Offshore compliance

In 2010, the government will continue its follow-up work in pursuing disclosures made by UBS AG, as well as by individuals who, in 2009, disclosed names of advisors and other facilitators in record numbers. According to IRS Commissioner Doug Shulman, an “unprecedented” number of offshore account disclosures have been made. In addition, the IRS will make inroads in its multi-plank offshore tax reform plan, publishing (and enforcing) loophole-closing guidance such as recent temporary regulations that tightened restrictions on corporate inversion transactions.

Net operating losses

Net operating losses took center stage in 2009 as the economic downturn continued to generate NOLs that were useless to many businesses as immediate cash generators under the regular two year carryback provisions. The five-year 2008 NOL carryback for small businesses of the American Recovery and Reinvestment Act of 2009 and the modified five-year 2008 or 2009 NOL carryback option under the Worker, Homeownership, and Business Assistance Act of 2009 created much IRS guidance on elections and refund claims. Since the modified five-year election between 2008 and 2009 need not be made until the extended due dates for 2009 tax returns (although the business pressure to claim cash refunds immediately remains intense), NOLs - how to compute them, how to generate them and how to claim them –are guaranteed to continue to be a hot focal point in 2010, as will the intense business pressure to claim cash refunds on the election as soon as possible.

Tax gap

As part of its effort to close the “tax gap” - the difference between what taxpayers owe and what is collected - the IRS (with encouragement from Capitol Hill) set into motion in 2009 an array of programs and initiatives that will expand in 2010. In addition to the offshore compliance initiative, IRS efforts will include a new employment tax audit program, plans to more tightly regulate tax return preparers, development of rules for credit card reporting on merchants, and laying the groundwork for implementing basis reporting by stockbrokers, as well as continuing the use of penalty provisions to create a virtual second tier of tax liability for missteps in determining when a tax strategy “crosses the line.”

Cancellation of indebtedness income

Although the recession has put a damper on acquiring real income, there continues to be no lack of cancellation of indebtedness (COD) income - nor issues over how exceptions to COD income should operate. Guidance regarding certain COD income continues to be a work in progress and the Treasury Department has promised rules on certain COD income in early 2010.

Homebuyer tax credit

The first-time homebuyer tax credit’s latest iteration extends through April 30, 2010 (or closings before July 1 on contracts executed before May 1). The credit has certainly been one of the most publicized tax breaks in recent years. As a result, many homeowners and real estate agents have acted first and then called on their tax professional to “confirm and collect” on the credit. Nevertheless, after-the-fact strategies are available for both 2009 and 2010 purchases. This is especially true in connection with the long-time homebuyer portion of the credit under which income, residency, and the election to claim on the prior year’s return offer some flexibility.

Change of accounting

In 2009, the IRS made significant revisions to its required procedures for taxpayers to obtain automatic IRS consent to a change in accounting method. A new revenue procedure added a number of methods for which taxpayers may obtain automatic consent and modified the rules that must be followed for obtaining automatic consent to an accounting method change. More companies are looking at accounting methods as part of their tax planning to enhance cash flow. Based on that evidence, filings of accounting method changes should continue into 2010 at a record pace.

AFRs and asset values at historical lows

These days, it is difficult to have a below-market loan on which interest must be imputed considering that the rate charged would need to be below the current applicable federal rate (AFR). Low asset valuation also creates a particularly advantageous environment in which to convert from a corporation to a partnership, with taxable gain fixed in many cases at its lowest point in years. In addition to these factors, add the deadline created by the probability of higher taxes starting in 2011. 2010 strategies to take advantage of low interest rates and low values cannot be overemphasized.

Legislation

The tax implications of health care reform, corporate tax reform, international tax reform, and a rise in the higher individual income tax rates (from the current 33 and 35 percent brackets to 36 and 39.6 percent, respectively, as well as higher capital gains rates) will all impact on long-term tax strategies undertaken in 2010 - so will those issues continuing to arise from the bumper crop of 2008 and 2009 tax legislation we have just gone through. Without any new case law, Treasury regulations or IRS initiatives in 2010 (of which there are sure to be plenty of surprises), tax legislation will keep individuals and businesses busy.

Estate tax

Effective for decedents dying on or after January 1, 2010, the traditional federal estate tax with its stepped-up basis at death rules no longer apply. New carryover basis at death rules apply. In addition, the generation skipping transfer (GST) tax does not apply to generation skipping transfers made after December 31, 2009. The federal gift tax, however, does continue, albeit in modified form from 2009.

All of these changes were set in motion by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which abolished the federal estate tax for 2010 but only for 2010. At that time, supporters expected the temporary elimination of the federal estate tax to be made permanent before 2010. They lacked sufficient support in Congress to make that happen. During 2009, many lawmakers in Congress proposed an extension of the 2009 estate tax rules with a $3.5 million exclusion ($7 million for married couples) and a top tax rate of 45 percent. In fact, the House passed such a bill. The Senate, however, did not approve the House bill before the end of 2009. Consequently, the rules put in place in 2001 have come into effect in 2010.

What does this mean? The flux in the estate tax adds to uncertainty in estate planning. However, Congress is expected to remedy the situation shortly. Congress will enact retroactive legislation in January or early in 2010 to extend the 2009 estate tax regime with its $3.5 million exclusion and 45 percent top tax rate for 2010. Carryover basis at death is expected to be short-lived.

Please contact our office if you have any questions about your estate plan. Congress’ inaction at the end of 2009 has caused confusion. We will review your plan and make sure you are well prepared for Congress’ expected extension of the 2009 estate tax treatment.

AMT

Another area of uncertainty is the AMT. The AMT was designed to ensure that very wealthy individuals did not evade federal taxes. However, Congress did not index the AMT for inflation. Consequently, the AMT has encroached on more middle income taxpayers, especially two income couples in high tax states.

In recent years, Congress has passed an AMT “patch” to help middle income taxpayers avoid the AMT. The patch provides higher exemption amounts and other relief. Congress enacted a patch for 2009 but recessed for the December holidays before passing a patch for 2010. One stumbling block is the cost of a patch and disagreements in the House and Senate whether the cost should be offset by revenue raisers. We will keep you updated of developments.

Health care

House and Senate Democrats are drafting a final health care reform bill for passage by both chambers, possibly in January. In December, the House and Senate passed similar health care reform bills but with important differences in revenue raisers. The Senate passed, by a vote of 60-39, the Patient Protection and Affordable Care Act late on Christmas Eve. The chief revenue raiser in the House bill is a proposed surtax on higher income individuals (individuals with incomes over $200,000 and families with incomes over $250,000). The Senate rejected the House surtax and instead approved a new excise tax on high-dollar insurance plans. Other revenue raisers under negotiation include new limits on health flexible spending arrangements and health savings accounts, a new excise tax on indoor tanning, an additional Medicare tax for higher-income individuals, and more.

The final conference bill is expected to require employers to provide health insurance to their employees.  Employers that do not will be subject to an additional tax with an exception for small employers. The final bill could classify a small employer as one with 50 or fewer full time employees or use a lower threshold; for example, 25 full-time employees. The conference bill is also expected to provide tax credits to help small businesses purchase health insurance for their employees. Individuals without coverage generally would be liable for an additional tax unless covered by Medicare or other qualified coverage.

The conference bill will change the fundamental landscape of health care in the U.S. The tax-related provisions in themselves are monumental. To complicate matters, some provisions go into force immediately and some are delayed for up to three years. Please contact our office if you have any questions about this important legislation.

COBRA

COBRA continuation coverage provides eligible individuals the opportunity to continue their employer-provided health insurance coverage after a layoff or other qualified event. However, COBRA requires individuals to 100 percent self-pay their premiums. The cost makes COBRA out of reach for many individuals.

In the American Recovery and Reinvestment Act of 2009, Congress created a temporary subsidy to help eligible individuals pay for COBRA coverage. Eligible individuals pay 35 percent of the premium cost and the former employer pays 65 percent, which it recovers through a payroll tax credit. Under the 2009 Recovery Act, eligibility for COBRA premium assistance expired after December 31, 2009.

Congress provided a temporary extension in the Fiscal Year (FY) 2010 Defense Appropriations Bill. This bill extends eligibility for COBRA premium assistance through February 28, 2010.

COBRA premium assistance is limited to eligible individuals (and certain beneficiaries) who are involuntarily terminated from employment. Generally, this means a lay-off or furlough but other separations from employment may also qualify. If you have experienced a separation from employment, please contact our office. You may qualify for COBRA premium assistance.

Jobs bill

Just before recessing for the December holidays, the House approved the Jobs for Main Street Act. The House jobs bill would extend eligibility for COBRA premium assistance through June 30, 2010. The House bill would also extend unemployment benefits and make the child tax credit available to more taxpayers.

The Senate did not take up the House jobs bill in December. Democrats in the Senate are drafting their own jobs bill, the details of which are expected to be revealed early this year. The Senate bill may include some tax incentives for businesses, such as an extension of bonus depreciation and enhanced Code Sec. 179 expensing. These incentives expired after December 31, 2009.

More bills

On January 1, 2010, the state and local sales tax deduction, the higher education tuition deduction and many other tax deductions and credits expired. These popular incentives are temporary and are known as extenders because Congress usually extends that every year. The House voted to extend these provisions through 2010 but the Senate recessed in December without taking up the House bill. The extenders bill could be put on the back burner until spring.

Congress is also debating whether to impose tougher rules on the reporting of foreign bank accounts owned by U.S. taxpayers. In December, the House passed a bill that would impose new penalties on taxpayers that fail to disclose certain foreign accounts on their tax returns. The House bill would also encourage foreign banks to enter into agreements with the IRS to voluntarily disclose the existence of certain accounts. The Senate did not vote on the House bill before its December recess. The provisions are popular in the Senate, which in the past has promised to crack down on so-called tax havens and Americans who hide money and assets offshore.

Planning

As 2010 unfolds, we’ll have a clearer picture of when these and other tax bills will be enacted. In the meantime, please contact our office if you have any questions about the bills we have discussed or any others.