The IRS issued frequently asked questions (FAQs) addressing the new deduction for qualified overtime compensation added by the One, Big, Beautiful Bill Act (OBBBA). The FAQs provide general information to taxpayers and tax professionals on eligibility for the deduction and how the deduction is determined.
The IRS issued frequently asked questions (FAQs) addressing the new deduction for qualified overtime compensation added by the One, Big, Beautiful Bill Act (OBBBA). The FAQs provide general information to taxpayers and tax professionals on eligibility for the deduction and how the deduction is determined.
General Information
The FAQs explain what constitutes qualified overtime compensation for purposes of the deduction, including overtime compensation required under section 7 of the Fair Labor Standards Act (FLSA) that exceeds an employee’s regular rate of pay. The FAQs also describe which individuals are covered by and not exempt from the FLSA overtime requirements.
FLSA Overtime Eligibility
The FAQs address how individuals, including federal employees, can determine whether they are FLSA overtime-eligible. For federal employees, eligibility is generally reflected on Standard Form 50 and administered by the Office of Personnel Management, subject to certain exceptions.
Deduction Amount and Limits
The FAQs explain that the deduction is limited to a maximum amount of qualified overtime compensation per return and is subject to phase-out based on modified adjusted gross income. Special filing and identification requirements also apply to claim the deduction.
Reporting and Calculation Rules
The FAQs describe how qualified overtime compensation is reported for tax purposes, including special reporting rules for tax year 2025 and required separate reporting by employers for tax years 2026 and later. The FAQs also outline methods taxpayers may use to calculate the deduction if separate reporting is not provided.
FS-2026-1
IR 2026-10
Proposed regulations regarding the deduction for qualified passenger vehicle loan interest (QPVLI) and the information reporting requirements for the receipt of interest on a specified passenger vehicle loan (SPVL), Code Sec. 163(h)(4), as added by the One Big Beautiful Bill Act (P.L. 119-21), provides that for tax years beginning after December 31, 2024, and before January 1, 2029, personal interest does not include QPVLI. Code Sec. 6050AA provides that any person engaged in a trade or business who, in the course of that trade or business, receives interest from an individual aggregating $600 or more for any calendar year on an SPVL must file an information return reporting the receipt of the interest.
Proposed regulations regarding the deduction for qualified passenger vehicle loan interest (QPVLI) and the information reporting requirements for the receipt of interest on a specified passenger vehicle loan (SPVL), Code Sec. 163(h)(4), as added by the One Big Beautiful Bill Act (P.L. 119-21), provides that for tax years beginning after December 31, 2024, and before January 1, 2029, personal interest does not include QPVLI. Code Sec. 6050AA provides that any person engaged in a trade or business who, in the course of that trade or business, receives interest from an individual aggregating $600 or more for any calendar year on an SPVL must file an information return reporting the receipt of the interest.
Qualified Personal Vehicle Loan Interest
QPVLI is deductible by an individual, decedent's estate, or non-grantor trust, including a with respect to a grantor trust or disregarded entity deemed owned by the individual, decedent's estate, or non-grantor trust. The deduction for QPVLI may be taken by taxpayers who itemize deductions and those who take the standard deduction. Lease financing would not be considered a purchase of an applicable passenger vehicle (APV) and, thus, would not be considered a SPVL. QPVLI would not include any amounts paid or accrued with respect to lease financing.
Indebtedness will qualify as an SPVL only to the extent it is incurred for the purchase of an APV and for any other items or amounts customarily financed in an APV purchase transaction and that directly relate to the purchased APV, such as vehicle service plans, extended warranties, sales, and vehicle-related fees. Indebtedness is an SPVL only if it was originally incurred by the taxpayer, with an exception provided for a change in obligor due to the obligor's death. Original use begins with the first person that takes delivery of a vehicle after the vehicle is sold, registered, or titled and does not begin with the dealer unless the dealer registers or titles the vehicle to itself.
Personal use is defined to mean use by an individual other than in any trade or business, except for use in the trade or business of performing services as an employee, or for the production of income. An APV is considered purchased for personal use if, at the time of the indebtedness is incurred, the taxpayer expects the APV will be used for personal use by the taxpayer that incurred the indebtedness, or by certain members of that taxpayer's family and household, for more than 50 percent of the time. Rules with respect to interest that is both QPVLI and interest otherwise deductible under Code Sec. 163(a) or other Code section are provided and intended to provide clarity and to prevent taxpayers from claiming duplicative interest deductions. The $10,000 limitation of Code Sec. 163(h)(4)(C)(i) applies per federal tax return. Therefore, the maximum deduction on a joint return is $10,000. If two taxpayers have a status of married filing separately, the $10,000 limitation would apply separately to each return.
Information Reporting Requirements
If the interest recipient receives from any individual at least $600 of interest on an SPVL for a calendar year, the interest recipient would need to file an information return with the IRS and furnish a statement to the payor or record on the SPVL. Definitions of terms used in the proposed rules are provided in Prop. Reg. §1.6050AA-1(b).
Assignees of the right to receive interest payments from the lender of record are permitted to rely on the information in the contract if it is sufficient to satisfy its information reporting obligations. The assignee may choose to make arrangements to obtain information regarding personal use from the obligor, lender of record, or by other means. The written statement provided to the payor of record must include the information that was reported to the IRS and identify the statement as important tax information that is being furnished to the IRS and state that penalties may apply for overstated interest deductions.
Effective Dates and Requests for Comments
The regulations are proposed to apply to tax years in which taxpayers may deduct QPVLI pursuant to Code Sec. 163(h)(4). Taxpayers may rely on the proposed regulations under Code Sec. 163 with respect to indebtedness incurred for the purchase of an APV after December 31, 2024, and on or before the regulations are published as final regulations, so long as the taxpayer follows the proposed regulations in their entirety and in a consistent manner. Likewise, interest recipients may rely on the proposed regulations with respect to indebtedness incurred for the purchase of an APV after December 31, 2024, and on or before the date the regulations are published as final regulations, so long as the taxpayer follows the proposed regulations in their entirety and in a consistent manner.
Written or electronic comments must be received by February 2, 2026. A public hearing is scheduled for February 24, 2026.
Proposed Regulations, NPRM REG-113515-25
IR 2025-129
The IRS has released interim guidance to apply the rules under Regs. §§1.168(k)-2 and 1.1502-68, with some modifications, to the the acquisition date requirement for property qualifying for 100 percent bonus depreciation under Code Sec. 168(k)(1), as amended by the One Big Beautiful Bill Act (OBBBA) (P.L. 119-21). In addition, taxpayers may apply modified rules under to the elections to claim 100-percent bonus depreciation on specified plants, the transitional election to apply the bonus rate in effect in 2025, prior to the enactment of OBBBA, and the addition of qualified sound recording productions to qualified property under Code Sec, 168(k)(2). Proposed regulations for Reg. §1.168(k)-2 and Reg. §1.1502-68 are forthcoming.
The IRS has released interim guidance to apply the rules under Regs. §§1.168(k)-2 and 1.1502-68, with some modifications, to the the acquisition date requirement for property qualifying for 100 percent bonus depreciation under Code Sec. 168(k)(1), as amended by the One Big Beautiful Bill Act (OBBBA) (P.L. 119-21). In addition, taxpayers may apply modified rules under to the elections to claim 100-percent bonus depreciation on specified plants, the transitional election to apply the bonus rate in effect in 2025, prior to the enactment of OBBBA, and the addition of qualified sound recording productions to qualified property under Code Sec, 168(k)(2). Proposed regulations for Reg. §1.168(k)-2 and Reg. §1.1502-68 are forthcoming.
Under OBBBA qualified property acquired and specified plants planted or grafted after January 19, 2025, qualify for 100 percent bonus depreciation. When determining whether such property meets the acquisition date requirements, taxpayers may generally apply the rules under Regs. §§1.168(k)-2 and 1.1502-68 by substituting “January 19, 2025” for “September 27, 2017” and “January 20, 2025” for “September 28, 2017” each place it appears. In addition taxpayers should substitute “100 percent” for “the applicable percentage” each place it appears, except for the examples provided in Reg. § 1.168(k)-2(g)(2)(iv). Specifically, these rules apply to the acquisition date (Reg. § 1.168(k)-2(b)(5) and Reg. §1.1502-68(a) through (d)) and the component election for components of larger self-constructed property (Reg. § 1.168(k)-2(c)).
With regards to the Code Sec. 168(k)(5) election to claim 100-percent bonus depreciation on specified plants, taxpayer may follow the rules set forth in Reg. § 1.168(k)-2(f)(2). Taxpayers making the transitional election to apply the lower bonus rate in effect in 2025, prior to the enactment of OBBBA may follow Reg. § 1.168(k)-2(f)(3) after substituting “January 19, 2025” for “September 27, 2017”, “January 20, 2025” for “September 28, 2017”, and “40 percent” (“60 percent” in the case of Longer production period property or certain noncommercial aircrafts) for “50 percent”, and applicable Form 4562, Depreciation and Amortization,” for “2017 Form 4562, “Depreciation and Amortization,” each place it appears .
For qualified sound recording productions acquired before January 20, 2025, in a tax year ending after July 4, 2025, taxpayers should apply the rules under Reg. § 1.168(k)-2 as though a qualified sound recording production (as defined in Code Sec. 181(f)) is included in the list of qualified property provided in Reg. § 1.168(k)-2(b)(2)(i). If electing out of bonus depreciation for a qualified sound recording production under Code Sec. 168(k)(7) a taxpayer should follow the rules under Reg. § 1.168(k)-2(f)(1) as if the definition of class of property is expanded to each separate production of a qualified sound recording production.
Taxpayers may rely on this guidance for property placed in service in tax years beginning before the date the forthcoming proposed regulations are published in the Federal Register.
Notice 2026-11
IR 2026-6
The IRS released the optional standard mileage rates for 2026. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:
- business,
- medical, and
- charitable purposes
Some members of the military may also use these rates to compute their moving expense deductions.
The IRS released the optional standard mileage rates for 2026. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:
- business,
- medical, and
- charitable purposes
Some members of the military may also use these rates to compute their moving expense deductions.
2026 Standard Mileage Rates
The standard mileage rates for 2026 are:
- 72.5 cents per mile for business uses;
- 20.5 cents per mile for medical uses; and
- 14 cents per mile for charitable uses.
Taxpayers may use these rates, instead of their actual expenses, to calculate their deductions for business, medical or charitable use of their own vehicles.
FAVR Allowance for 2026
For purposes of the fixed and variable rate (FAVR) allowance, the maximum standard automobile cost for vehicles places in service after 2026 is:
- $61,700 for passenger automobiles, and
- $61,700 for trucks and vans.
Employers can use a FAVR allowance to reimburse employees who use their own vehicles for the employer’s business.
2026 Mileage Rate for Moving Expenses
The standard mileage rate for the moving expense deduction is 20.5 cents per mile. To claim this deduction, the taxpayer must be:
- a member of the Armed Forces of the United States,
- on active military duty, and
- moving under an military order and incident to a permanent change of station
The Tax Cuts and Jobs Act of 2017 suspended the moving expense deduction for all other taxpayers until 2026.
Unreimbursed Employee Travel Expenses
For most taxpayers, the Tax Cuts and Jobs Act suspended the miscellaneous itemized deduction for unreimbursed employee travel expenses. However, certain taxpayers may still claim an above-the-line deduction for these expenses. These taxpayers include:
- members of a reserve component of the U.S. Armed Forces,
- state or local government officials paid on a fee basis, and
- performing artists with relatively low incomes.
Notice 2025-5, is superseded.
Notice 2026-10
IR 2025-128
The IRS issued frequently asked questions (FAQs) addressing the limitation on the deduction for business interest expense under Code Sec. 163(j). The FAQs provide general information to taxpayers and tax professionals and reflect statutory changes made by the Tax Cuts and Jobs Act, the CARES Act, and the One, Big, Beautiful Bill.
The IRS issued frequently asked questions (FAQs) addressing the limitation on the deduction for business interest expense under Code Sec. 163(j). The FAQs provide general information to taxpayers and tax professionals and reflect statutory changes made by the Tax Cuts and Jobs Act, the CARES Act, and the One, Big, Beautiful Bill.
General Information
The FAQs explain the Code Sec. 163(j) limitation, identify taxpayers subject to the limitation, and describe the gross receipts test used to determine whether a taxpayer qualifies as an exempt small business.
Excepted Trades or Businesses
The FAQs address trades or businesses that are excepted from the Code Sec. 163(j) limitation, including electing real property trades or businesses, electing farming businesses, regulated utility trades or businesses, and services performed as an employee.
Determining the Section 163(j) Limitation Amount
The FAQs explain how to calculate the Code Sec. 163(j) limitation, including the definitions of business interest expense and business interest income, the computation of adjusted taxable income, and the treatment of disallowed business interest expense carryforwards.
CARES Act Changes
The FAQs describe temporary modifications to Code Sec. 163(j) made by the CARES Act, including increased adjusted taxable income percentages and special rules and elections applicable to partnerships and partners for taxable years beginning in 2019 and 2020.
One, Big, Beautiful Bill Changes
The FAQs outline amendments made by the One, Big, Beautiful Bill, including changes affecting the calculation of adjusted taxable income for tax years beginning after Dec. 31, 2024, and the application of Code Sec. 163(j) before interest capitalization provisions for tax years beginning after Dec. 31, 2025.
FS-2025-9
IR 2025-126
The IRS issued frequently asked questions (FAQs) addressing updates to the Premium Tax Credit. The FAQs clarified changes to repayment rules, the removal of outdated provisions and how the IRS will treat updated guidance.
The IRS issued frequently asked questions (FAQs) addressing updates to the Premium Tax Credit. The FAQs clarified changes to repayment rules, the removal of outdated provisions and how the IRS will treat updated guidance.
Removal of Repayment Limitations
For tax years beginning after December 31, 2025, limitations on the repayment of excess advance payments of the Premium Tax Credit no longer applied.
Previously Applicable Provisions
Premium Tax Credit rules that applied only to tax years 2020 and 2021 were no longer applicable and were removed from the FAQs.
Updated FAQs
The FAQs were updated throughout for minor style clarifications, topic updates and question renumbering.
Reliance on FAQs
The FAQs were issued to provide general information to taxpayers and tax professionals and were not published in the Internal Revenue Bulletin.
Legal Authority
If an FAQ was inconsistent with the law as applied to a taxpayer’s specific circumstances, the law controlled the taxpayer’s tax liability.
Penalty Relief
Taxpayers who reasonably and in good faith relied on the FAQs were not subject to penalties that included a reasonable cause standard for relief, to the extent reliance resulted in an underpayment of tax.
FS-2025-10
IR 2025-127
The IRS issued guidance providing penalty relief to individuals and corporations that make a valid Code Sec. 1062 election to defer taxes on gains from the sale of qualified farmland. Taxpayers who opt to pay their applicable net tax liability in four annual installments will not be penalized under sections 6654 or 6655 for underpaying estimated taxes in the year of the sale.
The IRS issued guidance providing penalty relief to individuals and corporations that make a valid Code Sec. 1062 election to defer taxes on gains from the sale of qualified farmland. Taxpayers who opt to pay their applicable net tax liability in four annual installments will not be penalized under sections 6654 or 6655 for underpaying estimated taxes in the year of the sale.
The relief permits these taxpayers to exclude 75 percent of the deferred tax from their estimated tax calculations for that year. However, 25 percent of the tax liability must still be paid by the return due date for the year of the sale. The IRS emphasized that this waiver applies automatically if the taxpayer qualifies and does not self-report the penalty.
Taxpayers who have already reported a penalty or receive an IRS notice can request abatement by filing Form 843, noting the relief under Notice 2026-3. This measure aligns with the policy objectives of the One, Big, Beautiful Bill Act of 2025, which introduced section 1062 to support farmland continuity by facilitating sales to qualified farmers. The IRS also plans to update relevant forms and instructions to reflect the changes, ensuring clarity for those seeking relief.
Notice 2026-3
The IRS has extended the transition period provided in Rev. Rul. 2025-4, I.R.B. 2025-6, for states administering paid family and medical leave (PFML) programs and employers participating in such programs with respect to the portion of medical leave benefits a state pays to an individual that is attributable to employer contributions, for an additional year.
The IRS has extended the transition period provided in Rev. Rul. 2025-4, I.R.B. 2025-6, for states administering paid family and medical leave (PFML) programs and employers participating in such programs with respect to the portion of medical leave benefits a state pays to an individual that is attributable to employer contributions, for an additional year.
The IRS found that states with PMFL statuses have requested that the transition period be extended for an additional year or that the effective date be amended because the required changes cannot occur within the current timeline. For this reason, calendar year 2026 will be regarded as an additional transition period for purposes of IRS enforcement and administration with respect to the following components:
-
For medical leave benefits a state pays to an individual in calendar year 2026,with respect to the portion of the medical leave benefits attributable to employer contributions, (a) a state or an employer is not required to follow the income tax withholding and reporting requirements applicable to third-party sick pay, and (b)consequently, a state or employer would not be liable for any associated penalties under Code Sec. 6721 for failure to file a correct information return or under Code Sec. 6722 for failure to furnish a correct payee statement to the payee; and
-
For medical leave benefits a state pays to an individual in calendar year 2026, with respect to the portion of the medical leave benefits attributable to employer contributions, (a) a state or an employer is not required to comply with § 32.1 and related Code sections (as well as similar requirements under § 3306) during thecalendar year; (b) a state or an employer is not required to withhold and pay associatedtaxes; and (c) consequently, a state or employer would not be liable for any associated penalties.
This notice is effective for medical leave benefits paid from states to individuals during calendar year 2026.
Notice 2026-6
Addressing health care will be the key legislative priority a 2026 starts, leaving little chance that Congress will take up any significant tax-related legislation in the coming election year, at least until health care is taken care of.
Addressing health care will be the key legislative priority a 2026 starts, leaving little chance that Congress will take up any significant tax-related legislation in the coming election year, at least until health care is taken care of.
Top legislative staff from the tax writing committees in Congress (House Ways and Means Committee and Senate Finance Committee) were all in basic agreement during a January 7, 2026, panel discussion at the 2026 D.C. Bar Tax Conference that health care would be tackled first.
“I will say that my judgement, and this is not the official party line, by that my judgement is that a deal on health care is going to have to unlock before there’s a meaningful tax vehicle,” Andrew Grossman, chief tax counsel for the House Ways And Means Committee Democratic staff, said, adding that it is difficult to see Democratic members working on tax extenders and other provisions when 15 million are about to lose their health insurance.
Sean Clerget, chief tax counsel for the Ways and Means GOP staff, added that “our view’s consistent with what Andrew [Grossman] said, adding that committee chairman Jason Smith (R-Mo.) “would be very open to having a tax vehicle whether or not there’s a health care deal, but obviously we need bipartisan cooperation to move something like that. And so, Andrew’s comments are sort of very important to the outlook on this.”
Even some of the smaller items that may have bipartisan support could be held up as the parties work to find common ground on health care legislation.
“It’s hard to see some of the smaller tax items that are hanging out there getting over the finish line without a deal on health, Sarah Schaefer, chief tax advisor to the Democratic staff of the Senate Finance Committee, said. “And I think our caucus will certainly hold out for that.”
Randy Herndon, deputy chief tax counsel for the Finance Committee Republican staff, added that he agreed with Clerget and said that Finance Committee Chairman Mike Crapo (R-Idaho) would be “open to a tax vehicle absent any health care deal, but understand, again, the bipartisan cooperation that would be required.”
No Planned OBBBA Part 2
Clerget said that currently there no major reconciliation bill on the horizon to follow up on the One Big Beautiful Bill Act, but “I’ve always thought that if there were to be a second reconciliation bill, it would need to be very narrow for a very specific purpose, rather than a large kind of open, multicommittee, big bill.”
Herndon added that Chairman Crapo’s “current focus is on pursuing potential bipartisan priorities in the Finance Committee jurisdiction,” noting that a lot of the GOP priorities were addressed in the OBBBA “and our members are very invested in seeing that through the implementation process.”
Of the things we can expect the committees to work on, Herndon identified areas ripe for legislative activity in the coming year, including crypto and tax administration bills and other focused issues surrounding affordability, but GOP members will more be paying attention to the implementation of OBBBA.
Schaefer said that Finance Committee Democrats will maintain a focus on the child tax credit as well as working to get reinstated clean energy credits that were allowed to expire.
Clerget said that of the things that could happen on this legislative calendar is on the taxation of digital assets, stating that “I think there’s a lot of interest in establishing clear tax rules in the digital asset space.… I think we have a good prospect of getting bipartisan cooperation on the tax side of digital assets.”
He also said there has been a lot of bipartisan cooperation on tax administration in 2025, suggesting that the parties could keep working on improving the taxpayer experience in 2026.
By Gregory Twachtman, Washington News Editor
The Fifth Circuit Court of Appeals held that a "limited partner" in Code Sec. 1402(a)(13) is a limited partner in a state-law limited partnership that has limited liability. The court rejected the "passive investor" rule followed by the IRS and the Tax Court in Soroban Capital Partners LP (Dec. 62,310).
The Fifth Circuit Court of Appeals held that a "limited partner" in Code Sec. 1402(a)(13) is a limited partner in a state-law limited partnership that has limited liability. The court rejected the "passive investor" rule followed by the IRS and the Tax Court in Soroban Capital Partners LP (Dec. 62,310).
Background
A limited liability limited partnership operated a business consulting firm, and was owned by several limited partners and one general partner. For the tax years at issue, the limited partnership allocated all of its ordinary business income to its limited partners. Based on the limited partnership tax exception in Code Sec. 1402(a)(13), the limited partnership excluded the limited partners’ distributive shares of partnership income or loss from its calculation of net earnings from self-employment during those years, and reported zero net earnings from self-employment.
The IRS adjusted the limited partnership's net earnings from self-employment, and determined that the distributive share exception in Code Sec. 1402(a)(13) did not apply because none of the limited partnership’s limited partners counted as "limited partners" for purposes of the statutory exception. The Tax Court upheld the adjustments, stating it was bound by Soroban.
Limited Partners and Self Employment Tax
Code Sec. 1402(a)(13) excludes from a partnership's calculation of net earnings from self-employment the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments in Code Sec. 707(c) to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services.
In Soroban, the Tax Court determined that Congress had enacted Code Sec. 1402(a)(13) to exclude earnings from a mere investment, and intended for the phrase “limited partners, as such” to refer to passive investors. Thus, the Tax Court there held that the limited partner exception of Code Sec. 1402(a)(13) did not apply to a partner who is limited in name only, and that determining whether a partner is a limited partner in name only required an inquiry into the limited partner's functions and roles.
Passive Investor Treatment
Here, the Fifth Circuit rejected the interpretation that "limited partner" in Code Sec. 1402(a)(13) refers only to passive investors in a limited partnership. Reviewing the text of the statute, the court determined that dictionaries at the time of Code Sec. 1402(a)(13)’s enactment defined "limited partner" as a partner in a limited partnership that has limited liability and is not bound by the obligations of the partnership. Also, longstanding interpretation by the Social Security Administration and the IRS had confirmed that a "limited partner" is a partner with limited liability in a limited partnership. IRS partnership tax return instructions had for decades defined "limited partner" as one whose potential personal liability for partnership debts was limited to the amount of money or other property that the partner contributed or was required to contribute to the partnership.
The Fifth Circuit determined that the interpretation of "limited partner" as a mere "passive investor" in a limited partnership is wrong. The court stated that the passive-investor interpretation makes little sense of the "guaranteed payments" clause in Code Sec. 1402(a)(13), and that the text of the statute contemplates that "limited partners" would provide actual services to the partnership and thus participate in partnership affairs. A strict passive-investor interpretation that defined "limited partner" in a way that prohibited him from providing any services to the partnership would make the "guaranteed payments" clause superfluous.
Further, the court stated that had Congress wished to only exclude passive investors from the tax, it could have easily written the exception to do so, but it did not do so in Code Sec. 1402(a)(13). Additionally, the passive investor interpretation would require the IRS to balance an infinite number of factors in performing its "functional analysis test," and would make it more complicated for limited partners to determine their tax liability.
The Fifth Circuit rejected the Tax Court's conclusion in Soroban that by adding the words "as such" in Code Sec. 1402(a)(13), Congress had made clear that the limited partner exception applies only to a limited partner who is functioning as a limited partner. Adding "as such" did not restrict or narrow the class of limited partners, and does not upset the ordinary meaning of "limited partner."
Vacating and remanding an unreported Tax Court opinion.
Sirius Solutions, L.L.L.P., CA-5
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.
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.
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.
