Tax-exempt-status Scandal, The IRS Fix

We are all aware of the IRS scandal and how they categorically scrutinized Code Sec. 501(c)(4) applications for Tea Party and other conservative groups.  After IRS Commissioner Steven Miller resigned, President Obama appointed Daniel Werfel.  The new commissioner’s first priority was to do a 30-day review of IRS and it’s involvement in the scandal.

Well, the 30-days are up and a new report, titled “Charting a Path Forward at the IRS: Initial Assessment and Plan of Action” is out.  Among many other things, the report provides ways that the IRS can take immediate steps to improve the process for approving tax-exempt applications.

For our clients, the most important of the improvements is a new process whereby certain taxpayers whose applications for 501(c)(4) tax exempt status has been identified for potentially inappropriate campaign intervention and have been backlogged for more than 120 days have the option of obtaining an approval if they self-certify that no more than 40% of their expenditures and voluntary person-hours will go toward political campaign intervention activities and that at least 60% of their expenditures and voluntary person-hours will go toward promoting social welfare.

There is no way to know for sure if the IRS’s new procedures will prevent inappropriate delays for tax-exempt-status exemptions, but at the very least they have admitted to the issues are have put a plan in place to fix them.

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Parts of DOMA Struck Down

The Supreme Court struck down the section of DOMA (Defense of Marriage Act) that required same-sex spouses to be treated as unmarried for purposes of filing their Federal Income Tax Return.

What does this mean for tax professionals?  For one, it means that we won’t have to file those crazy tax returns for legally married same-sex partners in community property states.  The ones where income had to be combined and then split 50/50.

It also means that the taxpayers should consider filing amended returns to claim potential refunds for the following changes.

-A joint tax return can be filed.

-The ability to use the marital deduction for unlimited transfers free of gift tax.

-A surviving spouse can stretch out distributions from a qualified retirement plan or IRA after the death of the other spouse.

-The unused estate exclusion can pass to the surviving spouse.

Theses changes could make a difference in some of your clients tax liabilities.  We are always here to help if you have any questions.

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Are Cost Segregation Studies Dead?

Just for a quick review, cost segregation studies are reports put together by structural engineers and tax accounts to reclassify components of section 1250 real property into personal property. In doing so, owners in real estate can depreciate the segregated components over a shorter period (5, 7 or 15 years) as opposed to 27.5 years for residential and 39 years for commercial. The result can be huge tax savings over a short period of time.

Prior case-law has determined that if a component falls into one of the following three categories, taking into account all of the facts, than it can be segregated and depreciated as personal property.

1. Accessory to a business – courts have determined when property arguably serves a function specific to a taxpayer’s business or an item that specifically serves a piece of equipment is not serving the building in which that equipment is placed and is thus considered personal property.

2. Permanence – the following factors determine whether or not property is permanent

-whether the property is capable of being moved and whether it had in fact been       moved;
-Whether the property is designed or constructed to remain permanently in place;
-whether there are circumstances which tend to show that the property may or will have to be moved;
-whether removal of the property would be a substantial and time-consuming job;
-the damage the property would sustain upon removal; and
-the manner of “affixation” of the property to the land.

3. Ornamentation – tangible personal property includes special lighting, false balconies and other exterior ornamentation that have no more than an incidental relationship to the operation or maintenance of a building.

A recent Tax Court decision (TC Memo 2012-67) puts the kabosh on many items that had been typically segregated. If nothing else, the one thing that we should take from this case is how the Court defined a building’s “shell”. When looking at the purpose of a particular item, do we look at the items relation to a generic shell building or do we look at it in relation to the specific kind of building it is (whether it is an apartment building, commercial manufacturing, hotel, or office space). The Court decided that you look to the operation or maintenance of the specific type of building, in this case, an apartment building.

The following is a list of items that had been typically segregated as tangible personal property, but in this case were considered structural components.

-Sinks and piping
-Laundry-room drain
-Recessed lights
-Paddle fans
-Light Fixtures
-General use outlets
-Millwork
-Interior Windows
-Mirrors

Are cost segregation studies dead? Not necessarily. In fact this case confirms the legality of them. But, especially in the case of apartment buildings, this case does limit their effectiveness by reducing the number of components that can be segregated as tangible personal property.

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IRS, “Fresh Start”, Oxymoron?

The IRS just announced it’s “Fresh Start” program. I know what you are thinking, because I thought the same thing.  IRS and “Fresh Start” are two phrases that don’t exactly go together.  But in a continued effort to seem friendlier, they have rolled out a new program.  Below are some of the highlights.

Failure-to-pay Penalties Waved for Unemployed

If you meet the following qualifications, you will get a six-month grace period on failure-to-pay penalties.

  • Employee who was unemployed for at least 30 consecutive days between January 1, 2011 and April 17, 2012, or
  • Self-employed with a 25% or higher reduction in business income in 2011.
  • Income does not exceed $200,000 if filing joint, or $100,000 for single or head of household.
  • 2011 tax due does not exceed $50,000.

To get the penalty relief, a form 1127A will need to be filed.

Streamlined Installment Agreements

“Fresh Start” will allow taxpayers with up to $50,000 of tax due to apply for simpler installement agreement.  Payments will have to be paid over 72 months and financial statements will not have to be supplied to the IRS.

To apply, fill out forms 433-A or 433-F.

Offers in Compromise

For taxpayers that can’t afford to make intallement payments, the IRS is offering a streamlined Offer in Compromise program that can settle the tax liabilities for less than the full amount owed.

Do these changes help give the IRS a friendlier face, you be the judge.  At a minimum, it is good to see that the IRS is trying to be understanding of the tough economic situation that many people are finding themselves in.

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Supreme Court Considers Patient Protection and Affordable Care Act.

However you feel about the Patient Protection and Affordable Care Act (PPACA), you can’t help but be fascinated by seeing the checks and balances of the U.S. government at work. Or maybe that’s just me.

For those of you who have been working nonstop during tax season, I’ll give you a quick summary of what the Supreme Court hearings were about.

Whether the Anti-Injunction Act (AIA) prevents the court from considering the case.  How I understand the AIA is that a person can’t fight a tax in court that hasn’t been paid yet.  The argument is whether or not the Supreme Court can hear a case when no tax has been accessed or paid, and also whether or not the penalty for not purchasing health insurance is a penalty or a tax.

Individual Mandate- The question is, did Congress overstep its power by including requirement to purchase health insurance or pay a penalty?  Also, is the penalty a tax, or a penalty.

PPACA Viability- If the Supreme Court strikes down the individual mandate, does that mean that the entire act is null and void? Or does it mean that the rest of the PPACA can remain without the mandate?

For a tax guru like myself it’s been a little like the Super Bowl of tax law. Unfortunately we will not know the results of the hearings until summer.  Late June at the earliest. Until then, we will all be waiting with anticipation or at least I know I will.

Did you make it till the end? Gold star for you. Your sixth grade goverment teacher would be proud.

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S-Corporations and “Reasonable Compensation”

“What is reasonable compensation?” It’s a question that gives even the most seasoned tax preparer heart burn.   The goal has typically been to minimize the taxpayer’s employment taxes by keeping the sharehold’s wages as low as possible.  It would be nice if all S-Corp earnings could be distributed as return of capital but, for some reason the IRS keeps getting in our way.

More recently, the IRS put the brakes on a CPA firm in the case Watson, P.C. v. U.S.  In this instance, the Court of Appeals for the Eighth Circuit agreed with the District Courts decision to recharacterize an additional $67,044 from profit distributions to wages. At first look, the case appears to be a big loss for the professional services industry. But at a second look, it’s not all bad news. The court accepted a methodology for determining the shareholders wages that we could safley applied to some of our clients.

In determining reasonable compensation, the court allowed a calculation that primarily relied on a “Management of an Accounting Practice Compensation Survey” conducted by the AICPA. The calculation approximated the salary of a director of a similar firm size and in a comparable region and came up with $70,000.  Then, it compared the billing rates of a director and an owner and came up with a 33% difference.  This difference was then applied to the $70,000 and after making a downward adjustment for fringe benefits, the court accepted a reasonable compensation of $91,044.

This case sets a presidence for determining a “reasonable compensation” for professional service providers with a simular fact pattern. The method is summarized as follows.

  1. Look at several compensation surveys and studies for your particular industry and determine the average salary for the position directly under the owner.
  2. Divide the increase in billable rate between owner and position under the owner by the owners rate.
  3. Multiply (1 + rate rate in step 2) times the salary in step 1.
  4. Finally, subtract any fringe benefits from the amount calculated in step 3.

Keep in mind that your particular fact pattern will be different from the one in the case described above.  We believe that the above calculation provides a good guide, but make sure to use good professional judgement.

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28% Corporate Tax Rate.

“The President’s Framework for Business Tax Reform” is a document recently released by the Treasury Department.  It outlines the President’s plan for a 28% corporate tax rate, for simplify corporate tax rules and to reduce the tax burden for small business.

The following are some of the highlights of the document.  Keep in mind that none of these reforms have been introduced as bill in the House or Senate and there is a chance that they may never come to pass. It does however give us a hint to what the White House will be pushing for.

  • Plans to reduce the top corporate tax rate to 28%, and reduce top rate for manufacturing income to 25%.
  • Change the present depreciation schedule, this could mean longer asset lives or a change in MACRS
  • Increase the simpler tax research credit calculation from 14% to 17% and make the credit permanent.
  • Allow small businesses to expense up to $1 million in fixed asset purchases.
  • Increase the number of businesses that can use the cash method of accounting.
  • Double the deduction for start-up costs from $5,000 to $10,000.

It is always difficult to predict what will happen with Congress. If the corporate tax rate is in fact reduced, it could offer some tax planning opportunities. With the possibility of individual tax rates increasing, in some cases shareholders may be better served by owning a C-Corporation instead of a S-Corporation. Only time will tell.

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Don’t Always Trust What You Read on the Internet!

I know what you’re going to say, “If I can’t trust what I read on the Internet, why should I continue reading this blog”? The answer is simple.  You should continue reading because you will find a lot of helpful information. The Internet is full of great fact and figures that can help us find answers to many of our tax research questions. The problem is that there is also old information, misstated facts, and even information that is just plain wrong. The question you should be asking is how do we filter out the good information from the bad?

Case in point.  There is an IRS memo floating around that says an off duty police officer getting paid by a school district to direct traffic wouldn’t be subject to self-employment tax on those earnings.

There are a few potential problems with the IRS Memo and whenever we are doing tax research on the web we should be asking ourselves the following question.  (1) Do we know the information is current? (2) Do we know that the information is accurate? (3) Do we know the information is relevent?(4) Does the information set any legal precedents to my clients fact pattern?  I’m not suggesting that you not use the Internet or this blog to find information or to stay up to date on current events.  I’m suggesting that you be careful with the information that you find and to answer the above questions before relying on the information.

Oh, and as far as the memo, I can’t find it anywhere in our extensive tax library.

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