IRS to Implement New 2% 'Recapture Tax' in Two-Month Payroll Tax Cut Extension

Payroll Tax Cut Temporarily Extended into 2012 (IR-2011-124):

Under the terms negotiated by Congress, the law also includes a new “recapture” provision, which applies only to those employees who receive more than $18,350 in wages during the two-month period (the Social Security wage base for 2012 is $110,100, and $18,350 represents two months of the full-year amount). This provision imposes an additional income tax on these higher-income employees in an amount equal to 2% of the amount of wages they receive during the two-month period in excess of $18,350 (and not greater than $110,100). 

This additional recapture tax is an add-on to income tax liability that the employee would otherwise pay for 2012 and is not subject to reduction by credits or deductions. The recapture tax would be payable in 2013 when the employee files his or her income tax return for the 2012 tax year. With the possibility of a full-year extension of the payroll tax cut being discussed for 2012, the IRS will closely monitor the situation in case future legislation changes the recapture provision.

The IRS will issue additional guidance as needed to implement the provisions of this new two-month extension, including revised employment tax forms and instructions and information for employees who may be subject to the new “recapture” provision. For most employers, the quarterly employment tax return for the quarter ending March 31, 2012, is due April 30, 2012.

Medical Deduction Allowed for Breast Pumps

As a recent parent, I thought this information is important to share:

Medical Deduction for Breast Pumps: Breast pumps and supplies that assist lactation are considered to be medical care under IRC Sec. 213(d) because, like obstetric care, they affect a structure or function of a woman's body. If the remaining requirements of IRC Sec. 213(a) are met, expenses paid for breast pumps and supplies that assist lactation are deductible medical expenses. IRS Ann. 2011-14, 2011-9 IRB 532 .

IRS Offers Amnesty Program to Reclassify 1099 Contractors as Employees

IRS Voluntary Settlement Program: A new Voluntary Classification Settlement Program (VCSP) allows taxpayers to reclassify workers as employees for future tax periods with limited federal employment tax liability for the past nonemployee treatment. To be eligible, the taxpayer must (1) have consistently treated the workers in the past as nonemployees; (2) have filed all required Form 1099's for the workers for the previous three years; and (3) not be under audit by the IRS, the Dept. of Labor, or a state agency. [For more on the VCSP, see NTA-783 (10/4/11).] The IRS has posted a series of FAQs, which clarify that participating taxpayers will pay 10% of the employment taxes, calculated under the reduced rates of IRC Sec. 3509(a) , for the compensation paid to the workers being reclassified during the most recent tax year. But, they will not be liable for interest or penalties, and the IRS will not share information about them with other agencies.

Expiring Business and Individual Tax Provisions for 2011

Business Tax Provisions: According to a Congressional Research Service report dated 12/1/11, the following will expire on 12/31/11: (1) the research and development and the work opportunity tax credits; (2) the enhanced charitable deductions for contributions of food, books, and computer technology; (3) the special S corporation built-in gains tax suspension period; and (4) the 15-year recovery period for leasehold improvements, restaurant property, and retail improvements. Furthermore, the 100% bonus depreciation deduction will be scaled back to 50% in 2012, and the Section 179 deduction limit will fall from $500,000 this year to an inflation-adjusted $139,000 in 2012. 

Individual Tax Provisions: According to the same Congressional Research Service report, the following deductions will expire on 12/31/11: (1) elementary and secondary school teacher expenses, (2) state and local sales taxes, (3) mortgage insurance premiums, and (4) qualified tuition and related expenses. The 2010 Tax Relief Act allowed a taxpayer's nonrefundable personal credits to offset regular tax (net of any allowable foreign tax credit) and AMT for 2011, and also authorized a reduction in the employee's share of the Social Security payroll tax to 4.2% for 2011. Congress may extend the payroll tax break, and presumably will pass another (one year) AMT patch. Finally, the tax-free treatment of distributions from IRAs for charitable purposes will expire at the end of 2011. 

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Tax Benefits fo 529 College Savings Plans

The state-tax savings for families who invest in Section 529 college savings plans depend very much on where they live. WSJ.com provides a state-by-state breakdown:

For all the risks that come with investing in 529 college savings plans in a period of market tumult, investors in most states have one certainty: that they'll receive state tax benefits for their contributions to their home state's plan. But those tax savings are much richer in some states than in others, as these figures for one hypothetical family show. 

Investors make roughly a third of their contributions to the state-sponsored 529 plans during the fourth quarter of each year, and most of that money comes rushing in during December as families look ahead to tax season, says Paul Curley, director of college-savings research at Financial Research Corp. in Boston. 

Most states offer a tax deduction. For one child, a married couple's annual write-off is capped at levels ranging from $250 (in Maine) to $26,000 (in Pennsylvania), says Joe Hurley, founder of Savingforcollege.com, which tracks 529 plans. Four states—Colorado, New Mexico, South Carolina and West Virginia—don't have annual deduction limits, but cap total deductions over time for each child. The limit can be as much as $318,000 (in South Carolina). 

For parents saving for two children's college education, the annual deduction caps in 10 states double. In Kansas, for example, it's $6,000 for one child or $12,000 for two. 

Instead of deductions, three states—Indiana, Utah and Vermont—give tax credits for a portion of 529-plan contributions. 

Sixteen states don't offer any tax benefits. To be sure, a few are states that don't have a personal income tax, such as Florida and Texas. But several of those states, including California, Hawaii and Minnesota, have high tax rates. 

Beyond tax benefits, some states are offering free cash in their 529 plans. While most have income limits, some give money just for starting a 529 plan. For example, Maine and Rhode Island offer $500 and $100, respectively, for parents who start a 529 plan before their child's first birthday. 

One drawback: Because the tax benefits are typically limited to plans sponsored by the taxpayer's state, that can stop people from choosing a different 529 plan with better-performing investments, says Deborah Fox, a San Diego-based financial planner and founder of Fox College Funding. The exceptions are Arizona, Kansas, Maine, Pennsylvania and Missouri, where residents can choose a 529 plan from any state while still receiving their own state's deduction.

IRS Releases Information on Estate and Gift Taxes

On November 21, 2011, the IRS released its most recent publication on the topic of federal estate and gift taxes. The pub can be accessed at this link by clicking here. This updates the version released on December 14, 2009.

Most gifts are not subject to tax. Likewise, most estates are not subject to estate tax. 

If you die during 2011, you can pass estate tax free up to $5,000,000. For those dying in 2012, add another $120,000. Gifts in amounts up to those figures may also be made tax free. 

An extra tax free gift is permitted during any given year of up to $13,000.

For more information regarding our estate planning services, please visit http://pmaadvisors.com/estate_and_gift.php 

IRS Issues Guidance for 2012 Milage Rate

The IRS has issued guidance (Notice 2012-01) providing the 2012 standard mileage rates for taxpayers to use in determining the deductible costs of operating a car for business, charitable, medical, or moving expense purposes.

The rate for the business use of an automobile is 55.5 cents per mile, the rate for the charitable use of an automobile is 14 cents per mile, and the rate for using an automobile for medical or moving purposes is 23 cents per mile. The guidance also provides the amount taxpayers must use in calculating a basis reduction for depreciation taken under the business standard mileage rate and provides the maximum standard automobile cost that may be used in calculating the allowance under a fixed and variable rate plan. The guidance is effective for applicable expenses, allowances, or reimbursements that are paid or incurred after December 31, 2011.

The IRS requested comments in previous guidance (Notice 2010-88) on whether taxpayers should be allowed to use the business standard mileage rate for cars used in fleet operations. After considering one comment, and in light of the limited number of comments, the IRS won't change the current limitation on fleet operations.

Tax Increase Proposals Bubbling Up for California Ballot

Fox & Hound blog summarizes the five tax increase initiatives potentially making it to California's 2012 ballot:

• Governor Jerry Brown's (D) proposal to raise the sales tax by a half-cent and raise income taxes on high earners. Top rate would be 12.3 percent, up from the current 10.3 percent.
• Teachers' union "Courage Campaign" proposal to impose higher income taxes on top earners. Top rate would be 15.3 percent.
• Tom Steyer proposal to adopt single sales factor, taxing multistate companies based on their share of sales in California as opposed to their share of property or employees in the state.
• "Think Long" proposal that broadens the sales tax, lowers rates, and raises a large amount of revenue. Services would be taxed at 5.5%, taxes on goods would drop a half-cent, the top income tax rate would be 8.5 percent, and the corporate rate would drop from 8.84 percent to 7 percent.
• Molly Munger proposal to raise taxes across-the-board.

Much of this of course assumes that the problem is insufficient taxation. But California is not a low-tax state. Back in 2009 I pulled together some numbers. They might have changed slightly but the points are still relevant:

California is a high tax state. They are sixth highest in state-local tax burden as a percentage of state income. The sales tax is the highest state rate in the country even before the recent 1% increase, and numerous county rates keep them in the top 5 of state-local combined rates. Their individual income tax top rate is the second highest in the country, eclipsed only recently by Hawaii, and is sixth highest in the country in terms of collections. The corporate income tax is one of the highest in the country and sixth highest per capita in collections. Even the gas tax is the third highest in the countryand the state Lottery has the fifth highest implicit tax rate in the country. Only on property taxes is California "low": 28th highest in collections per capita.

The Tax Foundation's annual State Business Tax Climate Index evaluates tax structures for business-friendliness, and the 2009 edition ranked California 48th, or third worst. The individual income tax ranked second to last, corporate income tax ranked 45th, and sales tax ranked 43rd. (Property tax structure was a bright spot, ranking 15th in the country.)

With these comparisons, and the enormous growth in state spending, it's hard to say that California's problem is insufficient taxation. Ultimately, California voters need to decide whether they are willing to pay the taxes to fund the programs they want. The tax system prevents this from happening now, due to the state's overreliance on taxing capital gains, corporations, and high-income earners. Most Californians rightly think additional spending is a free lunch that they won't have to pay for.

More on California here.

Will we have Bonus Depreciation in 2012?

Yet another incentive set to expire at the end of 2011 is 100 percent bonus depreciation. Projects are eligible for that form of accelerated depreciation if they are placed in service by December 31. It is unclear whether the provision will be extended, but Gimigliano said the possibility remains, pointing to President Obama's call to extend the provision as well as Republicans' belief that bonus depreciation is "the holy grail" of tax incentives.

Nonetheless, accelerated depreciation in general could be eliminated under comprehensive tax reform, and it remains uncertain how effective bonus depreciation has been in encouraging growth, he said.

FTB Offers Clarification on Deductibility of Property Taxes

Legal Division Guidance 2011-12-01
(Real Property Tax Deductions)

Q: Does a real property tax need to be ad valorem in order to be deductible as an itemized deduction?

A: Yes. A real property tax needs to be ad valorem in order to be deductible under Internal Revenue Code section 164, to which California law is fully conformed.

The Internal Revenue Service's (IRS) well established official position, to which California law conforms, is that the only real property taxes deductible as an itemized deduction are those that are assessed on the basis of the value of the property, i.e., ad valorem. The federal position, supported by federal legal analyses (General Counsel Memoranda 37927 (1979); see also General Counsel Memorandum 36466 (1975)), rulings (Rev. Rul. 80-121, 1980-1 C.B. 44 (1980); see also Priv. Ltr. Rul. 8033022, May 20, 1980), regulation (Treas. Reg. sec. 1.164-4(a)), and case law (Sandy Lake Road Limited Partnership v. Commissioner (1997) TC Memo 1997-295), unquestionably limits the deduction for real property taxes to those that are assessed on the basis of the value of the property. Finally, the 2010 Instructions for Schedule A (Form 1040) provide, in part, as follows -- "Line 6 Real Estate taxes include taxes (state, local or foreign) you paid on real estate you own that was not used for business, but only if the taxes are based on the assessed value of the property assessed." (See also Publication 17 (2010), at p. 146, and Publication 530 (2010), at p. 2.)

Further, taxpayers may not deduct assessments (whether assessed on an ad valorem basis or otherwise) for local benefits (such as street, sidewalk, and other like improvements) of a kind tending to increase the value of the property assessed that are imposed because of and measured by some benefit inuring directly to the property against which the assessment is levied. These nondeductible amounts may be added to the basis of the property in accordance with Internal Revenue Code section 1016 and the applicable regulations. Federal law does, however, provide that the portion of the above-discussed assessments for local benefits that are made for the purpose of maintenance or repair, or for the purpose of meeting interest charges with respect to those local benefits, are deductible. Federal regulations provide that the burden is on the taxpayer to show that a portion of the amount assessed is allocable to these purposes. If the allocation cannot be made, the federal regulations provide that none of the amount so paid is deductible.

Finally, a 2003 IRS Office of Chief Counsel Memorandum provides the apparent basis for a conclusion that assessments may be deductible as real property taxes even though they are not imposed on an ad valorem basis. However, this was an internal memorandum drafted by a local IRS attorney which is inconsistent with published federal guidance, should not be considered written advice, and, according to conversations with IRS Office of the Chief Counsel, does not reflect the official position of the IRS. This internal memorandum has never been released nor made available by the IRS and the conclusion expressed in it has never appeared in any IRS ruling, written advice, publication or guidance.