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By Editor, December 20, 2011

Expiring Business Tax Provisions: According to a Congressional Research Service report dated 12/1/11, the following will expire on 12/31/11: (1) the research and development and the work opportunity tax credits; (2) the enhanced charitable deductions for contributions of food, books, and computer technology; (3) the special S corporation built-in gains tax suspension period; and (4) the 15-year recovery period for leasehold improvements, restaurant property, and retail improvements. Furthermore, the 100% bonus depreciation deduction will be scaled back to 50% in 2012, and the Section 179 deduction limit will fall from $500,000 this year to an inflation-adjusted $139,000 in 2012.

Expiring Individual Tax Provisions: According to the same Congressional Research Service report, the following deductions will expire on 12/31/11: (1) elementary and secondary school teacher expenses, (2) state and local sales taxes, (3) mortgage insurance premiums, and (4) qualified tuition and related expenses. The 2010 Tax Relief Act allowed a taxpayer’s nonrefundable personal credits to offset regular tax (net of any allowable foreign tax credit) and AMT for 2011, and also authorized a reduction in the employee’s share of the Social Security payroll tax to 4.2% for 2011. Congress may extend the payroll tax break, and presumably will pass another (one year) AMT patch. Finally, the tax-free treatment of distributions from IRAs for charitable purposes will expire at the end of 2011.

Recharacterizing S Corporation Distributions: S corporation taxable income passed through to a shareholder-employee and S corporation distributions paid to a shareholder-employee are not subject to federal employment taxes or self-employment tax. While this has tempted some shareholder-employees to reduce or even eliminate their salary to avoid employment taxes, the IRS can recharacterize distributions as disguised salary. In one recent case, the S corporation paid its sole shareholder an annual salary of $24,000, but also made distributions of $320,000 over a two-year period. In holding that $67,000 of each year’s distribution should be treated as salary (on top of the $24,000 salary already paid), the District Court noted that the shareholder was a highly qualified accountant with an advanced degree, and was a primary earner in a reputable firm with $5 million in gross revenue over the two-year period. Watson, P.C. v. U.S. , 107 AFTR 2d 2011-311 (DC Iowa).

Portability Election: Executors for the estates of decedents dying after 12/31/10 must file Form 706 , even if not otherwise required to do so, to make the portability election under IRC Sec. 2010(c)(5) allowing the surviving spouse to use the unused portion of the decedent’s exclusion ($5,000,000 in 2011 and $5,120,000 in 2012). This notice alerted taxpayers that the timely filing of Form 706, prepared in accordance with the instructions, will constitute the appropriate portability election for the unused exclusion. Estates not wanting to make the portability election whose gross value exceeds the applicable exclusion should follow the Form 706 instructions. [IRS Notice 2011-82, 2011-42 IRB 516.

Relief for 2010 Decedents: This notice provided estates of decedents who died in 2010 with additional time to file an estate tax return and to pay the estate tax due. The IRS will not impose late filing and late payment penalties on the estates of decedents who died after 12/31/09 and before 12/17/10 if the estate timely files Form 4768 [Application for Extension of Time to File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes], and then files Form 706 or Form 706-NA and pays the estate tax by 3/19/12. Similar relief is available to the estates of decedents who died after 12/16/10 and before 1/1/11 if the estate timely files Form 4768 and then files Form 706 or Form 706-NA and pays the estate tax within 15 months after the decedent’s death. Furthermore, the due date of Form 8939 (Allocation of Increase in Basis for Property Acquired from a Decedent) is delayed from 11/15/11 to 1/17/12. Finally, this notice provided penalty relief to certain persons who received property whose basis is determined under the Section 1022 carryover basis rules and then disposed of that property during 2010. Notice 2011-76, 2011-40 IRB 479.

Bonus Depreciation: In this revenue procedure, the IRS explained how the 100% bonus depreciation rules under IRC Sec. 168(k) will be applied. In part, the IRS (1) allowed 100% bonus depreciation for qualified restaurant or retail improvement property that also qualify as leasehold improvement property; (2) enabled taxpayers that placed qualified property in service in the tax year that includes 9/9/10 to elect out of bonus depreciation for any class of property, or default into bonus depreciation for the whole year, or claim 50% bonus depreciation for the whole year; and (3) provided a safe harbor method for handling post-year-of acquisition depreciation of autos subject to the Section 280F(a) luxury auto limits. Rev. Proc. 2011-26, 2011-16 IRB 664 .

Employer-provided Cell Phones: Almost a year after the removal of cell phones from the definition of listed property by the 2010 Small Business Jobs Act, the IRS issued guidance treating an employee’s use of a cell phone related to the employer’s business as an excludable working condition fringe benefit under IRC Sec. 132(d) when provided for substantial noncompensatory business reasons. Examples of substantial noncompensatory business reasons for providing a cell phone include the need to contact an employee at all times for work-related emergencies, and the need to speak with clients while away from the office or when the client is in another time zone. Notice 2011-72, 2011-38 IRB 407

Rental Real Estate Activities: Under IRC Sec. 469(c)(7)(A) and Reg. 1.469-9(g) , qualifying taxpayers can elect to treat all interests in rental real estate activities as a single activity. This can help them meet the material participation standard necessary to treat rental real estate losses as nonpassive (and so be used to offset wages, interest, and other nonpassive income). The IRS issued special procedures, in lieu of a letter ruling request, to obtain relief for late elections. To qualify, the taxpayer must have reasonable cause for failing to meet the election requirements, and must have filed all tax returns as if the election had been made. Rev. Proc. 2011-34, 2011-24 IRB 875.

Sale of Professional Practice: In this case, the 9th Circuit affirmed a District Court’s finding that amounts received by the taxpayer for personal goodwill from the sale of his dental practice represented the sale of a corporate asset and a subsequent dividend distribution. In the same year the taxpayer incorporated his dental practice, he entered into a covenant not to compete with the corporation. As an employee of the corporation with a covenant not to compete, any goodwill generated from his professional work belonged to the corporation. While the patient relationships were personal, the economic value of those relationships did not belong to the taxpayer. Howard v. U.S. , 108 AFTR 2d 2011-5993 (9th Cir.).

Standard Mileage Rates: The IRS raised the standard mileage rates for the last six months of 2011 to 55.5 cents per mile for business miles driven and 23.5 cents per mile for medical or moving expenses-both a 4.5 cent per mile increase over the rates in effect for the first six months of the year. The rates for 2012 will be 55.5 cents per mile for business miles (with 23 cents per mile treated as depreciation) and 23 cents per mile for medical or moving expenses. (This means the rate for business miles is unchanged from the midyear adjustment that took effect on 7/1/11.) The rate for providing services for a charity is set by statute and equals 14 cents per mile. IRS Ann. 2011-40, 2011-29 IRB 56 ; Notice 2012-1, 2012-1 IRB 1 .

If you would like to discuss these, or other matters, further,
please contact your Wilson Price accountant.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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By Editor, November 10, 2010

The IRS has still not finalized the form executors will use to report and allocate the basis of property received from a decedent in 2010.

We do know for certain, however, that a lot of information will be required for this filing.

Required Reporting

If you are an executor of a 2010 decedent, you will be required to file an informational return with the decedent’s final income tax return if:

The fair market value of all property (other than cash) exceeds $1,300,000 or

• The decedent transferred assets by gift or other lifetime transfer for which a gift tax return was required within the three year period preceding the decedent’s death

Note: if the decedent was a Nonresident, noncitizen of the United States, the filing is required if property situated in the United States exceeds $60,000

Information needed for preparation of the form

The form will be due April 15, 2011 along with the decedents final FORM 1040 return, with extensions permitted.  Executors will need to gather the following information to assist in preparation of the form.

• The decedent’s death certificate
• Marital status of the decedent
• Legal domicile and year domicile established
• Executor name, address and social security number
• Full name and social security number for surviving spouse
• Full name and social security number for all other beneficiaries
• Certified copy of decedent’s will
• Copy of decedent’s most recently filed individual income tax return
• A list of all assets owned by the decedent, solely and jointly with others, including:
  • A description of the asset
  • Date decedent acquired the asset
  • Indication if asset was acquired by gift
  • Adjusted basis of the asset at decedent’s date of death
  • Fair market value of the assets at decedent’s date of death
  • Indication if any gain in the asset would be an ordinary gain

Written statement to beneficiaries

After filing the informational form, executors will have 30 days to provide to each beneficiary a written statement that includes the information reported with respect to the property that the beneficiary acquired from the decedent. Failure to provide each beneficiary with this statement could result in a penalty of $50 for each failure.

Allocation of basis

In this year of estate tax repeal, the basis “step-up” rules do not apply.  Instead, basis of assets received from a decedent is the lesser of (1) the adjusted basis of the property at the decedent’s date of death or (2) the fair market value of the property at the decedent’s date of death.  Thus, a “step-down” is a possibility.  The law provides, however, basis increases for certain property.  The allocation of basis increases will be reported on the same form above.

General basis adjustment - a basis adjustment increase is allowed for any property acquired from a decedent for up to $1.3 million.  The executor will allocate this amount among the unrealized gains of the assets of the estate, as seen appropriate.

Additional basis adjustment – an additional increase of up to $3 million can also be applied to qualified spousal property, which would include property transferred to the spouse outright or to a QTIP trust where the spouse has a qualified income interest for life. 

Increases to basis adjustment amounts – if the decedent had any losses, such as capital loss carryforwards, net operating loss carryforwards, or certain built-in losses in 2010, these amounts could increase the general basis adjustment by the amount of the losses.  Additionally, if any assets received a “step-down” in the basis allocation process, the general basis adjustment of $1.3 million would be increased by that amount as well, thus keeping the aggregate increase in values at $1.3 million.

Property ownership

The basis increase adjustments cannot be allocated to property not owned by the decedent at death, which might be questionable in certain situations that are specifically addressed in the code.

Owned by decedent – property transferred by the decedent to a qualified revocable trust is considered to be owned by the decedent.  Additionally, if the decedent has at least one-half interest in community property, then for purposes of fulfilling the ownership requirement, this asset is considered 100% owned.

Not owned by decedent – the decedent is not considered to own property by means of holding a power of appointment over such property.

Partially owned by decedent:

• Jointly owned with surviving spouse – the decedent is considered to be owner of one-half of the property.          
• Jointly owned with someone other than spouse – the decedent is considered owning a percentage proportionate to the consideration provided.
• Jointly owned with someone other than spouse and was acquired by gift, bequest or inheritance – if parties interests are not otherwise fixed, the decedent is considered to own a percentage equal to one over the number of tenants.

Other information

There are additional provisions that should be considered:

• If the decedent is a nonresident, noncitizen of the United States, the basis increase adjustment is limited to $60,000
• IRAs, retirement plan benefits and other items of income in respect of a decedent (IRD) are not eligible for the basis increase adjustment
• Property acquired by the decedent by gift or other intervivos transfers for less than adequate consideration during the three year period preceding the date of death are not eligible for the basis increase adjustment

Penalties

Failure to report information to the IRS regarding an estate valued over $1.3 million or for certain transfers made within three years of death, will subject the executor to a penalty of $10,000. If the failure to report was an intentional disregard of the rules, the penalty could be as much as 5% of the fair market value of the property for which reporting was required.

So where is the form?

An unofficial draft (FORM 8939) has been circulating amongst professionals, but has not been officially released by the IRS.  IRS representatives say the official draft will be released to the public on their website, www.irs.gov. 

Please contact us if we can help you navigate through the administration of a 2010 estate.