IRS Reminds Persons with Foreign Connections of Pending Deadlines

IRS has provided filing advice for persons who had 2014 connections to foreign countries. For example, it reminded U.S. citizens and resident aliens, including those with dual citizenship who have lived or worked abroad during all or part of 2014, that they may have a U.S. tax liability and a filing requirement in 2015, and that the June 15th filing deadline is quickly approaching.

Income tax return filing requirements, including deadlines. U.S. citizens and resident aliens living overseas, or serving in the military outside the U.S. on the regular due date of their tax return, generally have an automatic 2-month extension beyond the regular April 15th deadline to file their returns. To use this automatic 2-month extension, taxpayers must attach a statement to their return explaining which of these two situations applies.

Nonresident aliens who received income from U.S. sources in 2014 must determine whether they have a U.S. tax obligation. The filing deadline for nonresident aliens can be April 15th or June 15th depending on sources of income.

U.S. citizens and resident aliens are legally required to report any worldwide income, including income from foreign trusts and foreign bank and securities accounts. In most cases, affected taxpayers need to fill out and attach Schedule B, Interest and Ordinary Dividends, to their tax return. Part III of Schedule B asks about the existence of foreign accounts, such as bank and securities accounts, and usually requires U.S. citizens to report the country in which each account is located.

Taxpayers who relinquished their U.S. citizenship or ceased to be lawful permanent residents of the U.S. during 2014 must file a dual-status alien return, attaching Form 8854, Initial and Annual Expatriation Statement. A copy of the Form 8854 must also be filed with IRS at the address provided by the due date of the tax return, including extensions.

Foreign account reporting. Certain taxpayers may also have to fill out and attach to their return Form 8938, Statement of Foreign Financial Assets. Generally, U.S. citizens, resident aliens, and certain nonresident aliens must report specified foreign financial assets on Form 8938 if the aggregate value of those assets exceeds certain thresholds.

Separately, taxpayers with foreign accounts, the aggregate value of which exceeded $10,000 at any time during 2014, must file electronically with the Treasury Department a Financial Crimes Enforcement Network (FinCEN) Form 114, an FBAR form. It is due to the Treasury Department by June 30, 2015, must be filed electronically, and is only available online through the BSA E-Filing System website (see http://bsaefiling.fincen.treas.gov/main.html). It is not a tax form.

Simplified reporting for Canadian retirement accounts. Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans, is used by U.S. citizens or residents to report contributions to Canadian registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs).

Report in U.S. dollars. Any income received or deductible expenses paid in foreign currency must be reported on a U.S. return in U.S. dollars. Likewise, any tax payments must be made in U.S. dollars. Both Form 114 and Form 8938 require the use of a December 31st exchange rate for all transactions regardless of the actual exchange rate on the date of the transaction. IRS generally accepts any posted exchange rate that is used consistently.

Free file and e-file now available. Taxpayers abroad can now use IRS Free File to prepare and electronically file their returns for free. This means both U.S. citizens and resident aliens living abroad with adjusted gross incomes (AGI) of $60,000 or less can use brand-name software to prepare their returns and then e-file them for free. A limited number of companies provide software that can accommodate foreign addresses.

A second option, Free File Fillable Forms, the electronic version of IRS paper forms, has no income limit and is best suited to people who are comfortable preparing their own tax return.

Both Free File and other e-file options are available until October 15, 2015, for anyone filing a 2014 return. Taxpayers can check out the e-file link on IRS’s website for details on the various electronic filing options.

Large Loss Allowed for Materially Participated Taxpayers in Real Estate Enterprises

The Tax Court has held that a taxpayer that stepped in during the 2008 financial crisis to rescue several related family businesses in which he held interests did so as a material participant, not as an investor. On the facts, the passive activity loss rules didn’t apply, and he could carry back a large loss to 2006 and thereby generate a refund of over $5 million.

Background. Taxpayers can’t use passive activity losses to offset nonpassive income. A passive activity is any trade or business in which the taxpayer does not materially participate. Taxpayers have a passive loss if their aggregate losses from their passive activities exceed their aggregate income from passive activities for a yearFor purposes of the passive activity rules, a taxpayer’s activities include those conducted through personal service corporations, closely-held C corporations, S corporations, and partnerships.

Facts. A successful businessman helped fund three businesses for his children, structuring each business with one child as the majority owner holding 60% of the shares, and the other two children each holding 20%. One of these three businesses, Shoma Development Corporation, an S corporation, was owned 60% by the businessman’s daughter, Maria Lamas, and her husband, Masoud Shojaee, and by Jose Lamas and his sister Alejandra, who each owned 20%. Shoma and the other two businesses were all related in some way to the business of real estate and tangentially to each other.

In 2004 Shoma formed Greens at Doral, LLC, a condominium conversion project. Shoma and Greens were closely intertwined. Greens had the same ownership structure as Shoma and consolidated its financial information with Shoma’s. Greens operated out of Shoma’s offices using Shoma’s employees, and the shareholders planned to liquidate Greens after the conversion project was completed. Greens was treated as a partnership for tax purposes.

Jose Lamas owned 20% of Shoma and Greens and served on Shoma’s board of directors. Throughout 2008, a bad year for real estate, he labored to raise capital for Shoma and find additional investors for Shoma’s projects to fill its capital needs. He spent considerable time trying to line up outside investors and purchasers for Shoma’s projects in an attempt to cure Shoma’s capital deficit. Much of this time was spent speaking on the phone with potential backers and meeting with them over a meal. Lamas also was involved in a lawsuit involving, among other things, the recovery of Shoma assets that his brother-in-law, Mr. Shojaee, had misappropriated. The parties settled in 2008.

Lamas had provided financing for a condominium conversion project called Bella Vista, and when its owner declared bankruptcy, Lamas took it over to try and salvage his investment. Lamas assumed a management role after taking over the Bella Vista project. He negotiated with plumbers and electricians who had worked on the project, took over tenant management, and dealt with existing code violations. After Mr. Lamas took over the project, he was responsible for the day-to-day finances, and he arranged for essential project loans.

Lamas incurred substantial losses in 2008 from Shoma and Greens. He claimed these losses as a tentative carryback adjustment to 2006, resulting in a tentative refund of $5,260,964.

IRS audited Lamas’s 2006 and 2008 returns, determined that Lamas’s 2008 NOL from Shoma and Greens was passive instead of nonpassive, and ultimately issued a notice of deficiency of $4,911,669 for 2006. During the audit, Mr. Shojaee originally made statements supportive of Lamas, but after yet another family conflict over a real estate project, which didn’t end well for Shojaee, he wrote IRS that Lamas hadn’t been a material participant in Shoma.

Activities were nonpassive. After weighing all the evidence, the Tax Court held that Lamas was a material participant in Shoma and Greens for 2008. As a result, it OK’d his claimed carryback to 2006. The Court cited the following factors in arriving at its decision.

Single economic activity under the grouping rules. The Tax Court determined that Shoma and Greens met all the five criteria: both were similar businesses engaged in commercial and residential real estate. They shared common control and ownership for the years at issue; they shared geographic locations (Greens operated out of Shoma offices), and they were interdependent (Greens used Shoma’s employees and consolidated its financial reporting with Shoma, and shareholders intended that Greens be dissolved after the project was completed and the capital returned to shareholders).

More than 500 hours of material participation. The Tax Court found that Lamas worked at least 691 hours for Shoma and Greens during 2008 . Credible testimony and phone records supported this conclusion. Mr. Shojaee’s inconsistent statements and personal conflicts with Mr. Lamas called his credibility into question, and the Court gave no weight to Shojaee’s testimony.

Participation wasn’t as an investor. The Tax Court rejected IRS’s contention that Lamas’s work for Shoma didn’t qualify because he was merely working in an investor capacity and wasn’t involved in day-to-day management and operations. The Court found that Mr. Lamas worked in the day-to-day management and operations of Shoma because he was working to meet its need for capital for its projects, an essential part of Shoma’s business during 2008. Mr. Lamas’ promotion went to the core goal for Shoma at the time, which was to find project investors. Accordingly, all of Mr. Lamas’ work for Shoma, including investor activity, qualified as participation.

Exception for work not customarily done by owners didn’t apply. On the facts, the Tax Court concluded that Lamas participated in work customarily done by owners, and he did not do this work with a purpose of avoidingloss limitations.

Significant participation activity test met. Even if Lamas worked fewer than 691 hours for Shoma and Greens during 2008, he would still qualify as materially participating, by having significant participation activities that exceed 500 hours in the aggregate for 2008. The Tax Court found that Lamas worked at least 294 hours during 2008 for Bella Vista. Thus, even if Lamas’s work for Shoma and Green had been less than 500 hours, Shoma and Greens would then qualify as a significant participation activity that could be aggregated with Bella Vista. Under that scenario, Mr. Lamas’ significant participation activities, Bella Vista, Shoma and Greens, exceeded 500 hours.

Changes to Estate/Gift Tax Laws

The Congressional Research Service (CRS) has issued a report in which it notes predictions of the effects of changes made to the estate, gift and generation skipping transfer (GST) taxes by the American Taxpayer Relief Act of 2012 (ATRA) and discusses recent proposals by Congress and the Administration to change those taxes.

Background-the estate and gift taxes from 2001 until the present. Under the Economic Growth and Tax Relief Act of 2001, the estate tax exemption rose from $675,000 in 2001 to $3.5 million in 2009, and the top tax rate fell from 55% to 45%. The gift tax exemption was, however, restricted to $1 million.

For 2010, EGTRRA scheduled the elimination of the estate tax, although it retained the gift tax and its $1 million exemption. EGTRRA also provided for a carryover of basis for assets inherited at death. However, that provision had a $1.3 million exemption for gain (plus $3 million for a spouse).

As with other provisions of EGTRRA, the above tax revisions were to expire in 2011, returning the tax provisions to their pre-EGTRRA levels. The exemption would have reverted to $1 million (a value that had already been scheduled for pre-EGTRRA law) and the rate to 55% (with some graduated rates). The carryover basis provision effective in 2010 would be eliminated.

During debate on the estate tax that took place before the EGTRRA provisions were scheduled to expire, President Obama proposed a permanent extension of the 2009 rules (a $3.5 million exemption and a 45% tax rate). Senate Minority Leader McConnell proposed an alternative of a 35% tax rate and a $5 million exemption. A similar proposal for a $5 million exemption and a 35% rate, which also included the ability of the surviving spouse to inherit any unused exemption of the decedent, was made in the Senate. At the end of 2010, a temporary 2-year extension, with a $5 million exemption, a 35% rate, and inheritance of unused spousal exemptions was enacted in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. These provisions provided for estate tax rules through 2012, and absent legislation, the provisions would have reverted to the pre-EGTRRA rules ($1 million exemption, 55% top rate).

ATRA established a permanent exemption  and portability of unused spousal exemption.

CRS cites predictions of effects of ATRA. Citing a 2010 report by the Tax Policy Center, CRS said that, compared with pre-existing law (a $1 million exemption and a 55% rate), the ATRA revision was projected to lose $369 billion in revenue from fiscal year (FY) 2013 to FY 2022. This change reduced total projected revenue from the estate tax by about two-thirds. CRS also noted the following predictions:

  • The estate tax would affect less than 0.2% of decedents over the first post-ATRA decade.
  • The estate tax would be concentrated among high income taxpayers: 96% would be paid by the top quintile, 93% by the top 5%, 72% by the top 1%, and 42% by the top 0.1%.
  • About 0.2% of estates with half or more of their assets in businesses would be subject to the estate tax.
  • About 65 farm estates per year are projected to be subject to the estate tax, and constitute 1.8% of taxable estates. Less than a fourth of those 65 are projected to have inadequate liquidity to pay estate taxes. 0.8% of farm operator estates are projected to pay the tax.
  • About 94 estates per year, that have at least half their assets in small business and who expect their heirs to continue in the business, are projected to be subject to the estate tax; they constitute 2.5% of total estates. Less than half of the 94 are projected to have inadequate liquidity to pay estate taxes.

CRS discusses some proposals to change the estate and gift taxes. Congressional Republicans and a few Congressional Democrats have favored repeal of the estate tax, while other proposals, principally put forth by the Obama Administration, seek to increase the tax and/or close loopholes in the tax.

Repeal of estate tax. which was passed by the House on April 16, 2015, would repeal the estate tax for estates of individuals dying on or after the date of enactment. The bill would also repeal the GST tax for such transfers made on or after the date of enactment. In addition, H.R. 1105 would lower the top marginal gift tax rate from 40% to 35%. The bill is estimated to cost $269 billion for the 10-year period from FY 2015 – FY 2025. S. 860 has similar provisions.

Return to 2009 rates and exemptions. The Administration’s FY 2016 budget proposes to restore the 2009 higher rates and lower exemptions.

Grantor retained annuity trusts. A grantor retained annuity trust (GRAT) is a trust that allows the grantor to receive an annuity, with any remaining assets transferred to the trust recipient. The value of the gift is reduced by the value of the assets used to fund the annuity. If the assets in the trust appreciate substantially, then virtually all of the gift can be reduced by the value of the annuity, while still providing a substantial ultimate gift to the recipient.

The GRAT proposal in the President’s budget proposal, much of which was also in his past budget proposals, would impose a minimum annuity term of 10 years, disallow any decline in the annuity, and require the remainder interest in the GRAT to have a value greater than zero at the time the interest is created. It would impose a maximum term of the annuitant’s life plus 10 years.

Minority discounts. There are existing restrictions to keep estates from engaging in artificial actions designed to reduce the value of estates (such as freezes on assets). However, courts sometimes allow estates to reduce the fair market value when assets are left in family partnerships in which no one has majority control. These discounts have even been allowed when assets are in cash and readily marketable securities, and the setting up of these family partnerships has become an estate tax avoidance tool. A provision to limit the use of minority discounts is not in the current budget proposal, but it has been proposed in the past.

Limit length of generation-skipping trusts. When generation-skipping transfers are made to a trust, the estate tax exemption applicable to them also exempts the associated earnings during the trust’s lifetime. In the past, a trust life has been limited because most states had a Rule Against Perpetuities that generally limited trusts to a 21-year life. Most of these laws have been eliminated. The Administration would limit the life of a GST trust to 90 years.

Estate tax liens. Currently, IRS has a lien on estate tax deferrals for closely held business, but these liens are for 10 years, shorter than the deferral period. A proposal would extend the liens through the deferral period.

Gift and GST exclusion for medical care and education. Currently, payments for medical care or education made directly to the provider for another are exempt from the generation-skipping tax and the gift tax.  Taxpayers have been using trusts to eventually pay for these expenses and avoid tax on the accumulations. The Administration indicates that the original purpose of this provision was to exempt payments between living persons and would disallow exemptions for payments to trusts.

Limit the use of Crummey trusts. A “Crummey” trust typically gives the beneficiary of the trust (or a guardian if the beneficiary is a minor) the right to demand distribution of any additional property transferred to the trust by the donor during the year, up to a specified amount. The power of withdrawal is noncumulative and must be exercised within a specified period. If the power to withdraw is not exercised, it lapses as to additions made during that year. This type of trust is designed to get the gift tax annual exclusion for present interests while limiting the beneficiary’s right to use the property.

A proposal would disallow the unlimited use of Crummey trusts by imposing an additional overall limit of $50,000 on gifts made via trusts.

Coordinate grantor trust income and transfer tax rules. In a grantor trust, an individual is treated as owner for income tax purposes. However, the trust and the individual are treated as separate persons for purposes of the estate and gift tax.

A previous year proposal from the Administration would include the assets of the trust in the grantor’s estate and subject distributions to the gift tax if the grantor is the owner for income tax purposes. If the grantor ceases to be the owner, the assets would be subject to a gift tax.

Employers Can Now Claim a Retroactive Work Opportunity Tax Credit

IRS has provided employers with additional time to obtain the certification necessary to claim the work opportunity tax credit (WOTC), which was retroactively extended by the Tax Increase Prevention Act of 2014 to cover eligible employees who begin work before January 1, 2015. An employer that hired a member of a targeted group or a tax-exempt organization that hired a qualified veteran during 2014 will meet the requirements under if a pre-screening notice to request certification is filed with the appropriate Designated Local Agency (DLA) no later than April 30, 2015.

Work Opportunity Tax Credit

The WOTC allows employers who hire members of certain targeted groups to get a credit against income tax of a percentage of first-year wages up to $6,000 per employee ($3,000 for qualified summer youth employees). Where the employee is a long-term family assistance (LTFA) recipient, the WOTC is a percentage of first and second year wages, up to $10,000 per employee. Generally, the percentage of qualifying wages is 40% of first-year wages; it’s 25% for employees who have completed at least 120 hours, but less than 400 hours, of service for the employer. For LTFA recipients, it includes an additional 50% of qualified second-year wages.

The maximum WOTC for hiring a qualifying veteran generally is $6,000. However, it can be as high as $12,000, $14,000, or $24,000, depending on factors such as whether the veteran has a service-connected disability, the period of his unemployment before being hired, and when that period of unemployment occurred relative to the WOTC-eligible hiring date.

Before an employer may claim the WOTC, the employer must obtain certification that the hired individual is a targeted group member. Certification of an individual’s targeted group status is obtained from a DLA—a State employment security agency. Targeted groups include: qualified IV-A recipients (qualified recipients of aid to families with dependent children or successor program); qualified veterans; qualified ex-felons; designated community residents (i.e., the former “high-risk youths” targeted group but with the maximum age requirement raised and the residency requirement expanded to include rural renewal residents); vocational rehabilitation referrals; qualified summer youth employees; qualified supplemental nutrition assistance benefits recipients; qualified SSI recipients; and long-term family assistance recipients, i.e., members of a family that receives or received assistance under a IV-A program for a minimum period of time.

An individual isn’t treated as a member of a targeted group unless: (1) on or before the day the individual begins work, the employer obtains certification from the DLA that the individual is a member of a targeted group; or (2) the employer completes a pre-screening notice (Pre-Screening Notice and Certification Request for the Work Opportunity Credit) on or before the day the individual is offered employment and submits such notice to the DLA to request certification not later than 28 days after the individual begins work.)

A reduced WOTC for hiring qualified veterans is also available to a tax-exempt employeras a credit against the employer share of Social Security tax.

Before TIPA was enacted very late in December of 2014, wages for purposes of the WOTC didn’t include any amount paid or incurred to eligible employees who began work after December 31, 2013.

Extension Time

Because TIPA extended the WOTC retroactively for 2014 for members of targeted groups, employers need additional time to comply with the requirements of Code Sec. 51(d)(13)(A). Accordingly, Notice 2015-13 provides that a taxable employer that hired a member of a targeted group, or a qualified tax-exempt organization that hired a qualified veteran, on or after January 1, 2014 and before January 1, 2015, will be considered to have satisfied the requirements of Code Sec. 51(d)(13)(A)(ii) if it submits the completed Form 8850 to request certification, to the appropriate DLA not later than April 30, 2015.

IRS notes that a timely request for certification doesn’t eliminate the need for the employer to receive a certification before claiming the credit.

Whether or not clients can file for retroactive WOTC opportunities is not the only important issue that you should take from this article. If you do not understand how the WOTC is developed; contact your Templeton & Company tax advisor.

It’s not too late to claim a research credit!

IRS has issued final regulations that allow taxpayers that did not claim a research credit on a previously filed return for a given tax year to elect the alternative simplified research credit (ASC) on an amended return for that year. The final regulations replace, largely follow, and somewhat liberalize, temporary regulations that were issued in 2014.

Background. For amounts paid or incurred before Jan. 1, 2015, the research credit for a tax year is an amount equal to the sum of:

  1. 20% of the excess (if any) of the qualified research expenses for the tax year over a base amount -unless the taxpayer elects the ASC;
  2. 20% of the basic research payments (the “university basic research credit”) ; and
  3. 20% of certain amounts paid or incurred to an energy research consortium (the “energy research consortium credit”).

Final regulations had provided that: a) the election to use the ASC may not be made or revoked on an amended return, and may not be revoked except with IRS consent; and b), taxpayers will not be granted an extension of time to make or revoke an ASC election.

In 2014, IRS issued temporary regulations that provided a rule that allows a taxpayer to make an ASC election for a tax year on an amended return. Those regulations provided that a taxpayer that previously claimed, on an original or amended return, a credit for a tax year may not make an ASC election for that tax year on an amended return. In addition, those regulations provided that a taxpayer that is a member of a controlled group in a tax year may not make an election for that tax year on an amended return if any member of the controlled group for that year previously claimed the research credit using a method other than the ASC on an original or amended return for that tax year.

Code Sec. 280C(c)(3) allows a taxpayer to make an annual irrevocable election to claim a reduced research credit rather than reducing the deduction (research and experimental expenditure deduction)

Final regulations largely adopt, and somewhat liberalize, temporary regulations:

In the preamble to the final regulations, IRS also notes that, if a taxpayer is undecided whether to claim the research credit for a tax year but wants to preserve the operative effect of the election for that tax year, then the taxpayer will make the election on line 17 of Form 6765 (Credit for Increasing Research Activities), but leave the remaining section of the form blank. An election on line 17 of Form 6765 made in a tax year does not, in and of itself, constitute a credit claim, and accordingly does not preclude a taxpayer from making an ASC election on an amended return for that tax year.

U.S. Supreme Court Divided Over Obamacare Challenge

On Wednesday March 4th, the U.S. Supreme Court appeared divided on ideological lines as it heard oral arguments on IRS’s regulations under the Affordable Care Act’s (ACA’s) premium tax credit provision. In this second major challenge to President Barack Obama’s healthcare law (Obamacare), Justice Anthony Kennedy appeared to be the possible swing vote in a final decision.

Background on ACA provisions:

The ACA credit is designed to make health insurance affordable for taxpayers who meet certain qualifying requirements. It is available for individuals who purchase affordable coverage through Exchanges.

States may establish and operate Exchanges, or the federal government may establish and operate an Exchange in place of the state where a state has chosen not to do so consistent with federal standards.

Exchanges make premium assistance payments (also called “subsidy” or “advance” payments) on the individual’s behalf to health plans, based on information available at the time of enrollment; then, at return time, the individual reconciles the actual credit that he is due with the amount of the subsidy payments that were made.

In describing the premium assistance amount,  ACA tax credit refers to “the monthly premiums for…qualified health plans offered in the individual market…which were enrolled in through an Exchange established by the State“.

Code Section 5000A requires non-exempt U.S. citizens and legal residents for tax years ending after December 31, 2013 to maintain minimum essential health insurance coverage (e.g., government-sponsored programs such as Medicare, Medicaid, Children’s Health Insurance Program; eligible employer-sponsored plans; plans purchased in the Exchange) or pay a penalty. This requirement is referred to as the “individual mandate” and the penalty as the “shared responsibility payment.”

There are a number of situations in which individuals are exempt from the penalty imposed by Code Sec. 5000A , including where individuals do not have an affordable health insurance coverage option available (i.e., whose required contribution for minimum essential coverage exceeds a percentage of the taxpayer’s household income-8% for 2014, 8.05% for 2015).

The issue:

In May of 2012, IRS issued regulations that interpreted the ACA tax credit to allow credits for insurance purchased on either a State or federally-established Exchange. Specifically, the regulations provide that a taxpayer may receive a tax credit if he is enrolled in one or more qualified health plans through an Exchange, which IRS defined as an Exchange serving the individual market for qualified individuals, regardless of whether the Exchange is established and operated by a State (including a regional Exchange or subsidiary Exchange) or by Health and Human Services (HHS).

By making credits more widely available, the regulation gives the individual and employer mandates-key provisions of the ACA-broader effect than they would have if credits were limited to state-established Exchanges. As noted above, the individual mandate requires individuals to maintain “minimum essential coverage” and enforces that requirement with a penalty. However, the penalty doesn’t apply to individuals for whom the annual cost of the cheapest available coverage, less any tax credits, would exceed 8% of their projected household income.

Most of the 50 states have not created exchanges. Thirteen states and the District of Columbia have set them up, with another 34 run by the federal government and three operating as state-federal hybrids. Thus, by making tax credits available in the states with federal Exchanges, IRS through its regulations significantly increases the number of people who must purchase health insurance or face a penalty.

If the Supreme Court rules against the Obama administration, up to 7.5 million people in at least 34 states would lose the tax subsidies that help low- and moderate-income people buy private health insurance, according to the consulting firm Avalere Health.

Court challenge:

Taxpayers brought suit against IRS and HHS (Health and Human Services), arguing that regulation § 1.36B-1(k) invalidly interpreted the ACA tax credit provision. On November 7, 2014, the Supreme Court agreed to resolve a Circuit split between the Fourth Circuit upholding the regulation.

Oral arguments before the Supreme Court:

In the Supreme Court’s oral arguments on March 4th, Justice Kennedy, a conservative on the nine-member court who often casts the deciding vote in close cases, raised concerns to lawyers on both sides about the possible negative impact on states if the government loses the case, suggesting he could back the Obama administration. But he did not commit to supporting either side.

The Court’s four liberals all appeared supportive of the government, while conservatives Justices Antonin Scalia and Samuel Alito asked questions sympathetic to the challengers. Conservative Justice Clarence Thomas, sticking to his usual practice, asked no questions.

Chief Justice John Roberts, who supplied the key vote in a 5-4 ruling in 2012 upholding the law in the previous challenge, said little during the argument to signal how he might vote.

Justice Kennedy’s concerns focused on the possibility that if the law allows subsidies only for states that set up their own insurance exchanges, it would raise a new, more serious question about whether the law is unconstitutionally coercive by essentially punishing states that fail to establish exchanges. “There’s a serious constitutional problem if we adopt your argument,” he said to the challengers’ lawyer, Michael Carvin. Justice Kennedy later said the states would not be giving states a “rational choice” if they had to either set up exchanges or face losing subsidies for their residents. Justice Kennedy said throwing out subsidies would potentially unlawfully pressure states and cause an insurance “death spiral: but Kennedy added that the challengers may win anyway based on the plain meaning of the provision at issue.

Justice Alito disputed Obama administration lawyer Donald Verrilli’s assertions about the disruptive impact of a ruling that allows subsidies only in states that set up their own exchanges. Justice Alito said states could simply establish new exchanges. “Going forward, there would be no harm,” Alito told Verrilli. It was when Mr. Verrilli noted that people would lose tax credits immediately if the government loses, that Justice Alito suggested that if the court rules against the government in the conservative challenge to Obama’s signature domestic policy achievement, it could give states time to prepare for the impact by saying the ruling would only go into effect at the end of the year.

Justice Scalia also noted that Congress could potentially amend the law, although Mr. Verrilli expressed skepticism that the Republican-led House of Representatives and Senate would do so.

One possible outcome is that the Court could find that the law is ambiguous and defer to the government interpretation of the law. In one of his few remarks, Roberts said that would allow a future president to reverse course.

A decision is due by the end of June.

The Small Business Health Care Credit

What is the Credit?

The Small Business Health Care Credit is designed to help you provide health insurance coverage to your employees. For tax years 2010 through 2013, the credit can be up to 35% of your share of your employees’ health insurance premiums; or, if you’re an eligible tax-exempt employer, up to 25% of your share of premiums.

You are an eligible small employer for the tax year if you meet these three requirements.

  1. You paid premiums for employee health insurance coverage under a qualifying arrangement.
  2. You had fewer than 25 full-time equivalent employees (FTEs) for the tax year. You may be able to meet this requirement even if you had 25 or more employees.
  3. You paid average annual wages for the tax year of less than $50,000 per FTE.

For tax years 2014 and later, there are changes to the credit:

  • The credit can be up to 50% of your share of your employees’ health insurance premiums, or, if you’re an eligible tax-exempt employer, up to 35 percent of your share of premiums.
  • You must purchase insurance for your employees through the Small Business Health Options (SHOP) Marketplace.
  • The credit is only available to you for two consecutive years.

For more information contact a Templeton Tax Professional.

 

 

Benefits of a Health Savings Account

Given the ever-escalating cost of providing employee health care benefits we wanted to inform you of a more cost-effective method of providing these benefits; a health savings account (HSA). For eligible individuals, HSAs offer a tax-favorable way for employees to set aside funds (or their employer can do so) to meet future medical needs. Here are the key tax-related elements:

  • contributions employees make to an HSA are deductible, within limits,
  • contributions employers makes aren’t taxed to you,
  • earnings on the funds within the HSA are not taxed, and
  • distributions from the HSA to cover qualified medical expenses are not taxed.

Employee Requirements:

Who is eligible? To be eligible for an HSA, you must be covered by a “high deductible health plan” (discussed below). You must also not be covered by a plan which (1) is not a high deductible health plan, and (2) provides coverage for any benefit covered by your high deductible plan. (It’s okay, however, to be covered by a high deductible plan along with separate coverage, through insurance or otherwise, for accidents, disability, or dental, vision, or long-term care.)

For 2015, a “high deductible health plan” is a plan with an annual deductible of at least $1,300 for self-only coverage, or at least $2,600 for family coverage. For self-only coverage, the 2015  limit on deductible contributions is $3,350. For family coverage, the 2015 limit on deductible contributions is $6,650. Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,450 for self-only coverage or $12,900 for family coverage.

An individual (and the individual’s covered spouse as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2015 of up to $1,000.

A high deductible health plan does not include a plan if substantially all of the plan’s coverage is for accidents, disability, or dental, vision, or long-term care, insurance for a specified disease or illness, or insurance paying a fixed amount per day (or other period) of hospitalization.

HSAs may be established by, or on behalf of, any eligible individual.

Deduction limits. You can deduct contributions to an HSA for the year up to the total of your monthly limitations for the months you were eligible. For 2015, the monthly limitation on deductible contributions for a person with self-only coverage is 1/12 of $3,350. For an individual with family coverage, the monthly limitation on deductible contributions is 1/12 of $6,650. Thus, deductible contributions are not limited by the amount of the annual deductible under the high deductible health plan.

Also, taxpayers who are eligible individuals during the last month of the tax year are treated as having been eligible individuals for the entire year for purposes of computing the annual HSA contribution.

However, if an individual is enrolled in Medicare, he is no longer an eligible individual under the HSA rules, and so contributions to his HSA can no longer be made.

Contributions may be made to an HSA by or on behalf of an eligible individual even if the individual has no compensation, or if the contributions exceed the individual’s compensation. Contributions made by a family member on behalf of an eligible individual to an HSA (which are subject to the limits described above) are deductible by the eligible individual in computing adjusted gross income.

Further, on a once-only basis, taxpayers can withdraw funds from an IRA, and transfer them tax-free to an HSA. The amount transferred can be up to the maximum deductible HSA contribution for the type of coverage (individual or family) in effect at the time of the transfer. The amount so transferred is excluded from the taxpayer’s gross income, and is not subject to the 10% early withdrawal penalty.

Employer contributions. If you are an eligible individual, and your employer contributes to your HSA, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from your gross income up to the deduction limitation, as described above. Further, the employer contributions are not subject to withholding from wages for income tax or subject to FICA or FUTA. The eligible individual cannot deduct employer contributions on his federal income tax return as HSA contributions or as medical expense deductions.

An employer that decides to make contributions on its employees’ behalf must make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer does not make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.

Contributions are comparable if they are either: (1) the same amount; or (2) the same percentage of the annual deductible limit under the high deductible health plan covering the employees. For these purposes, comparable participating employees (1) are covered by the employer’s high deductible health plan and are eligible to establish an HSA; (2) have the same category of coverage (either self-only or family coverage); and (3) have the same category of employment (either part-time or full-time). (IRS regulations provide detailed guidelines for comparable contributions.)

An exception to the comparable contribution requirements applies for contributions made on behalf of non-highly compensated employees. Under this exception, an employer may make larger HSA contributions for non-highly compensated employees than for highly compensated employees.

Employer contributions are also excludable if made at the election of the employee under a salary reduction arrangement that is part of a cafeteria plan (i.e., a plan which allows you to elect to use part of your salary towards a variety of benefits). Although contributions to an employee’s HSA through a cafeteria plan are treated as employer contributions, the comparability rule does not apply to contributions made through a cafeteria plan.

Earnings. If the HSA is set up properly, it is generally exempt from taxation, and there is no tax on earnings. However, taxes may apply if contribution limitations are exceeded, required reports are not provided, or prohibited transactions occur.

Distributions. Distributions from the HSA to cover an eligible individual’s qualified medical expenses, or those of his spouse or dependents, are not taxed. Qualified medical expenses for these purposes generally mean those that would qualify for the medical expense itemized deduction. If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it is made after reaching age 65, or in the event of death or disability.

Distributions from an HSA exclusively to pay for qualified medical expenses are excludable from the gross income of the account beneficiary even though the beneficiary is no longer an “eligible individual,” e.g., the individual is over age 65 and entitled to Medicare benefits, or no longer has a high deductible health plan.

As you can see, HSAs offer a very flexible option for providing health care coverage, but the rules are somewhat involved. Again, please call if you would like to discuss this topic further.

Templeton & Company Ranks as One of South Florida’s Top Charitable Giving Firms

West Palm Beach, Fla. – January 8, 2015 – Templeton & Company, a leading accounting and business consulting firm in South Florida was ranked among the top charitable giving corporations in South Florida by The South Florida Business Journal for the second year in a row.

The firm supports a variety of nonprofit organizations throughout South Florida and encourages all staff members and partners to contribute to the communities in which they live and work. Templeton believes giving back to the community has a powerful impact with lasting benefits for everyone.

“We’ve found that giving of yourself is a sure way to success and happiness, for ‘where your treasure is, there will your heart be also.’” said Steven Templeton, managing partner, Templeton & Company.

About Templeton & Company

Founded in 1990, Templeton & Company, LLP is a professional services firm providing comprehensive business solutions to help its clients discover and realize their vision for success. Located in West Palm Beach and Fort Lauderdale, Fla., the firm provides consulting services to businesses in multiple industries with a focus on audit, accounting, business valuations, and tax. Templeton & Company is also an independent member of the BDO Alliance USA, a nationwide network of leading CPA firms. For more information about Templeton, its people, services, experience, and alliances, visit www.templetonco.com.

Charity Auctions: Reporting and Tax Rules

By R. Michael Sorrells, CPA

While neither charity auctions nor the various rules governing them are new, we receive numerous questions about them and observe many examples of inadequate auction procedures by both large and small organizations.

Charity auctions (silent or live) typically sell merchandise or services that are donated to the organization. Thus, the first requirement for the organization is to acknowledge the donation of the item to be auctioned. Often, this step is missed, as the organization is more concerned about reporting to the purchaser and not the donor. If the donated item may have a $250 or higher fair market value (FMV), then the organization should be sending out acknowledgement letters with certain required language, including that no goods or services were received in exchange for the donation. This acknowledgement is required if the donor is going to take a tax deduction for the donation. For donated items, the organization should not put the value of the item on the acknowledgement letter, even though the donor may have provided it. The donor is responsible for valuing the donated item on his/her tax return and the rules can vary significantly here. For example, if the donation is from the donor’s inventory, the donor’s deduction may be different than if the donation is from the donor’s art collection.

Also, if the appraised value of the gift is greater than $5,000, the donor may be giving the charity a Form 8283 to sign. If this is the case, when the item is sold at the auction, the charity will be required to file Form 8282 with the IRS that indicates the donated item was sold and the price at which it was sold.

Similar acknowledgement rules apply to the purchasers at the auction when they spend $250 or more on an item. The organization should send them an acknowledgement for the purchase, but in this case the letter should tell them how much of the purchase price is for the goods and services received (not deductible) and how much is in excess of that
amount (deductible).

Often, donors to a charity auction donate use of a vacation home or personal services (for example, cooking a dinner) to be auctioned off. However, donations for use of facilities or services do not qualify as charitable deductions. In this case, it may be prudent for the organization to tell donors in advance that it is their understanding that these types of gifts are not tax-deductible, but that they should consult their tax advisors.

Another rule requires the organization to inform the donor of tax deductibility for event tickets or purchases of $75 or more (IRC Section 6115(a)). Failure to do this can result in penalties to the organization and disclosure of compliance is one of the questions on the Form 990. Under these “quid pro quo” rules for event tickets or purchases of $75 or more,
the organization is responsible for informing the purchaser as to how much of the purchase price is a donation and how much is for goods and services. In other words, any excess over the FMV of an item is a donation. If the purchase price does not exceed the FMV, then there is no donation by the purchaser (which is often the case). The easiest way to inform auction purchasers of FMV is to provide the information on the program. The value of each item should be listed and there should be prominent language saying that only the amount paid in excess of value is allowable as a charitable deduction. It is important that the retail value of the item be used on this listing—not simply its cost, as it may have
been purchased at a discount or produced by the donor. Often, the donor of the item can provide this information; if not, the organization will have to do some research. The valuation can be a good faith estimate.

Another area often ignored with charitable auctions is sales or local tax. Most states (and some localities) tax sales of merchandise by charitable organizations; having an exemption from paying sales tax is not an exemption from collecting it. Many organizations already are engaged in the sale of merchandise and are already registered with the state where the auction is occurring. However, when an organization does not ordinarily engage in merchandise sales or is conducting an auction in another state, it may be required to register and collect sales tax even for a one-time event. Some states have exclusions from registration and collection of tax for “occasional” sales and for charitable fundraising. So it is important to research sales tax issues well before the planned auction date.

Lastly, for the Form 990, charitable auctions will be reported as a fundraising activity on the revenue section (Part VIII) and, if above certain thresholds, on Schedule G. The donation portion of the receipts is reported on Line 1c for Part VIII as donations, while the value of purchased items (the FMV) goes on line 8a of Part VIII as gross income. Schedule G requires a listing of all fundraising events with a little more detail. The net income of the fundraising event will generally be shown in the “excluded” column of Part VIII, as it usually fits an exclusion from unrelated business
income either because of selling donated merchandise, use of primarily donated merchandise in the activity or because the activity is not regularly carried on (once a year or less in frequency). While charity auctions may be lucrative fundraisers, it is important to know and comply with the rules in order to keep the IRS, donors and state taxing authorities happy.

For more information contact a Templeton Advisor.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2014). Copyright © 2014 BDO USA, LLP. All rights reserved. www.bdo.com