The Payroll Tax Two-Month Holiday (Continued)

Here is the IRS announcement last Friday (December 23) about the two-month payroll tax holiday.

IR-2011-124, Dec. 23, 2011

WASHINGTON — Nearly 160 million workers will benefit from the extension of the educed payroll tax rate that has been in effect for 2011. The Temporary Payroll Tax Cut Continuation Act of 2011 temporarily extends the two percentage point payroll tax cut for employees, continuing the reduction of their Social Security tax withholding rate from 6.2 percent to 4.2 percent of wages paid through Feb. 29, 2012. This reduced Social Security withholding will have no effect on employees’ future Social Security benefits.

Employers should implement the new payroll tax rate as soon as possible in 2012 but not later than Jan. 31, 2012. For any Social Security tax over-withheld during January, employers should make an offsetting adjustment in workers’ pay as soon as possible but not later than March 31, 2012.

Employers and payroll companies will handle the withholding changes, so workers should not need to take any additional action.

OBSERVATION: Kruse & Crawford CPAs is one of the “employers and payroll companies” that will handle the withholding changes. So, we have a payroll tax holiday that does not last all the months in a quarter. Apparently Congress realized that the servicers may not have been prepared for this, so Congress decreed that we have an additional month to get it right.

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 percent 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.

OBSERVATION: If you think about this, there is a certain amount of sense. The FICA wage base for 2012 is $110,100. Since the holiday is for less than the entire year, Congress felt it necessary to prorate the wage base, as otherwise one could “game” the system. One would do that by taking his/her first $110,100 of payroll in the first two months of the year. That would require noncommon fact patterns, but it could and would happen. I know that we – as tax planners - would have taken advantage of it where possible for our clients.

OBSERVATION: How is the tax preparer to know if someone received more than $18,350 of payroll in the first two months? Will there be yet another “box” on the 2012 W-2 for this?

COMMENT: I suspect that Congress will extend the holiday for the full year, and the clawback provision will be deleted at that time.

Retirement and Health Plan Limits for 2012

Here are the 2012 contribution limits for the following retirement plans:

·         401(k) limits increase from $16,500 to $17,000. The same limit applies to 403(b) and  457 plans.

·         IRA limits remain the same at $5,000

·         SEP limits increase from $49,000 to $50,000

·         SIMPLE limits remain the same at $11,500

·         Catch-up contributions remain the same

o   $5,500 for 401(k), 403(b) and 457 plans

o   $2,500 for SIMPLEs

o   $1,000 for IRAs

Here are the new limits for high deductible health plans:

·         Health Savings Accounts

o   Individual contribution limits increase from $3,050 to $3,100

o   Family contribution limits increase from $6,150 to $6,250

·         High Deductible Health Plans

o   Minimum out-of-pocket limits remain the same at $1,200 and $2,400 for individuals and families, respectively

o   Maximum out-of-pocket limits increase from $5,950 to $6,050 for individuals and from $11,900 to $12,100 for families

·         Flexible Spending Accounts

o   No federal limits for 2012 but your employer may designate a limit

o   Federal limit of $2,500 beginning in 2013

The New 1099 For Credit Card Reporting

It’s been over a year since we talked about the new IRS Form 1099-K. This was part of the Housing Assistance Act of 2008, and it was to – at least partially - “offset” the cost of the first homebuyer’s credit.

This is Congress passing laws, mind you, so the reporting did not apply until sales made on or after January 1, 2011. This means you may be receiving this new 1099 during the 2012 tax filing season.

Let’s talk about the “why” for this form.

Say that you are a vendor on eBay or Amazon. It used to be that eBay or Amazon did not have to send you a tax reporting form. Why would they? They did not pay you; rather, a number of buyers using eBay or Amazon paid you. Let’s use another example. Let’s say that you use PayPal or Google Checkout on your website. As a third party payment network, they did not have to report the transaction. Why would they? They did not pay you; they just processed the transaction whereby some else paid you.

This caught the attention of a Congress that has all but gone through our sofa cushions for the next thing to tax.

So, let’s say that you are selling stuff on eBay or otherwise accepting payment through PayPal. Will you receive a 1099-K? It depends. If you have sales of less than $20,000 a year or fewer than 200 transactions per year, then 1099-K reporting will not be necessary.

The look and feel of Form 1099-K is very similar to Form 1099-INT used by banks to report interest and Form 1099-DIV used to report dividends.

Are we are expecting problems with the new 1099-Ks? Oh yes. The 1099-K will include sales tax and shipping charges, for example. The 1099-K will report the gross amount of payment card and third-party network payments, so one has to be careful with the reporting of refunds. The IRS is already talking about segregating receipts on different lines of the tax forms so that they can match to the 1099-Ks. When you consider that the IRS has a computer-matching program that generates notices without the intercession of human eyes, this may well be a disaster waiting to happen.

FATCA Filing Season

This past Saturday the IRS released the final version of Form 8938, Statement of Specified Foreign Financial Assets, and on Monday released the instructions. This form is in response to FATCA, and represents a further tightening of reporting requirements for foreign income and assets.

What do you have to report? The easy answer is overseas bank accounts and securities accounts. It gets a little trickier with hedge and private equity funds. It will also pick up your loan to Grandma Gretchen. This is reporting for foreign assets, not just foreign bank accounts.

Here are the dollar amounts if you live in the U.S.:

·         If single or married filing separately

o   $50,000 on the last day of the year or $75,000 at any time during the year

·         If married filing jointly

o   $100,000 on the last day of the year or $150,000 at any time during the year

Here are the dollar amounts if you live overseas:

·         If single or married filing separately

o   $200,000 on the last day of the year or $300,000 at any time during the year

·         If married filing jointly

o   $400,000 on the last day of the year or $600,000 at any time during the year

Are the dollar thresholds ridiculously low? Of course.

Form 8938 does not replace the FBAR (TD-F 90.22.1), which is filed separately from your income tax return and is due in Detroit by June 30^th every year.

Eventually the IRS intends for Form 8938 to also apply to domestic entities, but for right now the IRS is limiting its reach to only individuals.

My take?

We used to expect that the IRS would not assess penalties unless tax was due. That in turn meant that we did not overly fear information returns - that is, returns with numbers on them but no line that said “tax due.” There were some exceptions, such as W-2s and 1099s, of course; otherwise, this rule of thumb worked reasonably well.

No longer. There are penalties to these forms even if there are no taxes due or all taxes have been reported.  Congress has taken umbrage on Americans having assets overseas. I am at a loss why a married couple (say my wife and I) would draw Congress’ attention solely by having $100,000 overseas. That is not enough money to get a starring role next to Michael Douglas in Wall Street II. It is not enough money to get me invited to a White House dinner, and certainly not enough to join a presidential vacation.

If you are even close to the dollar limits, please see a professional. Do not fool around with this, as the penalties can be severe.

How Could I Live Without Filing Taxes?

Status of the Payroll Tax Cut

The Senate today approved a two-month extension of the employee Social Security tax cut.

You will recall that the employee FICA rate was cut from 7.65 to 5.65 percent, but only for 2011. The FICA tax is composed of two parts: a social security tax of 6.2 percent and a Medicare tax of 1.45 percent. Together they add-up to 7.65 percent and are referred to as FICA. The social security portion was reduced in 2011 by 2 points – from 6.2 to 4.2 percent. It is this portion that we are discussing.

A number of economic and financial commentators have pointed out that 2011 economic growth has been roughly equivalent to this payroll tax cut.  Add to the mix an upcoming election year and the issue of extending the cut has become quite electric.

The bill will next go to the House, where there has been some activism to cut the tax for all of 2012, not just two months.

The President has indicated his intention to sign the bill when it arrives.

My take?

Payroll is reported to the IRS on a quarterly basis. The first quarter is January through March. Accountants and payroll services now have to subdivide the quarter to determine which tax rate to apply to the payroll. Would it have been that difficult - especially since nothing has been accomplished anyway – to have the payroll tax cut run the full quarter?

The Honeymooners Income Tax Episode

The IRS Wants More Levy Power

The IRS wants Congress to expand its tax levy authority.

This is a response against the taxpayer protections under the IRS Restructuring and Reform Act of 1998 (RRA). One of the changes required the IRS to provide at least 30 days notice of a levy action, as well as the taxpayer right to appeal such action. The purpose is to slow down collections and allow the taxpayer to propose alternatives or to reiterate information that collections has chosen to ignore.

After enactment of the RRA, the number of IRS levies dropped by approximately 85 percent, from 473,000 for fiscal 1998 to 75,000 in fiscal 2000. This has reversed recently, and there was a 73 percent increase from fiscal 2009 to 2010. During fiscal 2010 the IRS filed approximately 667,000 levies.

The IRS does have some valid arguments. In some circumstances, timing requirements may require multiple levy actions. Some sources of income are difficult to reach and are currently beyond the reach of a continuous levy.

NOTE: A continuous levy remains in effect until cancelled and provides recurrent cash to the IRS. The most common example is a wage garnishment. This is in contrast to a bank levy, which is good for only one instance. Should the IRS want more cash, it has to file another bank levy.

The IRS wants to expand the continuous levy to reach rental income, nonemployee compensation, royalties and fishing boat proceeds.

Then there are questionable IRS arguments. For example, the Treasury Inspector General for Tax Administration (TIGTA) reviewed a sample of 30 cases where the taxpayer appealed a levy action. It found that appeals can be used to delay collection action. Gosh, I could have told them that without a study; it doesn’t mean, however, that the appeal right per se is without merit. In 28 cases Appeals upheld the levy action. The IRS extrapolates this to mean that the appeals protection under RRA is being abused.

Let’s talk about IRS abuses. The RRA protections were not enacted because the IRS was an innocent party. There are cases where the IRS has pursued levies for less than $30.  There are cases of IRS levies without any notification. We presently have a representation client where collections is pursuing more than $20,000 while we simultaneously are reducing that amount by almost 80 percent through a reconsideration. We put in a CDP request to put the brakes on collections and clue them that there is a favorable adjustment coming from exam. Do I even need to comment on IRS inflexibility with an unemployed/underplayed taxpayer who cannot continue a payment plan at the same amount as before being unemployed/underemployed?

Let me clue you in on a tax “secret.” The IRS says it will work with you if circumstances overwhelm your payment plan. However, the IRS keeps a golden key to itself. The IRS can reject a restructuring if one has defaulted on a payment plan. Think about this. I have a client who entered into a payment plan. Circumstances have been difficult, including foreclosure. She has continued her payments to the IRS, although sometimes in smaller amounts than agreed to. She takes pride in having lived up to her obligation. I contacted the IRS to formally restructure the plan to something like the following:

                First three months          $25 per month

                Next three months         $50 per month

                Next three months         $75 per month

               

The IRS refused. Why? Because she “defaulted” on her plan. Now think about this for a moment. My client is held in the same regard as a tax scofflaw who has never paid and has no intention of ever paying. Her default? She reduced her payment because she works for $7.50 per hour and is broke. She did not miss a payment, mind you, only reduced it. To be fair, we will work something out with the IRS, but it is a needless headache for both her and me. I do think it shows a blockheaded attitude at the IRS. Some of us – government employees excluded, apparently – can be fired.

Count me on the “nay” side of any proposal to expand IRS levy authority. Show me some proof of “kinder and gentler” before I board this bus.

Be Careful With Foreign Tax Information Returns

Today we filed an extension for a client company with a foreign subsidiary. I was recently reading a Chief Counsel’s Advice concerning the same type of tax return that our client will be filing in a few months.

There is an additional form to file when one owns a foreign corporation. That is Form 5471 “Information Return of U.S Persons with Respect to Certain Foreign Corporations.” The common ownership threshold for filing is 10 percent. There is a twist in which an officer or director has a responsibility to file, even if the officer or director owns no shares directly, as long as a US citizen owns at least 10 percent.

Frankly, this is a confusing return. There are four types of “filers,” and each has to fill-out – or not fill-out- certain sections of the return. One may have to provide an income statement for the foreign company, for example, or track its earnings and profits.

The 2010 HIRE Act amended the tax Code (Section 6501(c )(8)) so that the statute of limitations for an income tax return to which an international “information return“ relates does not start until the information return is filed.

What does this mean? Well, Form 5471 is considered an “information return.” This means that it has numbers on it, but there is no line that says “tax due.” There is a similar form (Form 8865) for foreign partnerships and another (Form 3520) for foreign trusts.

So you own (enough of) a foreign corporation to file Form 5471. The accountant doesn’t think about it and files the corporate return without it.  The IRS in CCA 201104041 clarified that the statute of limitations on the corporate return does not begin to run until the Form 5471 is filed.

The client referred to above is new to the firm. One of the reasons that they switched firms? Their former CPA had not been filing Forms 5471.

If you remember, there are also penalties for not filing foreign information returns, including Form 5471. That however is for another blog post.

Olsen v Commissioner

You may recall that there is a”super” penalty that the IRS can assess if one understates his/her tax by too much. This penalty is not trivial: it is 20% and is called the accuracy-related penalty. In many cases the IRS assesses the penalty as a mathematical exercise. You can however request that the penalty be abated by providing a reasonable cause for doing so. A long illness or the death of a close family member, for example, has long been considered as reasonable cause.

We now have a new reasonable cause. I suspect that it will enter the tax lexicon as the “Geithner” defense, for the secretary of the Treasury under President Obama.

Here is what happened.

Kurt Olsen (KO)’s wife received interest income for 2007 from her mother’s estate. This means that she received a Schedule K-1, an unfamiliar form to the Olsens. KO normally prepared the tax returns, and he liked to use TurboTax. Upon receipt of the K-1, he upgraded his version of TurboTax as a precaution in handling this unfamiliar tax form.

TurboTax uses an interview process to obtain information. Using this process, KO entered the name and identification number of the estate. He also took a swing at entering the interest income, but something went wrong. The interest income did not show up on the return. KO was quite responsible and used the verification features in his upgraded software, but he did not discover the error.

The IRS did, though. They sent him a notice requesting an additional $9,297 in tax. The change in tax was large enough to trigger the “super” penalty of $1,859 ($9,297 times 20 percent).

KO knew he owed the tax, but he felt that the penalty was unfair. He felt strongly enough about the penalty that he pursued the issue all the way to the Tax Court. He represented himself under a special forum for small cases.

                Note: The tax term for representing yourself is “pro se.”

Now, the Tax Court has not been forthcoming in considering “tax software” as a reasonable cause. The Court has long expected one to use the software properly. In fact, a famous case (Bunney v Commissioner) has the Court stating that “tax preparation software is only as good as the information one inputs into it.”

The Court however took pains to distinguish KO, commenting that…

·         “We found petitioner to be forthright and credible.”

·         “It is clear that his mistake was isolated as he correctly reported the source of the income.”

·         “He did not repeat any similar error in preparing his tax return.”

·         “Petitioner acted reasonably in upgrading his tax preparation software to a more sophisticated version.”

The Court found reasonable cause to abate the penalty.

The key thing is that the taxpayer had an unusual source of income. He did not know where to look to check that the income had been properly included on his return. He did however meticulously follow the verification features in the software, and he relied – not unreasonably – on the software to report this transaction correctly.

This type of case unfortunately cannot be used as precedent. Tax Court Judge Armen also took care to cite the “unique facts and circumstances of this case.” Nonetheless, as more and more taxpayers use software to prepare their returns, it is expected that we will see more and more instances of the “Olsen” defense. 

Payroll Tax Cut Voted Down

I was reading this morning that the Senate was unable to pass a payroll tax cut bill yesterday. There were two bills and neither passed.

You may recall that the employee share of FICA was reduced from 6.2 to 4.2 percent for 2011. The balance of 1.45 percent for Medicare was untouched. The purpose was to stimulate, or at least not depress, the economy.

The problem is that the 2 percent reduction expires at the end of 2011.

The politicians now want to extend the program. The Senate Democrats proposed a plan to reduce the 6.2 percent withholding to 3.1 percent. In an unanticipated move, the Democrats proposed this be paid for by a tax increase on the wealthy.

The Republicans proposed extending the tax cut at 2 percent and paying for it by freezing federal salaries and streamlining the federal workforce by 10 percent. This was predictably described as extreme.

The President demanded action and announced his next vacation.

The House is taking up the issue next.