July 29, 2011

Dear Clients & Other Friends:

The stage is being set for potential major changes in our tax laws over the next year.  Late in 2010 Congress passed a two year extension of the Bush era tax cuts.  As a result Congress will have to revisit the issue next year if they do not want a cross-the-board expiration of the tax cuts at the end of 2012.  In addition, the current debate over raising the debt ceiling has focused the nation on the fast growing deficit.   Although spending cuts will be a large part of any deficit reduction, it will be difficult to materially reduce the deficit without some increased tax revenue.  Throw in a presidential election year, and some strong partisanship and we will end up with some very creative and complex results. 

Already we have learned that eliminating tax breaks is not really a tax increase.  Also, cutting spending doesn't necessarily mean we will spend less.

I will keep you posted on the changes.  In the meantime we want to bring you up to date on recent changes that have occurred that may affect you.

Changes to 1099 reporting repealed. The expanded 1099 reporting requirements which Congress passed in 2010 to cover more payers, and more payment types have been retroactively repealed. For many years, any trade or business that paid $600 or more to an individual or non-corporate entity for services has been required to file 1099-MISC with the IRS.  Congress expanded this to require landlords to prepare 1099s for service payments starting in 2011.  They also expanded the reporting requirement to include basically all purchases, not just for services, of $600 or more, starting in 2012 for all trade or businesses and landlords.  With repeal, the requirements now revert to the previous rules.  As an aside, this $600 threshold was put into place many years ago when $600 was real money.  However, it was not indexed for inflation.  As a result we now have a threshold that hardly exceeds a payment out of petty cash resulting in ever increasing reporting to the IRS.

Standard mileage rates increase for last half of 2011. The IRS has announced that the optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is increased 4.5¢ from 51¢ to 55.5¢ per mile for business travel from July 1, 2011 to Dec. 31, 2011 to better reflect the real cost of operating an auto in this period of rapidly rising gas prices. This rate can also be used by employers to make tax-free reimbursements tax-free to employees who supply their own autos for business use. The rate for using a car to get medical care or in connection with a move that qualifies for the moving expense also increases 4.5¢ for the last half of 2011 from 19¢ to 23.5¢ per mile.   The rate for charitable use of an automobile remains at 14.5¢.

FUTA surtax is no longer in effect. Beginning July 1, 2011, the 0.2% federal unemployment tax (FUTA) surtax is no longer in effect. Thus, the FUTA tax rate, before consideration of state unemployment tax credits, is now 6.0%. Employers need to separately track FUTA taxable wages paid before July 1, 2011, and FUTA taxable wages paid after June 30, 2011, since the FUTA tax rates are different during those two periods. Employers whose FUTA tax is more than $500 for the calendar year need to make quarterly FUTA deposits. The next quarterly payment is due on Aug. 1, 2011, but that payment is based on taxable wages paid through June 30, 2011, so it will be computed using the 6.2% FUTA tax rate. However, the payment after that is due on Oct. 31, 2011, and it will be computed using the 6.0% FUTA tax rate if legislation is not enacted to retroactively reinstate the FUTA surtax beginning July 1, 2011.  The odds are Congress will reenact the .2% surtax and make it permanent.  There is a good chance they will make it retroactive to July 1^st.

Real estate professionals allowed late election to aggregate rental real estate interests. The IRS has provided guidance that allows certain real estate professionals to make a late election under the regulations to treat all interests in rental real estate as a single rental real estate activity for purposes of the passive activity loss (PAL) rules. This election can make it easier to currently deduct losses from real estate activities. As a general rule, the election is made by filing a statement with the taxpayer's original income tax return for the tax year. However, under new guidance, a taxpayer meeting certain conditions can make a late election on an amended return.

More courts treating basis overstatements as triggering 6-year limitations period. Late last year, the IRS issued final regulations under which an understated amount of gross income reported on a return resulting from an overstatement of unrecovered cost or other basis is an omission of gross income for purposes of the 6-year period for assessing tax. The 6-year limitations period applies when a taxpayer omits from gross income an amount that's greater than 25% of the amount of gross income stated in the return.  This extended 6-year period compares to a normal 3-year limitation period for the IRS to assess additional tax.  Prior to the IRS issuing these new regulations, several courts had held that a basis overstatement was not an omission of gross income for this purpose. In response to these decisions, the IRS issued these new regulations to clarify that an omission can arise in that fashion. This is an example of "if you lose, just change the rules". 

Trust's investment advice fees. The Supreme Court has held that investment advisory fees paid by a trust were deductible only to the extent that they exceeded 2% of the trust's adjusted gross income (AGI) (making the treatment the same as an individual taxpayer claiming the investment expense as a miscellaneous itemized deduction). Thus, such expenses didn't qualify for the exception to the 2% of AGI limit in the tax law for costs paid or incurred in connection with the administration of a trust or estate that wouldn't have been incurred if the property weren't held in the trust or estate. However, for the sake of administrative convenience, the IRS has provided that, until final regulations are issued, nongrantor trusts and estates will not have to "unbundle" a fiduciary fee (i.e., separate the fee into components that are subject to the deduction limit and those that aren't). As a result, until the regulations are issued, affected trusts can deduct the full amount of a bundled fiduciary fee without regard to the 2% floor.

IRA trustees weren't liable for Madoff losses. A district court has dismissed all claims brought by holders of self-directed individual retirement accounts (IRAs) against the IRA trustees for losses incurred by the IRAs for investments with Bernard Madoff's firm. A number of individuals owned self-directed IRAs with IRA agreements that clearly stated that they were solely responsible for making investment decisions in connection with the funds in their IRAs, and that the IRA trustees would not provide any investment advice. Pursuant to instructions given by these IRA owners, the IRA trustees sent IRA funds to Bernard Madoff's brokerage firm, Bernard L. Madoff Investment Securities LLC, for investment in securities. These funds were ultimately lost in Madoff's ponzi scheme. The IRA owners sought to hold the IRA trustees responsible for their role in the losses that the IRAs sustained. The action asserted claims under federal common law based on Internal Revenue Code sections governing IRAs, and state law negligence, contract, and unjust enrichment claims. However, the court rejected all such claims.  In other words, you can't have it both ways - if it is self-directed, you cannot blame someone else for directing you wrong!

IRS formally reverses position on two-year window for innocent spouse relief. Married joint return filers are jointly and severally liable for the tax arising from their returns. Innocent spouses may request relief from this liability in certain circumstances. Although an IRS regulation which states that a request for innocent spouse relief must be made no later than two years from the first collection activity against the spouse has been upheld by many courts, the IRS recently announced it would no longer enforce this regulation. The request now must be made within the limitation period for collection.

Nonspouse real estate transfers under scrutiny. A recent court case reveals that the IRS has discovered a pattern of taxpayers failing to file gift tax returns for real property transfers between nonspouse related parties. As a result, it launched a compliance initiative to capture data from states and counties regarding real property transfers taking place between nonspouse family members for little or no consideration during the period of Jan. 1, 2005, through Dec. 31, 2010. Thus, individuals who transferred real property to nonspouse family members should make sure that required gift tax returns were filed.   Some states, such as California, are not cooperating with the IRS on this initiative.  Our state is cooperating.

New law creates a 100% write-off for heavy SUVs used entirely for business. Under the 2010 Tax Relief Act, a taxpayer that buys and places in service a new heavy SUV after Sept. 8, 2010 and before Jan. 1, 2012, and uses it 100% for business, may write off its entire cost in the placed-in-service year. A heavy SUV is one with a gross vehicle weight (GVW) rating of more than 6,000 pounds.   However, if you later sell it or convert it to personal use you will have to recapture part of this write-off as income.

IRS further delays health insurance coverage information reporting for small employers. The new health reform legislation generally requires employers to report the cost of health insurance they provide to employees on their W-2 forms. Last fall, the IRS made this new reporting requirement optional for all employers for the 2011 W-2 forms. More recently, the IRS announced that the reporting requirement will continue to be voluntary for small employers at least through 2012.

New settlement offer for those voluntarily disclosing unreported offshore income. The IRS has announced a second voluntary disclosure initiative designed to bring offshore money back into the U.S. tax system and help people with undisclosed income from hidden offshore accounts get current with their taxes. It will be available through Aug. 31, 2011. As with the first offer, participants have to pay back taxes and penalties but will avoid criminal prosecution. The offshore penalty is different under the new offer. The general rule is that the penalty is 25% based on amounts in foreign bank accounts, but can be as low as 12.5% or 5% for some taxpayers.  Some mistakenly think that the required reporting of foreign accounts is only a "rich person's" problem.  However, many people will have an account that they do not realize falls under these rules.  For example, a Canadian bank or trust account, or a life insurance policy issued by a Canadian company would fall under the foreign account reporting rules.  Ask us if you are unsure.

IRS eases lien procedures. The IRS has announced new policies and programs to help taxpayers pay back taxes and avoid tax liens. Its goal is to help individuals and small businesses meet their tax obligations, without adding an unnecessary burden to taxpayers. Specifically, the IRS is:

·         Significantly increasing the dollar threshold when liens are generally issued, resulting in fewer tax liens.

·         Making it easier for taxpayers to obtain lien withdrawals after paying a tax bill.

·         Withdrawing liens in most cases where a taxpayer enters into a Direct Debit Installment Agreement.

·         Creating easier access to Installment Agreements for more struggling small businesses; and

·         Expanding a streamlined Offer in Compromise program to cover more taxpayers.

Lactation expenses now qualify as deductible medical expenses. Reversing its prior position, the IRS has announced that expenses paid for breast pumps and supplies that assist lactation qualify as deductible medical expenses. Amounts reimbursed for these expenses under FSAs (flexible spending accounts), Archer MSAs (medical savings accounts), HRAs (health reimbursement arrangements), or HSAs (health savings accounts) are accordingly not income to the taxpayer.  The IRS must have determined it didn't pay to mess with Mother Nature or Moms.

Tax consequences of governmental homeowner-assistance payments. The IRS has explained the income tax and information return consequences of payments made to or on behalf of homeowners under various government programs designed to prevent avoidable foreclosures of homeowners' homes and stabilize housing markets. In general, homeowners may exclude the payments from income, and may deduct all payments they actually make during 2010 - 2012 to the mortgage servicer, HUD (the Department of Housing and Urban Development), or the State HFA (housing finance agency) on the home mortgage. The aid payments aren't subject to information reporting, and there are transition rules for payments that are incorrectly reported.   Guess they didn't want to kick someone while they're down...

As we mentioned, the next year or so could bring material changes to our tax laws and overall tax structure.  When Congress touches the tax law, it usually results in more complexity.  Sacred deductions such as the home mortgage interest deduction are even being considered for further limitation.   Politically acceptable "revenue raisers" will enacted.  As always, we are here to help guide you through our ever-changing tax environment.

As a reminder, I am in either my Bainbridge Island office or my Seattle office every Wednesday.  And of course, I am in the Lacey office on the other days.

Thanks, Tim

Disclaimer: By nature of a newsletter, this information is in summary form and does not necessarily detail every requirement, restriction or tax planning opportunity.  Prior to executing any tax strategy, you should consider non-tax implications - you may cost yourself more than you save in taxes.  Please use this information with these limitations in mind.  If you are considering executing a particular tax strategy, please contact me so we can discuss the specifics. 

          Tim Jacobsen, CPA
 Strader Hallett & Co., P.S.
    Certified Public Accountants

5209 Corporate Center Court Southeast
Lacey, Washington   98503

(360) 456-2100 ext 134
(360) 456-2590  fax
www.StraderHallett.com

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