APPEALS COURT BREATHES NEW LIFE INTO OVERSTATED BASIS ISSUE

On several occasions, we have written about cases where courts have held that the six-year extended statute of limitations for a 25% omission of gross income from an income tax return will not apply when the unreported income arises from the taxpayer overstating his basis in a sold asset. It now appears that the IRS' dogged persistence in fighting these cases has paid off, at least in one court.

In a decision of the Seventh Circuit Court of Appeals, the court has reversed the Tax Court in its decision and held that an overstatement of basis is an omission of gross income for this purpose.

This decision is contrary to holdings in the Nine Circuit and in the Court of Appeals for the Federal Circuit. Thus, the stage is set for a possible US Supreme Court resolution of this issue.

Beard v Comm., (CA 7, 1/26/2011)

TAX INCENTIVES IN THE SMALL BUSINESS JOBS ACT OF 2010

A little lost in the attention garnered by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 are for the tax incentives for small businesses enacted under the Small Business Jobs Act of 2010. These provisions are meant to encourage growth and expansion for small businesses.

The following summary is largely based on the article by Linda Nelsestuen and Michael Chiasson in the December 2010 version of Practical Tax Strategies/Taxation for Accountants entitled "Exploiting the Tax Incentives Included in the Small Business Jobs Act of 2010."

1 Capital Gains Tax Relief

   1.1 Those who purchased qualified small business stock between 9/27/10 and 1/1/11 and hold it for at least five years, will pay absolutely no tax on the capital gain when the stock is sold.

   1.2 This is an expansion of the 50% excluding available under Code Section 1202(a).

   1.3 Qualified small businesses generally are domestic C Corporations whose aggregate assets are under $50 million and which use at least 80% of their assets in one or more active trade or businesses.

2 Section 179 Expensing

   2.1 Increased to $500,000 in 2010 and 2011.

        2.1.1 Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 for tax years beginning in 2012 a small business taxpayer will be allowed to write off up to $125,000 (indexed for inflation).

   2.2 The limitations on the value of assets placed into service have increased from $800,000 to $2 million. For assets placed into service beyond the $2 million limit, the deduction is lost dollar for dollar.

   2.3 The expensing now temporarily applies to “qualified real property” for the 2010 and 2011 tax years, which is defined as qualified, domestic (1) leasehold improvement property, (2) restaurant property, and (3) retail improvement property. Excluded, however, are units for air conditioning and heating.

3 Section 168(k) Depreciation Bonus

   3.1 This 50% depreciation bonus has been extended to include 2010.

   3.2 Note that the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 also subsequently provided for a 100% bonus for qualified tangible personal property placed in service after September 8, 2010 and through December 31, 2011 (through December 31, 2012 for certain longer-lived and transportation property).

4 Carryback of Credits

   4.1 The general business credit carryback period is temporarily increased to five years from one year. Other limitations and restrictions relating to the carrybacks are reduced or eliminated.

5 Health Insurance Deduction for Self-Employment Taxes

   5.1 For 2010, self-employed taxpayers may deduct health insurance costs to offset employment taxes.

   5.2 Note this is different from the deduction available against federal income to reduce income taxes.

6 Increase in Deductible Start-Up Expenditures

   6.1 The initial deduction is increased from $5,000 to $10,000, and with the phase-out threshold increased from $50,000 to $60,000.

7 Removal of Cell Phones from Listed Property

   7.1 Cell phones and other personal communication devices are no longer treated as listed property. Listed property is subject to strict substantiation requirements, and thus these items are no longer subject to these requirements.

   7.2 This is a permanent change.

   7.3 Note that personal use is still not deductible, and there still has to be some type of documentation as to the portion of the cell phone used for business purposes.

8 Reduction in Penalties for Failure to Disclose Information with Respect to "Reportable Transactions"

   8.1 Section 6707A penalties will now be based in large part on the tax savings resulting from the unreported Reportable Transaction instead of being a flat amount penalty.

IRS SAYS IT IS READY NOW FOR 2010 RETURNS

On December 30, 2010, the IRS advised certain taxpayers to wait until mid or late February, 2011 to file their income tax returns for 2010. This was because the IRS needed time to reprogram its computers to reflect the 2010 Tax Leave Act's changes. Taxpayers that were affected by the delay are those claiming:

--Itemized deductions on Schedule A;

--above-the-line deductions for higher education tuition and fees; and

--about-the-line deductions for kindergarten through grade 12 educators with out-of-pocket classroom expenses of up to $250.

In a January 20, 2011 news release, the IRS has announced that such returns can be submitted for processing on or after February 14, 2011. Taxpayers using commercial software can check with their providers, since many of those companies will accept returns prior to that date and hold them for submission to the IRS on February 14.

News Release 2011 – 7

APPLICABLE FEDERAL RATES–FEBRUARY 2011

PRESENTATION MATERIALS AVAILABLE

For any that are interested, the powerpoint presentation and full outline from my presentation last week on the foreign tax provisions under FATCA (as part of the 2010 HIRE Act) at the 29th International Tax Conference in Miami are available online here. Also available on the same page is the International Tax Update presentation of my partner, Robert Chaves.

IRS EXPANDS SIMPLIFIED FILINGS FOR SMALLER EXEMPT ORGANIZATIONS

The IRS has doubled the $25,000 gross receipts threshold to $50,000 that allows exempt organizations to file an “e-postcard” Form 990-N, in lieu of a full Form 990. More particularly, an exempt organization with annual gross receipts of less than $50,000 can use the Form 990-N:

--if for the first year of existence, total gross receipts (including amounts pledged by donors) are $75,000 or less;

--if in the second or third year, $60,000 or less;

--if in fourth or later year, $50,000 or less.

Now don’t get too excited – as before, private foundations and Code §509(a)(3) organizations cannot use the Form 990-N. Nor does it relieve organizations of having to file a Form 990-T to report unrelated business income.

Foreign organizations and U.S. possession organizations cannot use this alternate filing if they have significant activity (including lobbying and political activity or the operation of a trade or business, but excluding investment activity) in the U.S.

Rev.Proc. 2011-15

AMENDED RETURNS AND THE TIMELY MAILED/TIMELY FILED RULE

A recent Chief Counsel Advice reveals the quirky nature of the timely mailed/timely filed rule as to amended returns. The CCA notes that the rule which treats a return as filed as of the date of mailing under Code Section 7502 will NOT apply to an amended return that shows an increase in tax due. This is because Section 7402 only applies to returns that are “required to be filed” and such returns are not required. Thus, under the CCA, a taxpayer who submitted an amended return that was timely when mailed, but beyond the statute of limitations for assessment of taxes when received by the IRS, could not be assessed taxes for the increased tax amount shown on the return.

However, the CCA notes that if the amended return included a claim for refund, then the timely mailed/timely filed rule WOULD apply since the law requires a claim to filed in such case.

Thus, this is quite a quirky situation where the timely mailed rule should be available to help taxpayers submitting amended returns seeking a refund (to save them from a late filing based on the day the IRS receives the return), but will  not be applied to help the IRS when such a return shows additional tax due.

CCA 201052003

TREASURY SET TO CHASE OFF MORE FOREIGN CAPITAL

The U.S. does not tax nonresident aliens on interest earned on their U.S. bank deposits. This is an implementation of a policy to draw their capital to the U.S.

The Treasury Department doesn’t care too much about this policy – its mission is to increase tax compliance and collections. This disconnect with the broader policy of nontaxation is evident in recent proposed regulations issued by the Treasury Department.

Presently, under current Regulations, U.S. bank deposit interest payments are reported to the IRS only if the interest is paid to a U.S. person or a nonresident alien who resides in Canada. Treas. Regs. §1.6049-8. The IRS has now issued new proposed Regulations that will extend information reporting requirements to include bank deposit interest paid to nonresident aliens who reside in any foreign country.

The rationale for the enhanced reporting is to strengthen the U.S. information exchange program (i.e., the U.S. reporting of tax information to other countries so that other countries can tax their residents) and reducing the ability of U.S. persons to avoid taxation by fraudulently claiming to be nonresident aliens.

Will this Regulation, if finalized, decrease U.S. bank deposits (and the resulting lending and increased economic activity that results from such deposits)? Well, it surely isn’t going to increase them.

Proposed Treas. Regs. §1.6049-4 , §1.6049-5 , §1.6049-6 ,§1.6049-8 , §1.3406(g)-1

WHOLESALE CLUB PURCHASES CAN BE DEDUCTIBLE, BUT…

A semi-secret of many restaurants and stores is that a large part of their ingredients and inventory of items for sale are purchased at wholesale clubs, such as Costco and Sam’s Club. Such purchases are a testament to the favorable prices available at such clubs that are available to both businesses and individual shoppers.

There is nothing that prohibits a taxpayer from expensing items purchased from such clubs, or adding them to cost of goods sold for purposes of determining income from sale of inventory. However, there is a right way and wrong way to go about this. A recent Tax Court case illustrates the wrong way.

In the case, the taxpayers, who ran two restaurants, included in their cost of goods sold items purchased from grocery stores and wholesale clubs. They produced photocopied receipts from the stores to substantiate their expenses. In upholding the IRS in disallowing a large part of these deductions, the Tax Court noted:

These receipts are of little value. Without an explanation from the Daouds, it is impossible for us to distinguish items used at their Wienerschnitzels from those used by them personally. Many of the items on the receipts are household or personal care products, or food and drink (e.g., liquor) that we find were probably not served or used at their restaurants.

Some simple lessons can be gleaned. First, detail on the receipts what was purchased. Second, don’t combine personal items on the same receipts as business items.

It didn’t help the taxpayers that there were a multitude of other facts and issues detailed in the case that raised numerous questions for the Court as to the accuracy of the taxpayers’ returns, perhaps coloring the Court’s opinion of the taxpayers’ claims that the receipts substantiated bona fide business items.

Daoud, TC Memo 2010-282

APPLICATION OF NONDISCRIMINATION RULES TO GROUP HEALTH PLANS DEFERRED

In the past, there were no nondiscrimination rules that applied to employer-sponsored health coverage, outside of self-insured medical reimbursement plans. By “nondiscrimination,” this means that plans cannot be more favorable to highly compensated employees than to other employees. However, recent health care Acts now impose these rules on insured group health plans.

Due to lack of guidance on how to apply nondiscrimination rules in context of insured group health plans, the IRS has suspended the application of the nondiscrimination provisions (and any related sanctions) until after regulations or other administrative guidance is promulgated. Such guidance, when issued, will further provide for a time period for taxpayers to review and implement their provisions.

Notice 2011-1

ADDITIONAL NEW TAX LAW PROVISIONS

In our last installment of the review of the key tax provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, we take a quick look and some other key provisions of the Act:

I. Rates, Exemptions and Special Rules.

     A. Extension of Bush tax rates through 2012, including favorable capital gains rates and rates on qualified dividends.

     B. Numerous other favorable provisions are extended to 2011 or 2012.

II. Social Security Rate Reduction.

     A. The employee social security tax rate is reduced from 6.2% to 4.2%.
          1. This is for 2011 only. Given the expected deadlock in Congress in 2011 and 2012, the extension of this reduction to 2012 is uncertain.

     B. The self-employed social security tax rate is reduced from 12.4% to 10.4%.
          1. This is for 2011 only. Given the expected deadlock in Congress in 2011 and 2012, the extension of this reduction to 2012 is uncertain.

III. AMT Exemption Amounts Increased for 2010 and 2011.

     A. 2010
          1. $72,450 (up from $70,950 in 2009) for married couples filing a joint return and surviving spouses.
          2. $47,450 (up from $46,700 in 2009) for an individual who isn't married or a surviving spouse.
        3. $36,225 (up from $35,475 in 2009) for married individuals filing separate returns.

     B. 2011
          1. $74,450 for married couples filing a joint return and surviving spouses.
          2. $48,450 for an individual who isn't married or a surviving spouse.
          3. $37,225 for married individuals filing separate returns.

IV. Depreciation and Expensing Provisions.

     A. 100% first year depreciation deduction for qualified tangible personal property placed in service after September 8, 2010 and through December 31, 2011 (through December 31, 2012 for certain longer-lived and transportation property).
          1. Generally, the property must be (1) depreciable property with a recovery period of 20 years or less; (2) water utility property; (3) computer software; or (4) qualified leasehold improvements. Also the original use of the property must commence with the taxpayer - used machinery doesn't qualify.
          2. 50% write off applies in 2012.

     B. Under Section 179 expensing, for tax years beginning in 2012 a small business taxpayer will be allowed to write off up to $125,000 (indexed for inflation) of capital expenditures subject to a phaseout (i.e., gradual reduction) once capital expenditures exceed $500,000 (indexed for inflation)