Nathan P. Weber CPA, Ltd

With Obama set to take office next month and Congress passing tax changes late in the year... Readers are asking what’s going to happen. We’ll share our answers to those questions. Will there be relief on 2008 required payouts from IRAs and plans for folks who are at least 70½? We expect Treasury to ease the rules a bit. But we don’t think folks should expect a full waiver on taking their required distributions for this year. Rather, if the balance in their accounts has fallen since the end of 2007, they probably will be allowed  to take the lower balance into account when computing their withdrawals for 2008. So delay your ’08 payout if you can. Treasury is still working on the exact details. 

 There’s better news for 2009: Congress has waived all mandatory payouts for next year. The provision is part of a pension bill that lawmakers just approved. Is bonus depreciation making a comeback next year? Chances are good that this tax break will be renewed as part of an economic stimulus bill. The easing allowed firms to write off 50% of the cost of new assets placed in service in 2008. Firms recover the remaining 50% of costs via depreciation under the normal rules. Will Obama and the Democrats speed up tax hikes on upper-income filers? It’s unlikely. Democrats’ desire to raise income tax and capital gains rates on couples with adjusted gross incomes over $250,000 and single filers with AGIs over $200,000 will take a backseat to stimulating the economy. With the tax hikes delayed to 2010 or 2011, there’s no need to panic with your income tax planning. What will the income tax brackets look like after Congress raises tax rates? Here’s a close approximation for readers confused by Obama’s tax plan, which describes the cutoff points based on adjusted gross income, while tax rates are actually set based on taxable income. If you’re now in the 33% bracket, figure that you would pay 36%. Filers in the 35% bracket now would end up paying 39.6%. Is the estate tax going to disappear as scheduled in 2010? Not a chance. Lawmakers will freeze it at 2009 levels: A $3.5-million exemption and 45% top rate. When Congress tackles the estate tax in 2009, will carryover basis survive? It will be dropped. Now, the tax basis for inherited assets is their value on the date the owner dies. But in 2010, the law says many heirs must use the basis of the decedent. Next year’s legislation will retain the date-of-death valuation rules. Will the alternative minimum tax be repealed anytime soon? No. Permanent AMT reform is too expensive for Congress to pass at the same time that it OKs big tax cuts for the middle class. Temporary AMT patches will continue to be approved to prevent the minimum tax from ensnaring more middle-incomers.

Imprecise wording when you name your IRA beneficiary can cost your heirs, as this private letter ruling shows. An IRA owner wanted a trust he set up in his will to be the IRA beneficiary. But he wrote “as stated in wills” on the form, without specifically identifying the trust. In the Service’s view, the lack of specificity meant that his IRA did not have a designated beneficiary and thus had to be emptied within five years. Had he identified the particular trust, the trust’s beneficiaries would have been able to receive their shares of the IRA over the oldest one’s lifetime. Thus, they lost the ability to benefit from many years of tax free buildup in the IRA. Just being a member of a retirement plan limits your IRA deduction. Even if you don’t earn any benefits, you are an active plan participant, the Tax Court says. So you can deduct payins only if your adjusted gross income is below certain limits: In 2008, $63,000 for singles, $105,000 for married couples where both spouses are active participants and $169,000 if just one spouse is active. In this case, a retired state government employee who resumed working for the state had to pay into the plan to avoid having his pension cut. Although he was unable to earn more benefits, he was active in the plan (Starnes, TC Summ. Op. 2008-148).

IRS gives pharmacies and drugstores a reprieve on debit card rules requiring systems to verify that cards intended for reimbursement of health care costs are used properly. IRS now says they have until July 1, 2009, an additional six months, either to install systems that restrict card purchases or to show that 90% of their prior-year gross receipts came from qualified expenses. Providers that fail to meet the requirements will be barred from accepting the cards. 403(b) sponsors get additional time to have a plan document in place. Plans must be in writing by the end of 2009, IRS says. Also, during 2009, sponsors without a written plan must make reasonable efforts to make sure the plan complies with pension rules and to correct errors that crop up. The prior deadline of Jan. 1, 2009 was scrapped because IRS realized many plans needed more time.

Gambling activities are getting exempt groups in hot water with the IRS. Audits are under way of about 800 charities that failed to report income from casino nights or other gaming activities. Many of them may owe payroll taxes or tax on unrelated business income generated by the fundraisers. The scofflaws were discovered after IRS agents combed through databases of 18 state tax agencies. If these exams bear fruit, you can bet that IRS will expand its search to other states.

A homeowner hits the jackpot for housing her sister and her two little kids: She can claim the two children as her dependents, the Tax Court decides. They are her qualifying children because they lived with her more than six months during the year, were under 19 and she provided more than half of their support. She also gets a hat trick of tax breaks for them: The earned income credit, the child tax credit and head of household filing status (Pavia, TC Memo. 2008-270).

The IRS will give some relief on withholding on government contracts. Payments under $10,000 will be exempted under newly proposed rules. Under current law, payments by governments will be subject to 3% withholding, starting in 2011. This will affect contracts with the federal government, the states and any municipality that pays out $100 million or more on contracts a year. Interest and payments for realty are excepted. Withholding also won’t be required on payments made under binding contracts that are in effect on Dec. 31, 2010. And Congress is thinking of delaying the withholding rule until 2012. The House OK’d a one-year delay, but it died in the Senate. Now that Democrats will have a stronger hand in the Senate next year, the odds for passage are better.

A worker turned the tables on IRS on his employment tax classification. The Tax Court said he was an employee, even though the Service argued the worker owed self-employment tax because his firm treated him as a contractor. He supervised workers for the firm. He had no investment in his own equipment, had no other clients, and was issued a business card with the firm’s name on it. That’s enough to make him the firm’s employee (McWhorter, TC Memo. 2008-263). The court didn’t resolve a thorny issue, however: Whether the worker was supposed to be covered by the company’s retirement plan. If he was eligible to participate but was barred, the plan would be in danger of losing its tax-qualified status. A new rule for fixing errors on payroll tax returns takes effect in 2009. Employers will need to file new Form 941-X as soon as a mistake is discovered. And a reminder on payroll tax deposits by single-member LLCs next year: They must begin depositing taxes using the entity’s name and ID number, instead of the owner’s Social Security number. The change affects one-owner LLCs that elect to have their income or loss reported on the owners’ income tax returns. If you own a one-member LLC without a tax ID number, you should get one fast.

Living expenses incurred at distant job sites aren’t always deductible, the Tax Court says. To avoid a layoff, a union member used his seniority to take the job of another worker in a far-off city. He did this several more times over the next few years as he waited to have enough seniority to bump a worker in his home town. The Court nixed his deduction for living costs at the job sites, since his employment at each one was indefinite (Koepke, TC Summ. Op. 2008-151). Only living expenses at jobs that are expected to last a year or less can be deducted. For accrual-method firms: Good news on deducting worker health benefits. Payments to providers made after year end are deducted in the prior year, IRS says in a private ruling. Here, a firm self-insured its medical and dental plans. In some cases, the firm paid employee claims more than 2½ months after year end. On audit, an IRS examiner said that meant the company had to delay its deduction until the year of payment. But the IRS National Office disagrees, allowing the firm to accrue the deduction in the year the medical and dental services were performed. Firms forgoing bonus depreciation on ’08 assets can opt for another break: Accelerating some of their minimum tax and R&D tax credit carryovers, turning them into a refundable credit. IRS has a new worksheet to figure the credit. 

If you want to pay federal estate tax in installments, be sure to file on time. Late-filed elections will not be honored, the Service says in a private ruling. If business interests make up more than 35% of an estate’s value, federal estate tax on the business portion can be deferred for up to five years and can then be repaid in up to 10 installments. Also, the Service will charge only a 2% interest rate on the first $576,000 of deferred tax and 2.7% on the excess. That’s a good deal. And don’t pay any installments late if you made a timely election. If you do, the Revenue Service can send you a bill accelerating the remaining estate tax due. That could force you to sell a portion of the assets in the estate to pay the bill.

IRS will play hardball in certain disputes with municipal bond issuers. The Service is concerned that some issuers are stalling in negotiations over the extra taxes and penalties owed after an audit, hoping to run out the clock on the three-year statute of limitations. To limit the use of this strategy in the future and also keep the heat on issuers now, the Service will start contacting bondholders so they can be taxed on the bond interest if the issuers don’t reach a settlement. That’s a big switch for IRS, which normally tries to avoid such drastic measures. Want to guarantee that your exempt bond issue will be audited? Just ignore IRS when it asks about late-filed 8038 forms, which list details about the amount of the bond issue and the type of facility financed. The return is due 1½ months after the quarter in which the bonds were issued. Fail to respond when late filers are contacted in 2009, and you face a certain audit, the Service says. The Service is eyeing nonprofits with lots of cash but little to show for it. In 2009, the IRS will contact exempt organizations that report a lot of fund-raising or unrelated business income on their 990s, while also showing only small amounts spent on charitable endeavors. It will audit groups that can’t justify the numbers. The Service wants more quick settlements of disputes with taxpayers. For small businesses, IRS gave a two-year extension to a pilot program that operates in Chicago, Houston, St. Paul, Philadelphia and central New Jersey, and three areas in Calif...San Diego, Laguna Niguel and Riverside. Firms with assets under $10 million are eligible for the program’s fast-track settlement procedures. And for exempt groups and governmental entities: A new IRS program will be tested for two years. Its goal is to settle audit issues in 60 days or less. After that, it will be available nationwide and made permanent if it produces results. IRS is testing the use of mediation on disputes over two types of issues: Compromise offers to pay tax debts that are rejected by the IRS. And disagreements over whether a person is liable for their company’s failure to remit withheld taxes on employees’ wages. In both types of cases, IRS appeals officers act as referees. The two-year pilot project began this month and is set to run in Atlanta, Chicago, Houston, Cincinnati, Indianapolis, San Francisco, Phoenix and in Louisville, Ky.

Our final tax reminders for this year to help you avoid problems: Check your flexible spending account balance. You must clean it out by Dec. 31 if your employer still has not adopted the 2½-month grace period that the IRS now permits. Otherwise, any money left in your account is forfeited. Mail checks for deductible items before year end to ensure a 2008 write-off. You get to claim the deduction this year even if the checks do not clear until Jan. And make sure you know the rules if you are charging deductible items. For charges that you make with a retail store credit card, you are allowed to claim the deduction for the item only in the tax year in which you pay the bill. For transactions made with a bank credit card, you take the deduction in the tax year that you charged the goods, even though you pay the bill next year. And our final suggestion for this year: Have a happy holiday season. The income tax forms will start to arrive in mailboxes in less than three weeks.


The foregoing are excerpts from the Kiplinger Letter December 12, 2008.