William L. Stark and Company

The IRS has announced a significant increase in enforcement actions for syndicated conservation easement transactions. This is a "priority compliance area" for the agency.

Throughout the IRS, coordinated examinations are being conducted in the Small Business and Self-Employed (SB/SE) Division, Large Business and International (LB&I) Division, and Tax Exempt and Government Entities (TE/GE) Division. The IRS Criminal Investigation (CI) Division has also been initiating investigations. The audits and investigations cover billions of dollars of potentially inflated deductions, as well as hundreds of partnerships and thousands of investors.

"We will not stop in our pursuit of everyone involved in the creation, marketing, promotion and wrongful acquisition of artificial, highly inflated deductions based on these aggressive transactions. Every available enforcement option will be considered, including civil penalties and, where appropriate, criminal investigations that could lead to a criminal prosecution," said IRS Commissioner Charles "Chuck" Rettig. "Our innovation labs are continually developing new, more extensive enforcement tools that employ advanced techniques. If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options. It is always worthwhile to take advantage of various methods of getting back into compliance by correcting your tax returns before you hear from the IRS. Our continued use of ever-changing technologies would suggest that waiting is not a viable option for most taxpayers," he added.

Syndicated Conservation Easements

The IRS issued Notice 2017-10, I.R.B. 2017-4, 544, in 2016, which designated certain syndicated conservation easements as listed transactions. In these types of transactions, investors in pass-through entities receive promotional material which offer the possibility of a charitable contribution deduction worth at least two-and-a-half times their investment. The deduction taken in many transactions has been significantly higher than 250 percent of the investment.

Syndicated conservation easements were included on the IRS’s 2019 "Dirty Dozen" list of tax scams to avoid.

Not only do these transactions grossly overstate the value of the easement that was purportedly donated to charity, they often also fail to comply with the basic requirements for claiming a charitable deduction for a donated easement.

Taxpayers may avoid the imposition of penalties for improper contribution deductions if they fully remove the improper contribution and related tax benefits from their returns by timely filing a qualified amended return or timely administrative adjustment request.

Enforcement Actions

The IRS has prevailed in many cases involving the charitable deduction basic requirements, and has established a body of law that it believes supports disallowance of the deduction in a significant number of pending conservation easement cases. The IRS will soon be moving the Tax Court to invalidate the claimed deductions in all cases where the transactions fail to comply with the basic requirements, leaving only the final penalty amount to be determined.

In addition to auditing participants in syndicated conservation easement transactions, the IRS is pursuing investigations of promoters, appraisers, tax return preparers and others, and is evaluating numerous referrals of practitioners to the IRS Office of Professional Responsibility. The IRS will develop and assert all appropriate penalties, including:

penalties for participants (40 percent accuracy-related penalty);
penalties for appraisers (penalty for substantial and gross valuation misstatements attributable to incorrect appraisals);
penalties for promoters, material advisors, and accommodating entities (penalty for promoting abusive tax shelters, and penalty for aiding and abetting understatement of tax liability); and
penalties for return preparers (penalty for understatement of taxpayer’s liability by a tax return preparer).

Rettig, Desmond Highlight Heightened Focus

Rettig and IRS Chief Counsel Michael J. Desmond have each highlighted the IRS’s heightened, agency-wide focus on syndicated conservations easements.

While speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C., Rettig and Desmond both separately underscored the IRS’s increased enforcement efforts toward abuses of certain tax-advantaged land transactions under Code Sec. 170(h).

"We appreciate the value of conservation easements," Rettig said. "We do not appreciate the activities that have gone on with respect to the syndicated conservation easements—there are some artificial appraisals there… some fatal flaws."

Reiterating the IRS’s tough stance on the matter, Rettig said that the IRS is not going to "stand down." The information in IR-2019-182 issued on November 12 was "fair warning," Rettig said.

Likewise, Desmond stressed that the challenges surrounding syndicated conservation easements are an "institutional concern" for the IRS, "one that we will be responding to," he emphasized.

Close

Treasury and the IRS are expected to release proposed rules in "early 2020" that would clarify certain limitations on the carried interest tax break, according to David Kautter, Treasury’s assistant secretary for tax policy. Kautter briefly addressed the proposed regulations’ timeline while speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C.

Carried Interest Limitation

The forthcoming regulations are expected to restrict S corporations from taking advantage of a carried interest exemption provision under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The TCJA requires certain money managers to hold investments for at least three years before becoming eligible for the lower, 20 percent capital gains rate. However, it exempted corporations from this holding period, which Treasury and many lawmakers on Capitol Hill say resulted in an unintended "loophole."

The proposed regulations are expected to clarify the law’s intent that S corporations are subject to the three-year holding period for carried interest, according to Treasury’s last press release on the matter issued in March 2018 (see "Treasury, IRS Issue Guidance On Carried Interest," at https://home.treasury.gov/news/press-releases/sm0302).

Legal Questions May Arise

Most notably, however, the TCJA does not expressly contain this limitation on S-corporations, which has left some on Capitol Hill questioning Treasury and the IRS’s authority to implement such a restriction via regulations. The IRS on November 15 directed Wolters Kluwer to Treasury for confirmation on this anticipated rule and projected timeline. As of press time, Treasury had not responded to Wolters Kluwer’s request for comment.

Close

Hopes for a year-end tax extenders package appear to be dwindling on Capitol Hill.

Tax Extenders Need a Legislative Vehicle

Over 30 expired or soon-to-be expired tax breaks known as tax extenders were originally considered a top contender for hitching a ride on a larger, must-pass government funding bill. Considering the lack of time left on the legislative calendar this year, a stand-alone tax bill has been considered an unlikely initiative. Thus, a must-pass appropriations bill was seen by several lawmakers as the likely legislative vehicle for tax extenders and other tax items such as technical corrections to Republicans’ 2017 tax reform law.

However, a spokesperson for Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, confirmed to Wolters Kluwer on October 28 that Grassley believes there is "no hope" for action this year on a tax extenders package if lawmakers do not move quickly with respect to its legislative driver. Many within the practitioner community following these developments have said that the chances of providing taxpayers with certain tax breaks retroactively significantly decrease if Congress moves into next year leaving them expired.

Another Stopgap Spending Bill Appears Likely

Currently, the federal government is operating on a stopgap spending bill temporarily extending fiscal year (FY) 2019 funding levels through November 21. Previously, several lawmakers, in particular Grassley, had hoped that a tax extenders package would be attached to a larger, more comprehensive appropriations bill next month. However, Senate Appropriations Committee Chair Richard Shelby, R-Ala., told reporters that another short-term stopgap spending bill is the more likely option to keep the government open after November 21. "Unless a miracle happens around here with the House and Senate, we will have to put forth another [continuing resolution] CR," Shelby told reporters.

Notably, another short-term government funding bill is considered unlikely to have any policy riders. Generally, stop gap spending bills are usually considered "clean," for the most part. Also playing a role in tax extenders’ fate is whether President Trump would sign a more comprehensive appropriations bill. At this time, his support for a larger FY 2020 funding bill, apart from tax policy reasons, remains unclear.

Close

Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, and other top Senate tax writers are calling for Senate action on the bipartisan Setting Every Community Up for Retirement Enhancement Secure bill (HR 1994) (SECURE Act). The House-approved, bipartisan retirement savings bill has remained stalled in the Senate since May.

SECURE Act’s Route to Senate Floor Remains Unclear

Grassley’s communications director Michael Zona told Wolters Kluwer on October 21 that it remains "unclear at this point" whether the SECURE Act will move through committee, reach the Senate floor by unanimous consent, or be attached to a larger, year-end tax package. "Grassley supports the House-passed SECURE Act. There are several holds on the bill, and he is working to get them lifted," Zona said.

The SECURE Act cleared the House on May 23 by a 417-to-3 vote. The bipartisan measure, which proposes sweeping changes to retirement savings tax policy, was originally expected to quickly clear the Senate after its approval in the House. However, Sen. Ted Cruz, R-Tex., blocked the bill from reaching the Senate floor. Cruz blocked the bill in protest of House Democrats’ 11th hour-removal of a provision from the original bill that would have expanded tax-advantaged Section 529 education savings plans to include homeschooling and certain elementary and secondary expenses. Cruz and Sen. Patty Murray, D-Wash., are reportedly still holding up the measure from reaching the Senate floor.

Catch-All Tax Package

However, the SECURE Act, among other bipartisan tax-related items including tax extenders, could be attached to a catch-all tax package that is expected on Capitol Hill to hitch a ride on a year-end government funding bill. A "must-pass" appropriations bill, like the one currently being negotiated to keep the government open after funding expires on November 21, could serve as the tax package’s legislative vehicle, thus fast tracking its approval.

"As the economy continues to change, the way we approach retirement savings must change as well. Otherwise, too many Americans will be left behind," Grassley said on October 21, noting that the SECURE Act is under "active consideration."

Similar to Grassley’s push, Sen. Tim Scott, R-S.C., led a letter sent to Senate Majority Leader Mitch McConnell, R-Ky., urging immediate Senate consideration of the SECURE Act. "This bipartisan legislation would expand access to retirement plans for millions of Americans, allow older workers and retirees to contribute more to their retirement accounts, increase 401(k) coverage to part-time employees, prevent as many as 4 million people in private-sector pension plans from losing future benefits, protect 1,400 religiously affiliated organizations whose access to their defined contribution retirement plans is in jeopardy, and do the right thing for Gold Star families," according to Scott.

Close

The Senate blocked a Democratic resolution on October 23 to overturn Treasury rules preventing certain workarounds to the $10,000 state and local tax (SALT) federal deduction cap.

SALT Cap Workaround

Senate Democrats’ resolution, S.J. Res. 50, forced a vote on Wednesday to nullify Treasury regulations that block taxpayers from circumventing the SALT cap through certain states’ programs that convert state and local taxes into fully deductible charitable contributions. The resolution failed by a largely party-line vote of 43-to-52.

Sen. Michael Bennet, D-Colo., voted against the Democratic measure while Sen. Rand Paul, R-Ky., supported it. While the resolution would not repeal the SALT cap itself, House Democrats are reportedly crafting legislation to do so. Democrats and some Republicans, particularly from high-tax states, have criticized the SALT cap since its enactment in 2017 under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97).

Debate on SALT Cap, Treasury Rules

"Without any clear authority to do so, the Treasury Department reversed a long-standing IRS position that had allowed taxpayers a full deduction for charitable contributions to state tax credit programs," Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said on the Senate floor before the vote. "My view is the Treasury Department should not be putting its thumb on the scale on behalf of Republican interests, and it shouldn’t be using phony regulatory justifications to fix Republicans’ extraordinarily poorly drafted law."

However, several Republicans cited to a recent report from the nonpartisan Joint Committee on Taxation (JCT), which estimated that repealing the SALT cap beginning in 2019 would result in over $40 billion of the associated tax cut going to taxpayers with incomes of at least $1 million ( JCX-35-19).

"It’s bad enough that my Democratic colleagues want to unwind tax reform, but it’s downright comical that their top priority is helping wealthy people in blue states find loopholes to pay even less," Senate Majority Leader Mitch McConnell, R-Ky., said from the Senate floor on October 23. "Repealing the SALT cap would give millionaires an average tax cut of $60,000. Meanwhile, the average tax cut for taxpayers earning between $50,000 and $100,000 would be less than ten dollars."

Vaping Tax

In other news, the House Ways and Means Committee approved a bipartisan vaping tax bill, ( HR 4742), on October 23 by a 24-to-15 vote. The bill would establish a $27.81 tax per gram of nicotine used in vaping devices.

Close

Treasury and the IRS on October 31 announced the release of a new, draft form implementing certain reporting requirements under the Tax Cuts and Jobs Act Opportunity Zone program.

The proposed Form 8996 for Qualified Opportunity Funds (QOFs) comes after numerous calls on Capitol Hill for more transparency within the Opportunity Zone program. "The form is designed to collect information on the amount of investment by opportunity funds in business property by census tract," according to a Treasury press release.

Opportunity Zones’ Architect Applauds Treasury’s Steps Toward Reporting Requirements

Ken Farnaso, press secretary for Sen. Tim Scott, R-S.C., chief architect of the TCJA’s bipartisan Opportunity Zone program, told Wolters Kluwer on October 31 that reporting requirements, "an important piece of the puzzle," were, in fact, originally in the bill. "Unfortunately, during the tax reform process, Senate Democrats blocked these requirements from being included in the Tax Cuts and Jobs Act. Since then, Senator Scott has continued working to restore those reporting requirements," Farnaso said.

Additionally, Farnaso told Wolters Kluwer that Scott applauds Treasury’s steps to ensure a clearer picture of the impact the Opportunity Zones initiative can have on the country. "Senator Scott will also continue to push for his current bill restoring robust reporting requirements to create a holistic picture of how the initiative is functioning," Farnaso said. "Overall, today is a good day for Opportunity Zones. We look forward to the more than $44 billion in currently anticipated investment being deployed in distressed communities across the nation, and that number growing even larger in the future."

Opportunity Zones Tax Incentive

The Opportunity Zone Program enacted under TCJA ( P.L. 115-97) is considered on Capitol Hill as one of the most generous and ambitious tax incentives for investors in distressed communities. Under Code Sec. 1400Z-2, investors may defer taxation of capital gains that are invested in a QOF.

Generally, the following investor tax benefits were created under the Opportunity Zone program:

a temporary tax deferral for capital gains realized on the sale of appreciated assets and reinvested within 180 days in a QOF;
the elimination of up to 10 or 15 percent of the tax on the capital gain that is invested in the QOF and held between five and seven years; and
the permanent exclusion of tax when exiting a qualified opportunity fund investment held for at least 10 years.

Draft IRS Form 8996

Specifically, the new, draft Form 8996 for the 2019 tax year requires QOFs to report the following information:

the Employer Identification Number (EIN) of each business in which the QOF has an ownership interest;
the census tract location of the tangible property of the business;
the value of the QOF’s investment; and
the value and census tract location of qualified business property directly owned or leased.

"This is an important step towards a thorough evaluation of the Opportunity Zone tax incentive," Treasury Secretary Steven Mnuchin said. "We want to understand where Opportunity Zone investments are going and strengthening the economy so that investors and communities can learn from the successes of this bipartisan, pro-growth policy."

Generally, the collection of this information will play a role in allowing lawmakers and the public to evaluate the effects of the tax incentive and to understand why some locations may be more successful than others at attracting investment, according to Treasury.

Opportunity Zones Criticism

The Opportunity Zone program has not come to fruition without its share of criticism, however. Although lawmakers have called for reporting requirements related to QOFs since the TCJA’s enactment, the program has recently come under increased scrutiny and criticism. Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., has said that the lack of reporting requirements are "inexcusable."

"Requiring taxpayers to prove they’re actually following the rules of the Opportunity Zone program is a positive first step, but it’s one that should have been taken two years ago…," Wyden said in an October 31 statement. "The Opportunity Zone program has been operating without any effort to ensure compliance and that’s inexcusable."

Close

A California-based medical marijuana dispensary corporation’s motion for summary judgment challenging the constitutionality of Code Sec. 280E was denied. The Tax Court also addressed whether Code Sec. 280E applies to marijuana businesses legally operating under state (California) law, and whether the prohibition on deductions is limited to ordinary and necessary business expenses.

Section 280E

Congress enacted Code Sec. 280E after the court had allowed certain deductions for expenses incurred in connection with an illegal drug trade. Generally, Code Sec. 280E disallows any deductions attributable to a taxpayer’s illegal drug related trade or business. Taxpayers may reduce their income by the cost of goods sold (COGS), and Code Sec. 280E does not generally disallow deductions attributable to a taxpayer’s non-drug-related business.

Constitutionality

The Eighth Amendment of the Constitution prohibits excessive fines or penalties. The dispensary in this case claimed that Code Sec. 280E is a punitive provision that violates the Eighth Amendment. However, because Congress generally has the power to levy taxes under the Sixteenth Amendment, the Tax Court found that the law’s denial of certain deductions cannot be construed as a penalty.

Legality Under State Law

The dispensary also argued that its actions could not be considered "trafficking" for purposes of Code Sec. 280E because its activities were not illegal under California law. The court noted that because marijuana is still considered a Schedule I controlled substance and is banned under federal law, the application of Code Sec. 280E does not depend on the legality of marijuana sales under California law.

Additional Deductions

Finally, the dispensary argued that Code Sec. 280E only applies to deductions under Code Sec. 162, and that other deductions such as those under Code Secs. 164 and 167 should be permitted. However, the text of Code Sec. 280E broadly states that "no deduction or credit shall be allowed." It does not limit the deductions to those claimed under Code Sec. 162.

Dissenting Opinions

The Tax Court decision included several concurring and dissenting opinions, which primarily addressed the issue as to whether Code Sec. 280E is in fact a penalty provision that would violate the Eighth Amendment.

The dissenting opinions found that Code Sec. 280E is punitive in nature. One dissenter noted that rather than specify a narrow range of disallowed expenses, Code Sec. 280E attacks the entire marijuana industry with a broad denial of otherwise allowable deductions. The opinion stated that Congress passed Code Sec. 280E order to deter the sale of controlled substances and to penalize the drug trade. That intent was found to be "clearly in the nature of a penalty." Both dissents concluded with two additional questions, which the dissenters felt need to be addressed:

Is the punitive nature of Code Sec. 280E excessive to the point where it violates the Eighth Amendment?, and
Does the Eighth Amendment apply to corporation taxpayers?

Close

The IRS has proposed regulations that define an eligible terminated S corporation (ETSC), and provide rules relating to distributions of money by an ETSC after the post-termination transition period (PTTP). The proposed regulations also extend the treatment of distributions of money during the PTTP to all shareholders of the corporation, and update and clarify the allocation of current earnings and profits to distributions of money and other property.

Code Sec. 1371(f), as added by the Tax Cuts and Jobs Act ( P.L. 115-97) extends the period during which C corporation shareholders can benefit from the corporation’s accumulated adjustment account (AAA) generated during its former status as an S corporation. Specifically, the provision allows the C corporation to source qualified distributions of money to which Code Sec. 301 would otherwise apply to in whole or part to AAA. The provision only applies if the corporation is an ETSC as defined in Code Sec. 481(d).

Under the proposed regulations, the revocation of S corporation status may be made during the two-year period beginning on December 22, 2017, even if the effective date for the revocation occurs after the conclusion of the two-year period.

Shareholder Identity Requirement

A former S corporation is not an ETSC unless the owners of its stock are the same owners (and in identical proportions) on December 22, 2017, and on the date of the S corporation revocation. The proposed regulations identify various categories of stock transfers that are not considered an ownership change for purposes of this rule.

ETSC Proration

A distributing ETSC’s AAA is allocated to qualified distributions and the distributions are chargeable to the ETSC’s accumulated earnings and profits (AE&P) based on the ETSC proration. The ETSC proration is implemented in a manner that facilitates the prompt distribution of AAA and full transition to C corporation status. Specifically, the proposed regulations:

specify the time at which amounts of AAA and AE&P are determined for purposes of the ETSC proration;
provide AAA and AE&P ratios used to the implement the proration; and
describe in detail the method of characterizing qualified distributions.

The proposed regulations adopt a "snapshot" approach under which amounts of AAA and AE&P are determined on a specified date. As a result, the same ETSC proration is applied to all qualified distributions. Under the proposed regulations, the determination date is the date when the S corporation revocation election is effective. A "dynamic" approach that recalculated the amounts before each qualified distribution was rejected as administratively cumbersome.

The proposed regulations provide two ratios for determining the part of a qualified distribution that is sourced from AAA and from AE&P. The AAA ratio is the ratio of historical AAA to the sum of historical AAA and historical AE&P. The AE&P ratio is the ratio of historical AE&P and the sum of historical AAA and historical AE&P. The qualified distribution is multiplied by these ratios to determine the amount sourced from AAA and AE&P.

The proposed regulations provide a priority rule under which ETSC proration first applies to qualified distributions during the tax year. The rules of Code Sec. 301 and allocation rules of Code Sec. 316 then apply to any nonqualified distributions that are not fully accounted for by the ETSC proration because the corporation’s AAA or AE&P are exhausted.

Effective Date

The proposed regulations will be effective in tax years beginning after the date they are published as final regulations. A taxpayer may apply the regulations in their entirely to tax years that begin on or before the date of publication as final regulations.

Close

An LLC (limited liability company) is not a federal tax entity. LLCs are organized under state law. LLCs are not specifically mentioned in the Tax Code, and there are no special IRS regulations governing the taxation of LLCs comparable to the regulations for C corporations, S corporations, and partnerships. Instead, LLCs make an election to be taxed as a particular entity (or to be disregarded for tax purposes) by following the check-the-box business entity classification regulations. The election is filed on Form 8832, Entity Classification Election. The IRS will assign an entity classification by default if no election is made. A taxpayer who doesn't mind the IRS default entity classification does not necessarily need to file Form 8832.

"Check-the-Box" Election

An LLC with more than one member can elect tax status as:

Partnership
Corporation
S corporation (accomplished by electing to be taxed as a corporation, then filing an S corporation election)

An LLC with only one member can elect tax status as:

Disregarded entity
Corporation
S corporation (accomplished by electing to be taxed as a corporation, then filing an S corporation election)

The IRS will assign the following classifications if no entity election is filed for an LLC (the default rules):

any business entity that is not a corporation is classified as a partnership
any entity that is wholly-owned by a single person will be disregarded as an entity separate from its owner (taxed as a sole proprietorship).

Typically, an LLC with more than one member will elect to be taxed as a partnership, whereas a single-member LLC will elect to be disregarded and taxed as a sole proprietorship.

If you have any questions relating to LLCs, their benefits, drawbacks, or their treatment under the Tax Code, please contact our offices.

Close

The IRS has issued proposed reliance regulations on the 3.8 percent surtax on net investment income (NII), enacted in the 2010 Health Care and Education Reconciliation Act. The regulations are proposed to be effective January 1, 2014. However, since the tax applies beginning January 1, 2013, the IRS stated that taxpayers may rely on the proposed regulations for 2013. The IRS expects to issue final regulations sometime later this year.

The surtax applies to individuals, estates, and trusts. The surtax applies if the taxpayer has NII and his or her "modified" adjusted gross income exceeds certain statutory thresholds: $250,000 for married taxpayers and surviving spouses; $125,000 for married filing separately; and $200,000 for individuals and other taxpayers. The tax is broad and can raise tax bills by hundreds, if not thousands, of dollars.

Complex provisions

The regulations are extensive and complex. They address a number of issues that were not answered in the statute, such as the interaction of Code Sec. 1411 (the surtax provisions) and Code Sec. 469 (passive activity loss rules). Significant areas addressed in the proposed regulations include:

Identification of those individuals subject to the surtax,
Surtax's application to estates and trusts,
Definition of NII,
Disposition of interests in partnerships and S corporations,
Allocable deductions from NII,
Treatment of qualified plan distributions, and
Treatment of earnings by controlled foreign corporations and passive foreign investment companies.

Some issues, however, are not yet addressed, such as the application of the Code Sec. 469 material participation rules to trusts and estates. Further guidance from the IRS is expected.

Borrowed definitions and principles

Net investment income that is subject to the new 3.8 percent tax generally includes interest and dividend income as well as capital gains from investments. But Code Sec. 1411 doesn't stop there, seeking to tax "passive activities" and contrasting those activities with a "trade or business" in often complex ways.

Because Code Sec. 1411 does not define many important terms, the regulations use definitions from several other Tax Code provisions. For example, the definition of a trade or business is determined under Code Sec. 162, regarding trade or business expenses. This definition is essential to Code Sec. 1411, since the application of each of the three categories of net investment income depends on determining whether the income is from a trade or business. The regulations also borrow the definition of a disposition, which applies to category (iii) income, from other provisions, such as Code Section 731 (partnership distributions) and Code Sec. 1001 (dispositions of property).

New elections available

The regulations provide certain elections that may be beneficial to many taxpayers. Taxpayers that engage in multiple activities under Code Sec. are allowed to make another election to regroup their activities. Taxpayers married to a nonresident alien can elect to treat their spouse as a U.S. resident, which allow more income to escape the 3.8 percent surtax.

Net investment income generally includes interest and dividend income as well as capital gains from investments. To prevent avoidance of the tax, the regulations include substitute payments of interest and dividends in the definition. The IRS also warned in the preamble to the proposed regulations that it will scrutinize activities designed to circumvent the surtax and will challenge questionable transactions using applicable statutes and judicial doctrines. The IRS further warned that taxpayers should figure their exposure to the 3.8 percent tax quickly since liability for this additional tax must be included in quarterly estimated tax computations and payments starting with first quarter 2013.

Please feel free to contact this office for a personalized review of how the 3.8 percent tax may impact you, and what compliance and planning steps should be considered as a consequence.

Close

Effective January 1, 2013, a new Medicare tax takes effect. The Additional Medicare Tax imposes a 0.9 percent tax on compensation and self-employment income above a threshold amount. Unlike regular Medicare tax, the Additional Medicare Tax has no employer match but employers have withholding obligations. The IRS issued proposed reliance regulations about the Additional Medicare Tax in December 2012.

Medicare

Medicare is funded through payroll taxes. Employees and employers (and self-employed individuals) all pay into Medicare. Employees and employers each pay Medicare tax at a rate of 1.45 percent (self-employed individuals pay at a combined rate but are allowed to deduct half of the Medicare tax as an adjustment to income). The Additional Medicare Tax is a new tax that may apply to certain taxpayers in addition to regular Medicare tax. The new tax was part of the Patient Protection and Affordable Care Act (Affordable Care Act), which was passed by Congress in 2010. However, Congress delayed the start date of the new tax until 2013.

Liability

Generally, an individual is liable for Additional Medicare Tax if the individual's wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individual's filing status. Only individuals with incomes above the threshold amount will be liable for the new tax and if their employer does not withhold it, they will have to pay it when then they file their returns.

The threshold amounts are: $250,000 for married couples filing jointly; $200,000 for single individuals, head of household (with qualifying person) and qualifying widow(er) with dependent child; and $125,000 for married couples filing separately.

Withholding

An employer must withhold Additional Medicare Tax from wages it pays to an individual in excess of $200,000 in a calendar year, without regard to the individual's filing status or wages paid by another employer. The IRS explained in its proposed reliance regulations that the employer has this withholding obligation even though an employee may not be liable for Additional Medicare Tax because, for example, the employee's wages together with that of his or her spouse do not exceed the $250,000 threshold for married couples filing jointly.

Let's look at an example from the IRS proposed reliance regulations:

Elena, who is married and files a joint return, receives $100,000 in wages from her employer for the calendar year. Caleb, Elena's spouse, receives $300,000 in wages from his employer for the same calendar year. Elena's wages are not in excess of $200,000, so her employer does not withhold Additional Medicare Tax. Caleb's employer is required to collect Additional Medicare Tax only with respect to wages it pays which are in excess of the $200,000 threshold (that is, $100,000) for the calendar year.

Planning considerations

Taxpayers who believe they may be liable for the Additional Medicare Tax in 2013 and beyond should carefully plan ahead. The IRS has cautioned that an individual may owe more than the amount withheld by the employer, depending on the individual's filing status, wages, compensation, and self-employment income. All these factors come into play in planning for the Additional Medicare Tax.

One strategy may be to make estimated tax payments and/or request additional income tax withholding. Our office can help you determine which strategy would work best for you.

Employers

There is no employer match for the Additional Medicare Tax. However, the Affordable Care Act and the IRS proposed reliance regulations require employers to withhold Additional Medicare Tax on wages it pays to an employee in excess of $200,000 in a calendar year, beginning January 1, 2013. If an employer fails to withhold, the IRS may impose penalties on the employer and the employee would be liable for the tax.

Reliance regulations

The regulations issued by the IRS in December 2012 are proposed reliance regulations. The IRS explained that it intends to finalize the proposed regulations in 2013. Taxpayers may rely on the proposed regulations for tax period beginning before the date that the regulations are finalized.

If you have any questions about the Additional Medicare Tax, please contact our office.

Close

Beginning with 2012 Forms W-2, large employers must report the aggregate cost of employer-sponsored health insurance provided to employees. 2012 Form W-2s must be furnished to employees by January 31, 2013.

For tax years beginning on or after January 1, 2011, the Patient Protection and Affordable Care Act (PPACA) required that employers report the aggregate cost of employer-sponsored health insurance provided on Form W-2, Wage and Tax Statement. The IRS then exempted all employers from the requirement for 2011, making 2011 reporting optional.

Reporting took effect in early 2012, but only for large employers filing 250 or more Forms W-2 for the preceding calendar year (2011). Small employers are exempt from reporting for 2012 and beyond, until the IRS issues further guidance. An employer does not have to report the cost if it is not required to issue a Form W-2. This would be the case for a retiree or other former employee who does not receive compensation.

The aggregate reportable cost should be shown on Form W-2, Box 12, using Code DD. The IRS has reiterated that reporting is for informational purposes only, and that the cost of health insurance generally remains excludable from income.

Reporting applies to applicable coverage under any group health plan provided by an employer or employee organization, if the coverage is excludable from the employee's income or would have been excludable if provided by the employer. Costs for self-insured plans and plans of self-employed persons are covered, unless the only coverage provided by the employer is a self-insured plan that is not subject to COBRA continuation coverage requirements (e.g. a self-insured church plan). Coverage does not include long-term care; accident or disability coverage; coverage for treatment of the mouth; and coverage only for a specified illness or disease.

Reportable costs include both employer costs and employee costs for the health insurance, even if the employee paid his or her share through pre-tax or salary reduction contributions. The aggregate cost includes the cost of coverage included in the employee's income, such as the cost of coverage for a person who is not a dependent or a child under age 27.

However, costs do not include amounts contributed to an Archer Medical Savings Account, health savings account, or health reimbursement arrangement, and salary reduction contributions made to a flexible spending arrangement.

Reporting is required of most employers, including federal, state, and local governments, and churches and other religious organizations.

Please contact this office if you would like further information on how these new reporting obligations may apply to your business.

Close