CPA With a View

IRS Rules on Life Insurance Notification Requirement

Most people believe life insurance proceeds are tax-free.  Most of the time they are.  However, there are certain situations where they are not, one of which is included in Internal Revenue Code(IRC) section 101(j)(1).  It provides that for an employer-owned life insurance policy issued after August 17, 2006, the amount of death benefits excluded from gross income won’t exceed the sum of the premiums and other amounts paid by the employer (i.e., policyholder) for the contract.  In other words, life insurance proceeds in excess of these amounts is taxable income. 

However, Code Sec. 101(j)(2) provides several exceptions to Code Sec. 101(j)(1)’s general rule, if certain notice and consent requirements are met.

These require that the employee must (1) be notified in writing that the policyholder (i.e., the employer) intends to insure the employee’s life and of the maximum face amount for which the employee could be insured at the time the contract was issued; (2) provide written consent to being insured under the contract and to such coverage potentially continuing after the insured terminates employment; and (3) be informed in writing that the policyholder will be a  beneficiary of any proceeds payable upon the employee’s death.

IRS Notice 2009-48 provides that for certain employer-owned life insurance contracts that inadvertently fail to comply with the notice and consent requirements, the IRS won’t challenge the applicability of an exception under Code Sec. 101(j)(2) based on the inadvertent failure provided that:

1. The policyholder made a good faith effort to satisfy those requirements;
2. The failure to satisfy the requirements was inadvertent; and
3. The failure to obtain the requisite notice and consent was discovered and corrected no later than the due date of the tax return for the policyholder’s tax year in which the employer-owned life insurance contract was issued.

PLR 201217017 indicates, under the facts included in the ruling and summarized below, the notice and consent requirements were met.

The facts were as follows:  A corporation and certain employee stockholders executed an agreement that the corporation will purchase each employee-stockholder’s interest upon their death or termination of employment.  Under the agreement, the corporation will obtain life insurance on the life of each employee-stockholder of which it is the owner and beneficiary.  Each employee-stockholder had to complete an application, which indicated the amount of coverage being obtained and that the corporation was to be the owner and beneficiary, as part of the purchase process.  The corporation did not meet the notice and consent requirements before purchasing these contracts.  However, it did provide and receive the notice and consent forms later, but not before the due date of its U.S. income tax return for the year the policies were executed.

The IRS determined that although the corporation didn’t obtain from each employee-stockholder separate documentation meeting the notice and consent requirements, its documentation as a whole was sufficient to satisfy the Code Sec. 101(j)(4) requirements before the contracts were issued.

Specifically, through the agreement and/or policy application, each employee-stockholder:

• Was notified in writing that the corporation intended to insure his life;
• Consented to being insured by signing both the agreement and application;
• Had written notification of the maximum face amount for which he could be insured at the time the contract was issued;
• Consented to such coverage potentially continuing after termination of employment by signing the agreement; and
• Was informed in writing that Taxpayer will be a beneficiary of any proceeds payable upon his death.

This is good news for taxpayers who have not complied with requirements but have a fact pattern similar to PLR 201217017. Although a PLR cannot be used as support for a taxpayer position, it does represent the IRS’s current view.

If a company has a large policy for which they did not execute the proper notice and consent forms, they could take the following action:

• Review the file and document that you complied in a manner similar to PLR 201217017 and consider getting a private letter ruling, if the policy is large enough
• Replace the policy with a new one and timely comply with the requirements for the new policy.

I recommend every business that has employer-owed life insurance issued after August 17, 2006, review their files to make sure the notice and consent requirements are met.

Family in Florida

We made it.  Seven days in Florida with eight grandchildren at the condo. What a blast - swimming, beach, boat, dolphins, manatee and grilling. Oh, yeah - reading tax articles, too. A couple of days rest and I am ready to do it again on the river in Stillwater, Minnesota. Man, am I lucky! I love serving my clients and my family. Nothing is better.

Local Lodging Expense Rules

The IRS recently issued proposed reliance regulations explaining the treatment of local lodging expenses incurred by businesses.

Generally, lodging expenses incurred for business-related, out-of-town travel is fully deductible by a business and is not treated as compensation to the employee receiving the lodging.  Pretty simple rule.

What if a business pays for local lodging?  Under current guidance it may or may not be a deductible business expense, based on the fact and circumstances. Generally, the determination is based on the business vs. personal reason for the lodging. 

The new proposed regulations provide guidance relating to the treatment of such lodging expense. This guidance is similar to, but not exactly the same as, Notice 2007-47 guidance. Once final, the regulations would supersede the notice. For those of you who like to read regulations, like me, the proposed regulations are 1.162-31 and 1.262-1.

Under the proposed rules, local lodging will be treated as a deductible business expense, and not treated as compensation for the applicable employee, if the following four conditions exist:

1-it is necessary to participate in a bona fide business meeting, conference, training or other business function.

2-the lodging does not exceed five days and does not occur more than once per quarter for such employee, owner, or partner.

3-the employee, owner, or partner is required to utilize the lodging.

4-there is no significant element of personal pleasure or recreation of benefit from the lodging, and it is not lavish or extravagant.

The regulations have several examples of what does and does not qualify. Basically, a legitimate business purpose vs. an employee’s convenience purpose is the theme.  For example, a firm-wide offsite training program, or an on-call overnight for business emergencies at a hotel are two situations that qualify. Avoiding a long commute or temporary lodging while looking for a permanent home are two situations that do not qualify.

Even though these are proposed regulations, they can be relied upon by taxpayers now and in any tax year where the statute of limitations hasn't expired. This could be a refund opportunity, if 1) employers treated certain local lodging as compensation that would qualify as a deductible local lodging business expense; or 2) self-employed personnel and partnerships treated qualifying local lodging as a non-deductible personal expense.  Check with your accountant or payroll administrator.

Uncle Joe's Birthday

My eight (nine including the one my daughter is having in October) grandchildren celebrated Uncle Joe's birthday Sunday.  They love Uncle Joe. They really love Uncle Joe's gum he hands out. I think the party was more for them and less for Joe. 

Next week they join us for 7 days in Florida. It will be crazy. We are going down a couple of days in advance to get ready. Really to avoid the flight. Those of you flying from Minneapolis to Fort Myers on Delta the morning of Monday, May 7th, change your flight. Just kidding, bring your ear plugs or head set.

Internal Revenue Section 263: Treatment of Tangible Property Expenditures

This has been a slow year for tax legislation and changes. Even though there is all kinds of talk regarding tax reform, loop hole closers, job creating incentives and various changes to the existing rules. It appears to be political rhetoric with no real chance of changes in this 2012 election year. Makes for a boring year for a person who loves to review new tax legislation and determine what taxpayers should do. Other than the extension of the payroll tax holiday to the end of 2012, the only other major development in 2012 so far was probably the issuance of hundreds of pages of a new regulation under Internal Revenue Section 263.

Section 263 deals with the treatment of expenditures relating to the cost to acquire, improve, enhance, and repair tangible property. The regulations include numerous rules, examples and safe harbors, and incorporate many previous IRS positions and court cases.

One of the segments includes rules for the treatment of rotable and temporary spare parts; reflected in Regulation 163-3T. The rotable and temporary parts rules apply to taxpayers with fleets or groups of assets where the taxpayer removes parts, repairs/refurbishes them, and reinstalls them. Examples of industries impacted are trucking, airline, equipment leasing, construction and certain manufacturing processes.

There are four methods for handling expenditures to refurbish rotable and temporary spare parts in the regulation. All four methods are currently used by many taxpayers; a short summary of each follows:

#1-Defer Deduction Method. Deduct the cost to purchase the rotable and temporary spare part in the year the part is completely disposed of. Cost to repair and refurbish the part is deducted in the year incurred, or capitalized based on the general rules relating to property repairs and betterments.

#2-Optional Method. Deduct the cost of the part in the year it is installed on a unit of property. When the part is removed from the unit of property, include the value in income. Then add this value plus the cost to remove, repair and refurbish to determine the parts basis. When the part is again installed on a unit of property, or if completely disposed of, deduct the basis plus the cost to install.

#3-Apply the de minims rule of Reg. 1.263-2T(g). This rule allows the taxpayer to deduct in aggregate the costs of applicable materials and supplies up to the greater of 1% of gross receipts or 2% of total depreciation and amortization. To use this method, the taxpayer must use it on its applicable financial statements (basically audited statements). If the total costs exceed these amounts, one can elect to ignore some of the parts for this rule and use one of the other methods for the excess.

#4-Capitalize and Depreciate. Treat the cost of rotable and temporary spare parts as an asset subject to depreciation.  This includes election bonus depreciation and Section 179 expensing if the property qualifies for either. Treat repair and refurbishments as deductible or capitalized based on the general rules relating to property repairs and betterments.

If a taxpayer wants to change the method they currently use for rotable and temporary spare parts, they can use the automatic accounting method change procedures recently announced by the IRS.

The Boat "Start Me Up" is in the river

My boat was launched last week. I am pumped to get back out on the water to relax and read a bunch of tax articles. Nothing better.

I decided to create this post from the boat, even though it is 40 degrees. Many more will be created and posted from the boat over the next 5 months.  A few may be created in May on "Miss You" the deck boat in Florida. A little warmer and aqua blue.

I can't wait to get on the water. Stones music will be blasting too.  

April 17 Deadline

The April 17^th deadline is coming up fast.

The end of my favorite time of the year - Tax Season. This year is a special year, ending on the 17^th instead of the 15^th, due to a Washington D.C. holiday and the 15^th being on a weekend.  Also, because it was a leap year, we had the longest tax season possible.  Awesome. 

Planning season starts right after April 17^th.  Don’t wait until the fall.  Review your returns, meet with your advisor, and start determining what you can do to achieve your tax planning goals in 2012.

2012 is an odd tax year.  It is an election year, and if nothing happens, the 2013 tax rules will be substantially different than 2012. 

Some of the potential changes in 2013 include:

• Higher individual and pass-through entity tax rates for all levels of income

• Lower AMT exemptions

• Higher capital gains tax rates

• Phase-outs of itemized and dependent deductions

• Higher estate and gift tax rates

• The elimination of many credits

 

Also, the additional Medicare tax on investment income begins in 2013 as a result of the health care law.

There are many planning ideas and opportunities that can be implemented in 2012, depending on your business and personal goals.

Easter before April 15^th

It is always tough for a tax preparer when Easter is the weekend close to April 15^th.  This is another one of those years. We have so much to do, it is hard to relax at home.  Client needs are so important to us.

But, I am for sure spending the afternoon with my 9 grandchildren, which includes the new one due in October.   I call them the 9 little dependent exemptions.  Pat, Cami, Max, Kiera, Jimmy, Vinny, Jack, Frankie, and the new dude coming.

We will have a great Easter egg hunt at the boathouse and a family dinner that gets out of control.

 

 

Tax Law Extension and Tax Reform Talk

The budget recently introduced in the U.S. House of Representatives has some interesting tax proposals. 

#1-There is a proposal to extend all the tax provisions set to expire 12/31/11 and some that already have expired.

#2- There is a proposal for comprehensive budget-neutral tax reform including the following major reform points: 

• Consolidate the current six individual income tax brackets into just two brackets of 10 and 25 percent.
• Reduce the corporate rate to 25 percent.
• Repeal the Alternative Minimum Tax.
• Broaden the tax base to maintain revenue growth at a level consistent with current tax policy and at a share of the economy consistent with historical norms of 18 to 10 percent in the following decades.

I can’t imagine anything gets passed this year; but it is interesting to see the proposals being introduced. Tax reform will come, it is just a matter of when.

Tax Season

Nothing fun to report on the personal side, except that I had a fantastic weekend working with my team on tax returns. Awesome Saturday and Sunday. Can’t beat it. I call tax season the play-offs for accountants.

No Legislation Action, But Lots of Compliance

There is really not much going on with tax legislation. Political posturing is the current game. Introducing legislation or making announcements with regards to tax reform is a daily occurrence, but in an election year nothing will get much traction. On the other hand, 2013 will be exciting if you are interested in tax law. I sure am.

On the compliance front, it is another story. Tax preparers are working long hours and weekends to meet clients’ timeline needs.

I am a fan of extending tax returns, when a client is okay with it.

Statistically, extended tax returns get audited less than other returns. Mistakes may occur while the return is being rushed to completion.  However, no matter what time of year, a good preparer takes the time necessary to review the tax return for errors and more importantly, to generate planning ideas. That is where the value is in hiring a tax preparer.  I always tell my clients, “if I were you, I would much rather have me working on your return in May, than the second week of April.”

If one ends up owing money on an extended return, the IRS will assess interest and a penalty if the amount exceeds 10% of the total tax. The interest rate is 3%, not a big deal. The same rate applies to the underpayment of estimated tax penalty/interest. Extending the return allows one to take their time and make better estimates later in the year without being hit with large penalties.

Check with your accountant and get their take on extending. 

Finally, page through your return when it is complete. Ask the preparer about anything that looks unusual or have them walk you through it.  If you don’t understand the return or don’t have time to review it with the preparer, most returns have two-year comparisons. Check that out for sure.

Anniversary

I celebrated my 34th wedding anniversary Sunday with my awesome wife, Jan. She is the nicest and most beautiful person on the planet. She is my home run, my grand slam.

Ok enough of that, back to working on a multiple K-1 tax return, my second love.

President Obama’s Proposal for Corporate Tax Reform

The Administration released its outline for business tax reform last week.  A 22-page joint Treasury/White House release.   

The plan proposes a reduction in the top corporate tax rate from 35 to 28 percent.  Manufacturing businesses would be allowed a 25-percent rate via a manufacturing deduction.  In addition, certain advanced manufacturing activities would receive a larger rate reduction.  Pass-through entities would not benefit from the rate reduction.

To offset the cost of the lower corporate rates, the proposal would repeal LIFO accounting, accelerating depreciation and tax carried interest as ordinary income; reduce the deductibility of certain types of interest payments; impose a new minimum tax on foreign income; and tax large-pass-through entities as C-Corporations.  Several other business tax deductions would be modified or repealed. 

The proposal also includes provisions to allow expensing up to $1 million in certain asset purchases; to allow cash accounting for companies under $10 million in gross receipts; and to expand the small business tax credit under health care reform. 

At first blush, this appears to be a good thing for C-Corporations.  Other entities may consider changing to a corporation; however, long-term that could be a disadvantage if the assets of the entity are sold and the entity is liquidated or as excess earnings are distributed to the owners. This is C-Corporation double taxation.

There is no indication individual rates that apply to pass-through entities will be reduced for S-Corporations, partnerships/LLCs and Sole Proprietors. In fact, as it was presented, and in combination with the Admistration's proposed change to taxes in 2013, (see my post on Feb. 20, 2012) pass-through entities would be subject to the reduced deductions above and higher individual tax rates.

It sure doesn’t look like there is any consideration given to closely held businesses in the proposed tax reform. If these and other proposed provisions become law, every closely held business will need to review their tax structure. I believe hybrid structures will begin to surface to avoid getting double taxed and/or be subject to high individual rates.

Tax Season Update

We are in the middle of tax and audit season. It is really fun. I am so lucky to have a career that has such an intense and exciting time of year. Serving clients is so rewarding and makes it all worth it.

I spent the weekend in Florida, working and playing a bit on the deck boat. Good time, but was happy to get back to the team and continue caring for and serving clients.

Payroll Tax Relief Extension

The payroll tax relief extension was approved by Congress and signed by the President.  Click here to view a summary of the law.

Frank is here

My new grandson Frank James was born on Feb. 17. Frankie is awesome. A beautiful 8.5 pound baby boy. Another tax accountant in the family. He received his first tax code on Feb. 18.

That makes 8 grandchildren; all under seven years old. What a blast. We were lucky enough to keep Frankie’s two sisters (Cami and Kiera) and his brother (Vinny) at our house while mom was delivering the new guy.

What a fantastic weekend.  Nothing better than family.

The Green Book is Out

The U.S. Treasury Department released the “General Explanation of the Administration’s Fiscal Year 2013 Revenue Proposal” (The Green Book-because it has a green cover). It is 200 pages of the Obama Administration’s proposal for changes in the tax law in 2012 and beyond.

A few of the proposals are highlighted below: 

• A tax credit for increased wages paid to employees.
• 100% bonus depreciation for 2012.
• Payroll tax reduction extension to the end of 2012.
• For years after 2013, repeal LIFO and lower-of-cost-or-market inventory valuation methods. LIFO reserves would be picked up in income over a 10-year period.
• Tax LLC and Partnership “profits interests” issued for services as ordinary income.
• Provides a variety of tax incentives for generating business and jobs in the U.S. and tax disincentives for transferring business and jobs outside the U.S.

Individual Tax Proposals beginning in 2013:

• Increase the highest-two tax brackets of 33% and 35% to 36% and 39.6%, starting when income equals $250,000 for a joint return and $200,000 on a single taxpayer’s return.
• Tax a portion of dividends at ordinary tax rates for high-income taxpayers.
• Increase long-term capital gains from 15% to 20% and add the Buffet Tax explained in my last BLOG post.
• Start itemized deduction and exemption phase-outs for high-income taxpayers.
• Limit the rate in which itemized deductions reduce taxes to 28% of the deduction for certain high-income taxpayers.

Estate and gift tax proposals:

• For taxpayers who die after 2012, the estate and gift tax rules would basically be what was in effect in 2009.  A 45% tax rate with a $3,500,000 Estate Tax and Generation-Skipping Transfer (GST) Tax  exclusion amount per person. Portability among spouses of the exclusion amount would still apply. The lifetime gift tax exclusion would be limited to $1,000,000. Currently, the exclusion amount for Estates, GST and gifts is $5,000,000 and tax rate is 35%.
• GRATs (grantor retained annuity trusts) would be required to have at least a 10-year term and generate some value in the remainder interest.
• New rules would greatly reduce the estate tax benefit of using Grantor Trusts, by coordinating the income tax and estate treatment of such trusts. This is a big deal.

The Green Book is truly a wish list by the Administration. Whether any or all of the items get enacted, will rest with the make-up and direction of Congress, after the election.  

We will see. It will be fun being involved in the process.

Fair Share Tax

The Paying Fair Share Act of 2012 (S-2059) was introduced to the Senate and referred to the Finance Committee by U.S. Senator Sheldon Whitehouse (D-RI) on February 1, 2012.

The goal of the bill is to reduce the deficit by imposing a minimum effective tax rate for high-income taxpayers.

The bill would add Section 59B to the Internal Revenue Code.  If it becomes law, it would be effective beginning in 2013.  It applies to individuals with adjusted gross income in excess of $1,000,000.  This includes all income, for example S-corporation or LLC pass-through income, and capital gains, including gains from the sale of one’s business.

The tax is basically a flat tax of 30% of total adjusted gross income less charitable contributions. The tax would be offset by certain self-employment taxes and payroll taxes incurred by the taxpayer, including the special Medicare taxes that become effective in 2013, pursuant to the 2009 Health Care Bill.

The tax is structured as a second additional minimum tax. The additional tax is the excess of the total tax under Section 59B; less the taxpayer’s regular tax and additional alternative minimum tax (AMT); and less certain credits and payroll taxes mentioned above. The additional amount is phased in for taxpayers with adjusted gross income between one and two million dollars. The full additional amount applies if one’s adjusted gross income is $2,000,000 or more.

For example, assume a taxpayer sold his/her business in 2013 and recognized a $3,000,000 capital gain and also had $400,000 of other ordinary income. In addition, assume itemized deductions for taxes, home interest and charitable deductions ($200,000) equaled $400,000.  In this example, the person’s regular and AMT tax would be approximately $475,000. Under the the Paying Fair Share Act there would be additional taxes of $365,000, calculated as follows:

$3,000,000 less $200,000 (charitable contribution) times 30% equals $840,000. Reducing the $840,000 by the regular and AMT tax of $475,000 results in the Section 59B fair share tax of $365,000.

What a hit for a small business owner who took major risks and created jobs over the years. You judge the fairness. You know my thoughts.

The good news is the S-Corporation Association is aware of the bill.  The Association understands how it impacts small business, especially flow-through entities like LLCs and S-Corporations, and will be working to educate Congress on the impact of this provision.

Also, based on my conversations with contacts in Washington, D.C., it doesn't seem likely this type of legislation could pass with the current make-up of Congress and the fact that it is an election year.  It truly seems to be a political play.  That's too bad.

More to come.

Caribbean

My wife and friends are back from the sailing trip in the Caribbean. Sounds like I should have joined them, relaxing and sailing for a week.  At least I got to walk my dog in the freezing cold in Minnesota four times a day.  There is always next year.