The estates of wealthy individuals who died in 2010 didn’t pay any federal estate tax, but that situation has changed. Under the recently enacted “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,” the federal estate tax, which disappeared for 2010, sprung back to life in 2011 and is imposed at the top rate of 35% of the estate’s value after the first $5 million. I hope, in this blog article, to provide some useful information via this brief overview of the new law.

Background

The modern estate tax dates back to 1916, when it was imposed at a rate of 10% on the portion of estates above $50,000. Over the following years, the rates and exemption amounts have varied, reaching a high of 77% from 1941 to 1976 with a $60,000 exemption amount.

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the first of the two large legislative packages that contain most of what are now commonly referred to as the Bush tax cuts. EGTRRA gradually lowered the maximum estate tax rate and substantially raised the applicable exclusion amount over the years 2002 through 2009. The maximum tax rate fell from 60% under prior law in 2001 (a 55% marginal rate on taxable estate values over $3 million plus a 5% surtax from $10 million to $17 million) to 45% in 2007-2009. EGTRRA repealed the estate tax completely for decedents dying in 2010. That led to several well-publicized instances in which famous people died in 2010 leaving multibillion-dollar estates that will pass to their heirs without paying so much as a penny in federal estate tax. However, all of those provisions were scheduled to sunset on December 31, 2010, meaning that if Congress had not acted, starting January 1, 2011, the estate tax would have sprung back at a level that no one seemed to want. Where the exclusion was $3.5 million ($7 million for couples) in 2009 – a level at which it affected relatively few households – it would have been $1 million ($2 million for couples) in 2011. The tax rate would also have risen, from a top rate of 45% in 2009, to a top rate of 55% in 2011.

New law

The new law brings back the estate tax, for 2011 and 2012 anyway. During 2011 and 2012, the top rate is 35%. For 2011, the exemption amount is $5 million per individual (indexed for inflation after 2011). At those levels, the vast majority of estates (all but an estimated 3,500 nationwide in 2011) will not be subject to any federal estate tax, and the tax will raise about $11.4 billion for the government. By way of comparison, the 55% tax with a $1 million exemption would have resulted in about 43,540 taxable estates in 2011, and raised about $34.4 billion. Tax historians would also note that except for the temporary repeal of the estate tax in 2010, the estate tax rate has not been less than 45% since 1931.

The new law also gives heirs of decedents dying in 2010 a choice of which estate-tax rules to apply – 2010′s or 2011′s. That’s important because although there is no estate tax in 2010, some inherited assets are subject to higher capital gains tax under the 2010 rules, a situation that actually raises the tax burden for some heirs. Inherited assets under the 2010 rules have a tax basis equal to the price when they were purchased (referred to in tax parlance as “carryover basis”) rather than their value at death. That could lead to a significant tax burden for heirs who sell assets such as stocks that had been held for many years and have greatly appreciated in value. Under the 2011 rules, by contrast, heirs are allowed to inherit assets with a “stepped-up basis.” While most heirs would choose the 2011 regime ($5 million exemption from both estate and generation-skipping tax and an unlimited step-up in the basis of assets to their current market value), the heirs of superrich decedents could find it more advantageous to elect the original 2010 law (limited step-up in the basis of assets and no estate tax). If the executor does not elect to have the original 2010 rules apply, the estate tax return’s due date will not be earlier than the date that’s nine months after the new law’s enactment date (Sept. 19, 2011).

For gifts made after December 31, 2010, the gift tax is reunified with the estate tax. Under the new law, the estate and gift tax exemptions are reunified in 2011, which means that the $5 million estate tax exemption will also be available for gifts. The law in effect prior to 2010 provided a $3.5 million lifetime exemption for estates, but only $1 million for gifts. The gift tax rate, starting in 2011, is 35%. The exemption from the generation-skipping tax (GST) – the additional tax on gifts and bequests to grandchildren when their parents are still alive – also rose to $5 million from the $1 million it would have been without the new law. The GST tax rate for transfers made in 2011 and 2012 is 35%.

From a planning standpoint, a nice feature of the new law is that it makes it easier to transfer the $5 million exemption to a surviving spouse, so married couples can shield $10 million of their assets from taxes. In the language of tax professionals, the estate tax exemption will be “portable.”

I hope this article provided useful information or was at least thought provoking. If you would like more details about the estate tax or any other aspect of the new law, please do not hesitate to call me or any other principal at HBK.

J. Michael Sowers, CPA is a Principal with Hill, Barth & King LLC in the Fort Myers, Florida office and has extensive experience in accounting, auditing and litigation support. He joined the firm in 2010 when Gilbert, Wallace, Stewart, Stramel & Sowers, P.A. merged with HBK.  Mike can be contacted by phone at 239-482-5522 or email at msowers@hbkcpa.com.

In addition to extending the Bush tax cuts, providing relief from the AMT, and cutting the payroll tax by two percentage points, the recently enacted “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” (Tax Relief Act) extends a host of other important tax breaks for businesses and individuals. I’m writing to give you an overview of these key tax breaks that were extended by the new law. Please call our office for details of how the new changes may affect you or your business.

Individual tax relief

The following tax breaks for individuals that expired at the end of 2009 have been retroactively reinstated by the Tax Relief Act and extended through 2011.

• The election to take an itemized deduction for State and local general sales taxes instead of the itemized deduction permitted for State and local income taxes
• The above-the-line deduction for qualified higher education expenses
• The $250 above-the-line tax deduction for teachers and other school professionals for expenses paid or incurred for books, certain supplies, equipment, and supplementary materials used by the educator in the classroom
• The increased contribution limits and carryforward period for contributions of appreciated real property (including partial interests in real property) for conservation purposes
• The provision that permits tax-free distributions to charity from an Individual Retirement Account (IRA) of up to $100,000 per taxpayer, per tax year. Individuals also will be allowed to make charitable transfers during January of 2011 and treat them as if made during 2010
• The look-thru rule for certain regulated investment company (RIC) stock in determining the gross estate of nonresidents
• The increase in the monthly exclusion for employer-provided transit and vanpool benefits to equal that of the exclusion for employer-provided parking benefits

In addition, the new law extends for an additional year (i.e., through 2011) the rule allowing premiums for mortgage insurance to be deductible as qualified residence interest.

Business tax relief

On the business side, the following business tax breaks that expired at the end of 2009 have been retroactively reinstated and extended through 2011 by the Tax Relief Act.

• The research and development credit
• 15-year writeoffs for qualified leasehold and retail improvements, and restaurant buildings (and certain improvements to such restaurant buildings)
• 7-year writeoffs for certain motorsports racetrack property
• The employer wage credit for activated military reservists
• The active financing exception from the Code’s Subpart F rules for a controlled foreign corporation predominantly engaged in the conduct of a banking, financing, or similar business
• Look-through treatment of payments between related controlled foreign corporations
• The Indian employment credit
• The new markets tax credit
• Accelerated depreciation for business property on an Indian reservation
• The railroad track maintenance credit
• The special expensing rules for certain film and television productions
• The mine rescue team training credit
• The election to expense advanced mine safety equipment
• Expensing of environmental remediation costs
• The deduction allowable for domestic production activities in Puerto Rico
• The American Samoa economic development credit
• The rules exempting from gross basis tax and from withholding tax the interest-related dividends and short-term capital gain dividends received from a RIC by certain foreign persons (extended to apply to tax years of a RIC beginning before 2012)
• The inclusion of a RIC within the definition of a “qualified investment entity” under the provisions of the Foreign Investment in Real Property Tax Act as codified in Code Sec. 897
• The enhanced deduction for contributions of food and book inventories, and computer equipment for educational purposes
• A liberal rule for S corporations making charitable donations
• The special rules for interest, rents, royalties and annuities received by a tax-exempt entity from a controlled entity
• Empowerment zone tax incentives
• Tax incentives for investments in the District of Columbia
• The work opportunity credit (extended for four months (through the end of 2011))
• Qualified zone academy bonds

In addition, the new law extends for an additional year (i.e., through 2011) the temporary exclusion of 100% of gain on the sale of certain small business stock.

Energy provisions

The following energy provisions were extended by the Act (through 2011).

• The credit for manufacturers of energy-efficient new homes
• Incentives for biodiesel and renewable diesel
• The credit for refined coal facilities
• Excise tax credits and outlay payments for alternative fuel and alternative fuel mixtures
• The special rule to implement FERCs and State electric restructuring policy
• Suspension of the limitation on percentage depletion for oil and gas from marginal wells
• Grants for specified energy property in lieu of tax credits
• Provisions related to alcohol used as fuel
• The energy efficient appliance credit
• The credit for energy-efficient improvements to existing homes
• The 30% investment tax credit for alternative vehicle refueling property

Disaster relief provisions

The following disaster relief provisions are extended through 2011.

• New York Liberty Zone tax-exempt bond financing
• Increased rehabilitation credit for structures in the Gulf Opportunity Zone
• Low-income housing credit rules for buildings in Gulf Opportunity Zones
• Tax-exempt bond financing for the Gulf Opportunity Zones
• Bonus depreciation deduction applicable to specified Gulf Opportunity Zone extension property

I hope this information is helpful. If you would like more details about these changes or any other aspect of the new law, please do not hesitate to call.

Keith A. Veres, CPA is a Principal with Hill, Barth & King LLC in the Fort Myers, Florida office.   Keith has worked as a CPA helping clients in Fort Myers, Cape Coral and other Southwest Florida communities for the last 8 years.  He has been with Hill, Barth & King LLC, a top 75 accounting firm, since 1991.  Keith can be contacted by phone at 239-482-5522 or email at kveres@hbkcpa.com.

The heart of the recently enacted “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” is a two-year extension of the Bush tax cuts. But what, exactly, are the Bush tax cuts? Here’s a primer:

Bush tax-cut legislation

The Bush tax cuts refer primarily to tax changes in two major pieces of legislation back in 2001 and 2003: the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs in beijing and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).

The 2001 legislation (EGTRRA) was a 10-year $1.35 billion tax cut package that was the largest tax cut since 1981. Key elements of EGTRRA included:

• A lowering of individual income tax rates from 15%, 28%, 31%, 36%, and 39.6% to 10%, 15%, 25%, 28%, 33%, and 35%.
• A doubling of the child tax credit from $500 to $1,000.
• A gradual reduction in estate taxes, culminating in a one-year repeal in 2010 (but reinstatement in 2011).

But the crucial element of the 2001 tax cuts, at least for current purposes, is that they were temporary, set to expire at the end of 2010 unless Congress acted to extend them.

The 2003 legislation (JGTRRA) accelerated certain tax changes passed in EGTRRA, but the centerpiece of the law was a cut in the top capital gains rate from 20% to 15% and a cut in the top individual rate on dividends from 35% to 15%. Under the 2003 legislation, the capital gains and dividends cuts were set to expire after 2008, but they were later extended for two additional years (until 2010).

So when people talk about the “Bush tax cuts,” they are referring, for the most part, to the provisions in the 2001 and 2003 Acts that lowered individual income tax rates and cut the top rates on capital gains and dividends.

New law extends lower rates for all taxpayers for two years

Over the past several years, a lot of political energy has been expended on the issue of whether the favorable individual income tax rates, which were set to expire at the end of 2010, should be extended for everyone, or for everyone except the “rich.”

The new law settles the issue by extending the lower rates for all taxpayers. Under the new law, the rates that have been in effect in recent years—10%, 15%, 25%, 28%, 33%, and 35%—will remain in place. However, the extension is only for two years—through 2012.

New law extends lower capital gains rates for two years

Capital gains, generally speaking, refers to the profits realized on sales of non-inventory assets. For individuals, capital gains are generally taxed at a preferential rate in comparison to ordinary income.

The amount of tax depends on both the investor’s tax bracket and how long the investment was held before being sold. Short-term capital gains on investments held for a year or less are taxed at the investor’s ordinary income tax rate. Long-term capital gains, which apply to assets held for more than one year, are taxed at a lower rate than short-term gains.

Since 2008, the tax rate on long-term capital gains has been 0% for individuals in the 10% and 15% income tax brackets, and 15% for everyone else. However, those rates were scheduled to expire at the end of 2010, as explained above, with the result that in 2011 the long-term capital gains tax rate would have risen to 20% (10% for taxpayers in the 15% tax bracket) if Congress had not acted.

The new legislation forestalls these increases by extending the 0% and 15% long-term capital gains tax rates for two years (through 2012).

New law extends lower rates for qualified dividends for two years

Since 2003, “qualified dividends” have been taxed at the same low tax rates that apply to long-term capital gains. For dividend income falling in the higher tax brackets, the rate is 15%. In the first two brackets (where ordinary income is taxed at 10% and 15% rates), the dividend rate is 0%.

To count as “qualified,” dividend-paying common stocks must be held for at least 61 continuous days before the ex-dividend date—the last purchase day for collecting the dividend. For preferred stock, the required holding period is 91 days before the ex-dividend date.

The low rates for qualified dividends, like the other Bush tax cuts, were scheduled to expire at the end of 2010. If Congress had not acted, beginning in 2011 taxes on dividends would have returned to the rates that were in effect before 2001, and all dividend income received in 2011 would have been taxed as ordinary income. Since the top income tax rate was scheduled to return to 39.6%, individuals could have paid as much as a 39.6% tax on dividends.

The new legislation prevents that from happening by continuing the tax regime in effect for qualified dividends (i.e., treatment as long-term capital gains, subject to a 0% tax rate for individuals in the 10% and 15% tax brackets and a 15% tax rate for other taxpayers) for two years—through 2012.

I hope this information is helpful. If you would like more details about the extension of the Bush tax cuts or any other aspect of the new law, please do not hesitate to call.

Elizabeth (Libby) M. Slater, CPA is a Principal with Hill, Barth & King LLC in the Fort Myers, Florida office.  Libby has worked as a CPA helping clients in Fort Myers, Cape Coral and other Southwest Florida communities for the past 10 years.  She has been with Hill, Barth & King LLC, a top 75 accounting firm, since 2002.  Libby can be contacted by phone at 239-482-5522 or lslater@hbkcpa.com.

United States exporters continue to benefit from powerful tax savings through the use of Interest Charge Domestic International Sales Corporations (IC-DISCs). By establishing an IC-DISC, the owners of a US operating company can save tax at the rate of up to 20% on commissions paid to the IC-DISC on qualifying foreign sales. Because Congress extended the preferential capital gains rates to qualifying dividends for another two years, the IC-DISC continues to be a viable tax saving tool.

Here’s How it Works
A United States exporter can pay income tax on ordinary operating profit at a rate as high as 35%. Once an IC-DISC is established, the operating company can pay to the IC-DISC a commission on foreign sales, which is generally equal to 4% of qualified export gross receipts or 50% of taxable income, whichever is greater. The commission is taken as a deduction by the operating company which in turn saves income tax at its bracket rate.  The IC-DISC does not pay tax on the income it receives. Rather, the IC-DISC distributes some or all of its profit to its shareholders as qualified dividends taxed to the shareholders at the preferential capital gains rate (as high as 15%).  Therefore, by establishing an IC-DISC, the owners of a US exporter may convert income which would normally be taxed at rates as high as 35% into qualified dividends taxed at rates as high as 15% (thus the 20% savings mentioned above).  It is important to note that only individuals, including shareholders of pass-through entities such as S corporations and limited liability companies, are entitled to the preferential capital gains rate on qualified dividend income.

The IC-DISC is not required to currently distribute all of its profit. For any amount not distributed, the shareholders will incur a small interest charge on the deferred income tax amount.  The IC-DISC tax regime gives U.S. exporters the ability to defer up to $10,000,000 of income per year almost entirely tax-free.  Because there are some costs involved in creating and maintaining an IC-DISC, history shows that in order to benefit from the creation of an IC-DISC, the operating company must generally have foreign sales of at least $500,000.  And because foreign sales cannot be counted until the IC-DISC is actually established, the sooner one establishes the IC-DISC the better.

Establishing and Operating the Entity
To receive the tax savings of an IC-DISC, it is first necessary to establish the entity. Tax benefits will only be applicable to income transferred to the IC-DISC after the entity is created. The IC-DISC is a domestic corporation that may be established in any state in the United States for which a valid IC-DISC election can be made on Form 4876-A.  All shareholders of the IC-DISC must sign form 4876-A.  Particular attention needs to be paid to the proper incorporation state, as some states offer additional tax savings over others.

To qualify as an IC-DISC for a taxable year, the IC-DISC must have, on every day of the year, at least $2,500 of capital and only one class of stock.  We recommend starting the company with $3,000 so as not to run afoul of this rule.

95% of the gross receipts must be qualified export receipts.  This criterion must be satisfied on an annual basis.  In addition, 95% of the entity’s assets must be qualified export assets.   This test must be satisfied on the last day of the entity’s tax year.  Qualified export assets include:

1. Customer accounts receivable
2. Commissions receivable (if paid within 60 days of year end)
3. Stock and securities in related foreign export corporations
4. Producer’s loans
5. Certain financial assets (PEFCO paper)
6. Cash not in excess of excess of working capital needs of the IC-DISC

The entity must not be a member of a controlled group of which a FSC (Foreign Sales Company) is also a member. The entity must also not be an ineligible corporation.  Examples include Personal Holding Company, a Financial Institution, and an Insurance Company operating under Subchapter L, Regulated Investment Company, Electing Small Business Corporation and China Trade Act Corporation among others.

Taxpayers should enlist the assistance of Hill, Barth & King LLC’s experienced tax practitioners to ensure that qualification requirements are met and maximum tax savings potential is achieved.

If you have any questions about the content above, please contact the HBK team member with whom you regularly work.

Joe Ledford is a Principal at Hill, Barth & King and leads the firm’s Manufacturing Group. Joe has over 23 years experience serving clients in the manufacturing industry.

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On December 6th President Obama announced an agreement with Congressional Republicans on a two-year extension of the Bush tax rates and the extension of several other tax cuts.  However, the House Democratic Caucus announced on December 9th that they would not support the tax cuts.  The sticking point for the House Democratic Caucus is the proposal to increase the estate tax exemption to $5 million and lower the estate and gift tax rate to 35%.  The political debate promises to continue and may well extend into January 2011 when the shift to a more Republican Congress will occur. The proposed Obama – GOP agreement includes the following:

• Extending the Income-Tax Rates for Two Years. The current income tax rates would be extended for two years, including the extension of the favorable 15% capital gain and dividend tax rate.
• Payroll Tax Cut. The agreement includes a one year payroll tax holiday by reducing the 6.2% social security rate to 4.2% for 2011 only.  The holiday would also apply to self-employed persons.  This payroll tax holiday would not reduce the employer’s payroll tax.
• Alternative Minimum Tax “Patch”. The AMT “patch” would increase the AMT exemption and allow certain personal credits, such as the child credit and education credits to reduce AMT.  Without this patch, an estimated 21 million households would see their taxes increase in 2011.
• Estate Tax Relief. The agreement would increase the estate tax exemption to $5 million and reduce the tax rate to 35% for decedents dying in 2011 and 2012.  This is a significant increase in the exemption and reduction in the tax rate.
• 100 Percent Expensing. The agreement allows ALL businesses a 100% bonus depreciation for qualified investments made between September 8, 2010 and the end of 2011.
• Research Tax Credit. The research tax credit had expired at the end of 2009.  The agreement would extend the research tax credit to 2010 and 2011.
• Itemized Deduction Limitation. The limitation on itemized deductions would be delayed for two years.  For higher income taxpayers, this limitation effectively increases the tax rate by more than one percentage point.
• Personal Exemption Phase-out. The phase-out of personal exemptions would be delayed two years for certain higher income taxpayers.  Over the last several years, this phase-out has been reduced.  Taxpayers who lose the benefit of their personal exemptions would have seen their taxes increase.
• Other Extenders. The state and local sales tax deduction, teacher’s classroom expense deduction, higher education tuition deduction and deduction for donations of conservative easements would be extended for two years.
• Marriage Penalty Relief. The plan would extend the marriage penalty relief for two years.
• Child Tax Credit. The child tax credit would stay at $1,000 per child and a portion would continue to be refundable for eligible taxpayers under the plan rather than being reduced to $500 per child and eliminating the refundable tax benefit.
• IRA Rollover to Charity. Before 2010, individuals over age 70-1/2 were able to contribute up to $100,000 directly from their IRA to charity.  This would be extended to rollovers made in 2010 and through January 31, 2011.
• Extension of Unemployment Benefits. The agreement extends emergency unemployment benefits at their current level for 13 months, preventing an estimated 7 million workers from losing their benefits as they search for jobs.
• Earned Income Tax Credit. The expanded Earned Income Tax Credit would be extended for two years.

We will continue to monitor progress of this legislation and keep you informed.  Please contact a member of HBK if you have any questions.

James M. (Jim) Rosa, CPA, PFS is the Principal in charge of the Tax Department at Hill, Barth & King LLC.  Jim has worked as a CPA helping clients in Fort Myers, Cape Coral and other Southwest Florida communities for the last 23 years. He has been with Hill, Barth & King LLC, a top 75 accounting firm, since 1986.

On November 26th the Internal Revenue Service issued Notice 2010-84, providing guidance under Section 402A(c)(4) relating to rollovers from Section 401(k) to designated Roth accounts in the same plan.

The guidance, which also generally applies to rollovers from Section 403(b) plans applies to contributions after Sept. 27, 2010. The guidance is in the form of questions and answers for sponsors of these plans, and provides details on when amendments to the plan are required, the tax consequences of in-plan Roth rollovers, and what exceptions are permitted.

Specific Guidance for 401(k) Roth Rollovers

• For a participant in a 401(k) plan who is still working, an in-plan Roth rollover from the participant’s pre-tax elective deferral account is permitted only if the participant has reached age 59, has died or become disabled, or receives a qualified reservist distribution as defined in Section 72(t)(2)(G)(iii).
• The 20 percent mandatory withholding requirement does not apply to an in-plan Roth direct rollover
• In-plan Roth direct rollovers are not treated as a distribution in situations involving plan loans, spousal annuities, participant consent before an immediate distribution of an accrued benefit in excess of $5,000, and in situations involving elimination of optional forms of benefit.
• A plan that offers in-plan Roth rollovers must include a description of this feature in the written explanation the plan provides pursuant to Section 402(f) to an individual receiving an eligible rollover distribution.
• A participant who elects an in-plan Roth rollover cannot later unwind the in-plan Roth rollover, as can be done with rollovers to Roth IRAs.
• The taxable amount of the in-plan Roth rollover must be included in the participant’s gross income.

The guidance also stated that a plan amendment providing for in-plan Roth rollovers in a 401(k) plan is not required to be adopted by the end of the 2010 plan year. Instead, the deadline for adopting a plan amendment is extended to the later of the last day of the plan year in which the amendment is effective or Dec. 31, 2011, provided that the amendment is effective as of the date the plan first operates in accordance with the amendment.

James M. (Jim) Rosa, CPA, PFS is the Principal in charge of the Tax Department at Hill, Barth & King LLC.  Jim has worked as a CPA helping clients in Fort Myers, Cape Coral and other Southwest Florida communities for the last 23 years. He has been with Hill, Barth & King LLC, a top 75 accounting firm, since 1986.

The recently enacted 2010 Small Business Jobs Act includes a wide-ranging assortment of tax breaks and incentives for small business, paid for with various revenue raisers. Here’s a brief overview of the tax changes in the new law.

Tax Breaks and Incentives

• Enhanced small business expensing (Section 179 expensing). In order to help small businesses quickly recover the cost of certain capital expenses, small business taxpayers can elect to write off the cost of these expenses in the year of acquisition in lieu of recovering these costs over time through depreciation. Under pre-2010 Small Business Jobs Act law, taxpayers could expense up to $250,000 of qualifying property—generally, machinery, equipment and certain software—placed in service in tax years beginning in 2010. This annual expensing limit was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 exceeded $800,000 (the investment ceiling). Under the new law, for tax years beginning in 2010 and 2011, the $250,000 limit is increased to $500,000 and the investment ceiling to $2,000,000.    The new law also makes certain real property eligible for expensing. For property placed in service in any tax year beginning in 2010 or 2011, the up-to-$500,000 of property expensed can include up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).

• 100% exclusion of gain from the sale of small business stock for qualifying stock acquired after date of enactment and before Jan. 1, 2011. Before the 2009 Recovery Act, individuals could exclude 50% of their gain on the sale of qualified small business stock (QSBS) held for at least five years (60% for certain empowerment zone businesses). To qualify, QSBS must meet a number of conditions (e.g., it must be stock of a corporation that has gross assets that don’t exceed $50 million, and the corporation must meet active business requirements). Under the 2009 Recovery Act, the percentage exclusion for gain on QSBS sold by an individual was increased to 75% for stock acquired after Feb. 17, 2009 and before Jan. 1, 2011. Under the new law, the amount of the exclusion is temporarily increased yet again, to 100% of the gain from the sale of qualifying small business stock that is acquired in 2010 after date of enactment and held for more than five years. In addition, the new law eliminates the alternative minimum tax (AMT) preference item attributable for that sale.
• General business credits of eligible small businesses for 2010 allowed to be carried back five years. Generally, a business’s unused general business credits can be carried back to offset taxes paid in the previous year, and the remaining amount can be carried forward for 20 years to offset future tax liabilities. Under the new law, for the first tax year of the taxpayer beginning in 2010, eligible small businesses can carry back unused general business credits for five years. Eligible small businesses consist of sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years.
• General business credits of eligible small businesses in 2010 aren’t subject to AMT. Under the AMT, taxpayers can generally only claim allowable general business credits against their regular tax liability, and only to the extent that their regular tax liability exceeds their AMT liability. A few credits, such as the credit for small business employee health insurance expenses, can be used to offset AMT liability. The new law allows eligible small businesses, as defined above, to use all types of general business credits to offset their AMT in tax years beginning in 2010.
• S corporation holding period. Generally, a C corporation converting to an S corporation must hold onto any appreciated assets for 10 years following its conversion or face a business-level tax imposed on the built-in gain at the highest corporate rate of 35%. This holding period is reduced where the 7th tax year in the holding period preceded the tax year beginning in 2009 or 2010. The 2010 Small Business Jobs Act temporarily shortens the holding period of assets subject to the built-in gains tax to 5 years if the 5th tax year in the holding period precedes the tax year beginning in 2011.
• Extension of 50% bonus first-year depreciation. Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008 or 2009 (2010 for certain property), by permitting the first-year write-off of 50% of the cost. The new law extends the first-year 50% write-off to apply to qualifying property placed in service in 2010 (2011 for certain property).
• Special rule for long-term contract accounting. The new law provides that in determining the percentage of completion under the percentage of completion method of accounting, bonus depreciation is not taken into account as a cost. This prevents the bonus depreciation from having the effect of accelerating income.
• Boosted deduction for start-up expenditures. The new law allows taxpayers to deduct up to $10,000 in trade or business start-up expenditures for 2010. The amount that a business can deduct is reduced by the amount by which startup expenditures exceed $60,000. Previously, the limit of these deductions was capped at $5,000, subject to a $50,000 phase-out threshold.
• Limitation on penalty for failure to disclose certain reportable transactions (including listed transactions) on a return. The new law limits the penalty to 75% of the decrease in tax resulting from the transaction. The minimum penalty is $10,000 for corporations and $5,000 for individuals (for failure to report a listed transaction, the maximum penalty is $200,000 and $100,000, respectively). These changes are retroactively effective to penalties assessed after Dec. 31, 2006.
• Deductibility of health insurance for the purpose of calculating self-employment tax. The new law allows business owners to deduct the cost of health insurance incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.
• Cell phones removed from listed property category. This means that cell phones can be deducted or depreciated like other business property, without onerous recordkeeping requirements.

Offsets (Revenue Raisers)

• Information reporting required for rental property expense payments. For payments made after Dec. 31, 2010, the new law requires persons receiving rental income from real property to file information returns with IRS and service providers reporting payments of $600 or more during the tax year for rental property expenses. Exceptions are provided for individuals renting their principal residences on a temporary basis (including active members of the military), taxpayers whose rental income doesn’t exceed an IRS-determined minimal amount, and those for whom the reporting requirement would create a hardship (under IRS regs).
• Increased information return penalties. Effective for information returns required to be filed after Dec. 31, 2010.
• Application of continuous levy to tax liabilities of certain federal contractors. For levies issued after date of enactment, the new law allows IRS to issue levies before a collection due process (CDP) hearing on Federal tax liabilities of Federal contractors (taxpayers would have an opportunity for a CDP hearing within a reasonable time after a levy is issued).
• Allow participants in governmental 457 plans to treat elective deferrals as Roth contributions. For tax years beginning after Dec. 31, 2010, the new law will allow retirement savings plans sponsored by state and local governments (governmental 457(b) plans) to include designated Roth accounts. Contributions to Roth accounts are made on an after-tax basis, but distributions of both principal and earnings are generally tax-free.
• Allow rollovers from elective deferral plans to designated Roth accounts. The new law allows 401(k), 403(b), and governmental 457(b) plans to permit participants to roll their pre-tax account balances into a designated Roth account. The amount of the rollover will be includible in taxable income except to the extent it is the return of after-tax contributions. If the rollover is made in 2010, the participant can elect to pay the tax in 2011 and 2012. Plans will be able to allow these rollovers immediately as of date of enactment.
• Crude tall oil (a waste by-product of the paper manufacturing process) is excluded from eligibility for the cellulosic biofuel producer credit. The new law limits eligibility for the tax credit to fuels that are not highly corrosive (i.e., with an acid number of 25 or less), effective for fuels sold or used after Dec. 31, 2009.
• Nonqualified annuity contracts. The new law permits holders of nonqualified annuities (annuity contracts held outside of a qualified retirement plan or IRA) to elect to receive part of the contract in the form of a stream of annuity payments, leaving the remainder of the contract to accumulate income on a tax-deferred basis.
• Guarantee fees. Amounts received directly or indirectly for guarantees of indebtedness of a U.S. payor issued after date of enactment are sourced, like interest, in the U.S. As a result, amounts paid by U.S. taxpayers to foreign persons will generally be subject to U.S. withholding tax.

Please keep in mind that these are just highlights of the most important changes in the new law. If you would like more details about any aspect of the new legislation, please do not hesitate to call our Fort Myers Hill, Barth and King CPA office in Southwest Florida 239-482-5522.

Every tax-exempt organization (other than churches) is now required to file a Form 990 series tax return, including the smallest organizations.  This requirement began in 2007.  The IRS will revoke the tax-exempt status of any organization that fails to meet its annual filing requirement for three consecutive years.

The IRS has offered tax-exempt organizations the opportunity to salvage their tax-exempt status by filing the appropriate Form 990 for the 2007, 2008 and 2009 if filed by October 15, 2010.  A list of tax-exempt organizations that are at risk of losing their tax-exempt status can be found at this IRS site:  http://www.irs.gov/charities/article/0,,id=225889,00.html

If an organization loses its tax-exempt status, then it is required to re-apply by filing Form 1023 and paying the fees and costs of gaining IRS approval of their exempt status.

The amount of loss permitted to be deducted by an S corporation shareholder is generally limited to the shareholder’s basis in corporate stock and/or debt.  Losses in excess of a shareholder’s basis in stock and/or debt is suspended and carried forward indefinitely to be used at such time as additional basis is created.  Thus, if a shareholder expects a loss for the current year, but anticipates not having sufficient basis to deduct the loss, one or more of the following techniques may be utilized to increase basis before year-end.

I.  Techniques for Creating Additional Basis:

• Cash Contribution: A shareholder may increase stock basis by contributing additional capital to the corporation before the last day of the corporation’s taxable year. This technique is generally used, however, only if all shareholders plan to contribute cash on a pro-rata basis.
• Stock Purchase: Stock basis is also increased by purchasing additional corporate stock prior to year-end, either from other shareholders or directly from the corporation.
• Cash Loan: A shareholder may increase basis by lending money directly to the S corporation. The loan will be respected so long as the shareholder is placed in the economic position of being a creditor.
• Back-to-Back Loan: A shareholder may personally borrow money and lend the proceeds directly to the S corporation. This back-to-back loan will generally result in a basis increase for the shareholder.
• Property Contribution: A contribution of property by a shareholder to an S corporation will create additional stock basis equal the basis of the property in the shareholder’s hands. A contribution of appreciated property will generally be tax-free to the shareholder so long as all shareholders contributing on that day own at least 80% of the corporate stock immediately after the contribution.
• Purchase of Stock or Debt for Shareholder’s Note: A shareholder should receive cost basis for S corporation stock or debt obligations purchased from a third party for the shareholder’s note.
• Payment of Corporate Debt: The payment of corporate debt guaranteed by the shareholder will increase the shareholder’s basis. Through subrogation, the corporation becomes indebted to the shareholder, and the result is the same as if the shareholder had loaned cash to the corporation, which in turn paid its own debt.
• Shareholder Loan Substitution: A shareholder’s basis is increased by the substitution of a shareholder’s own note for a corporate obligation for which the shareholder is a guarantor, so long as the corporation is released from the obligation and the creditor looks solely to the shareholder for satisfaction of the debt.
• Shareholder Assumption of Corporate Debt: Basis may be increased when a shareholder assumes a corporate debt and the corporation is released by the creditor.

II. Techniques Not Resulting in Additional Basis:

• Guarantee of Corporate Debt: It is important to note that the S corporation rules differ significantly from their partnership counterpart in that corporate debts to third parties do not increase a shareholder’s stock basis.  Thus, if a shareholder guarantees a corporate debt, the shareholder’s stock basis will not presently increase as a result the mere guarantee.
• Related-Party Loan: Loans to an S corporation from individuals or entities related to the shareholder generally do not result in a shareholder basis increase.

Mark R. Giallonardo, JD, LLM is a Principal in HbK’s Tax Department and currently supports HbK’s Florida offices. Mark has been developing tax planning strategies for owner-operated companies for more than 20 years and may be reached at (239) 263-2111 or mgiallonardo@hbkcpa.com.

Distributions from your S Corporation are generally tax free to the extent that you have basis in your stock.  However, when your C Corporation elected S status, all of its accumulated earnings and profits (E&P) were frozen.  Any distributions you take from E&P accrued when your business was a C Corporation are taxed as a dividend.

Under current tax law, qualified dividends are taxed at a maximum rate of 15%.  Starting in 2011, dividends will be taxed at the same rate as ordinary income.  The top marginal rate on ordinary income for 2011 will be 39.6% (unless new legislation is passed extending the current lower rate).  Given the expected increase to the tax rate on dividends, the cost of distributing your E&P may substantially increase.

Distributions are typically deemed to be made from accumulated E&P when they exceed the corporation’s accumulated adjustments account (AAA).  A corporation’s AAA generally consists of its net income or loss for all S Corporation years less any distributions that were sourced from AAA.  However, an S Corporation can elect, with the consent of all its shareholders, to distribute its earnings and profits before AAA.

If the corporation does not have sufficient cash on hand to distribute all of its E&P, it can eliminate E&P by distributing its own corporate notes, or by making a deemed dividend election.  A deemed dividend is a hypothetical distribution of E&P to all shareholders that is treated as being immediately contributed back to the corporation.  As a result, the stockholder pays tax on the deemed distribution and receives basis for the contribution.  The additional created basis can be used by the taxpayer to take losses otherwise suspended by basis limitations, or offset gain on the ultimate sale of the S Corporation Stock.

With the expected increase in tax on dividends, we suggest that you consider distributing your E&P in 2010.   There are many relevant considerations when deciding to distribute E&P.  Please contact us to discuss if it will be advantageous for you to distribute your E&P in 2010.

Tax Department – Hill, Barth & King For more information about how these changes relate to your unique circumstances, please call our Fort Myers office at 239-482-5522.