job hunting expenses do not materialize as a tax deduction.

For those who are able to use job seeking expenses as a deduction, it can be difficult to determine what a new field is. A professional photographer who pursues a job in the retail industry clearly is searching in a new field and cannot deduct any of his or her job-hunting expenses. But there are exceptions. The IRS has allowed persons who retired from the military to search for jobs in new fields and claim their job-hunting expenses. Taking a temporary job while searching for permanent employment in your current field will not be considered a job change that disqualifies your job-hunting expenses.

Persons entering the job market for the first time, such as college students, and persons who have been out of the job market for a long period of time, such as parents of young children, cannot deduct their job-hunting expenses. However, a college student who worked in a particular field while in school may be able to deduct job-hunting expenses.

Deductible expenses include typing, printing and mailing a resume. Long-distance phone calls are also deductible. You can deduct travel costs for going on a job search or an interview, including air transportation, railroad, or car expenses. The standard rate for car expenses for business is 55 cents per mile for 2012. Amounts you pay to a job counselor, employment agency or job referral service are all deductible.

It is important to keep records of your costs. While your individual expenses may not be substantial, your total expenses can add up to a significant amount.