Lawmakers from both parties spent much of June debating and discussing tax reform, but without giving many details of what a comprehensive tax reform package could look like before year-end. At the same time, several bipartisan tax bills have been introduced in Congress, which could see their way to passage.

Lawmakers from both parties spent much of June debating and discussing tax reform, but without giving many details of what a comprehensive tax reform package could look like before year-end. At the same time, several bipartisan tax bills have been introduced in Congress, which could see their way to passage.

Tax reform

House Speaker Paul Ryan, R-Wisc., predicted that tax reform would be accomplished in 2017. “Transformational tax reform can be done, and we are moving forward," Ryan said in June. We need to get this done in 2017. We cannot let this once-in-a-generation moment slip by.” Last year, House Republicans unveiled their “Better Way Blueprint,” which sets principles for tax reform, including lower individual tax rates, a reduced corporate tax rate, and a border adjustment tax, among other measures.

“Republicans have been afraid to expose their Blueprint to scrutiny,” Rep. Lloyd Doggett, D-Texas, a senior member of the House Ways and Means Committee, said. “The Republican Blueprint is both the wrong way for tax policy and the wrong way to legislate tax reform,” Doggett said.

In the Senate, the chair of the Senate Finance Committee (SFC), Orrin Hatch, R-Utah, asked stakeholders for input on tax reform. Hatch requested recommendations on individual, business and international tax reform. "After years of committee hearings, public statements, working groups, and conceptual exercises, Congress is poised to make significant steps toward comprehensive tax reform," Hatch said. “As we work to achieve those goals, it is essential that Congress has the best possible advice and insight from experts and stakeholders," he added.

Sen. Ron Wyden, D-Oregon, is ranking member of the SFC and urged lawmakers to take a bipartisan approach to tax reform. "The only way to pass lasting, job-creating tax reform that’s more than an economic sugar-high is for it to be bipartisan," Wyden said. "Tax reform takes a lot of careful consideration to write a bipartisan tax reform bill, and I know because I’ve written two of them."

Small business

The Senate Small Business Committee explored tax reform at a hearing in June. “Tax compliance costs are 67 percent higher for small businesses," Committee Chair James Risch, R-Idaho, said. Ranking member Jeanne Shaheen, D-N.H., said that “small businesses spend 2.5-billion hours complying with IRS rules.”

Mark Mazur, former Treasury assistant secretary for tax policy, was one of the experts who testified before the committee. Mazur said that small businesses generally have a larger per-unit cost of tax compliance than larger businesses. “One particular area that adds to the complexity of complying with the tax code is accrual accounting,” he said.

Other tax legislation

In June, the House passed HR 1551, a bipartisan bill. The legislation generally modifies the tax credit for advanced nuclear power facilities.

A number of bipartisan stand-alone tax bills have been introduced in Congress recently. They include:

• The Invent and Manufacture in America Bill, a bipartisan bill that would enhance the research tax credit. Generally, the bill would increase the value of the credit by up to 25 percent for qualified research activities.
• The Graduate Student Savings Bill, introduced by a group of Senate Democrats and Republicans. The bill would generally allow funds from a graduate student’s stipend or fellowship to be deposited into an individual retirement account (IRA).
• The Adoption Tax Credit Refundability Act is another bipartisan bill. The measure generally would enhance the adoption tax credit.
• Another bipartisan proposal would treat bicycle sharing systems as mass transit facilities for purposes of qualified transportation fringe benefits.

Additionally, a group of House Democrats and Republicans wrote to Treasury Secretary Steven Mnuchin in June. The bipartisan group of lawmakers asked Mnuchin to preserve the state and local sales tax deduction in any tax reform plan.

If you have any questions about tax reform, please contact our office.

The much-anticipated regulations (REG-136118-15) implementing the new centralized partnership audit regime under the Bipartisan Budget Act of 2015 (BBA) have finally been released. The BBA regime replaces the current TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) procedures beginning for 2018 tax year audits, with an earlier "opt-in" for electing partnerships. Originally issued on January 19, 2017 but delayed by a January 20, 2017 White House regulatory freeze, these re-proposed regulations carry with them much of the same criticism leveled against them back in January, as well as several modifications. Most importantly, their reach will impact virtually all partnerships.

The much-anticipated regulations (REG-136118-15) implementing the new centralized partnership audit regime under the Bipartisan Budget Act of 2015 (BBA) have finally been released. The BBA regime replaces the current TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) procedures beginning for 2018 tax year audits, with an earlier "opt-in" for electing partnerships. Originally issued on January 19, 2017 but delayed by a January 20, 2017 White House regulatory freeze, these re-proposed regulations carry with them much of the same criticism leveled against them back in January, as well as several modifications. Most importantly, their reach will impact virtually all partnerships.

Scope

Under the proposed regulations, to which Congress left many details to be filled in, the new audit regime covers any adjustment to items of income, gain, loss, deduction, or credit of a partnership and any partner’s distributive share of those adjusted items. Further, any income tax resulting from an adjustment to items under the centralized partnership audit regime is assessed and collected at the partnership level. The applicability of any penalty, addition to tax, or additional amount that relates to an adjustment to any such item or share is also determined at the partnership level.

Immediate Impact

Although perhaps streamlined and eventually destined to simplify partnership audits for the IRS, the new centralized audit regime may prove more complicated in several respects for many partnerships. Of immediate concern for most partnerships, whether benefiting or not, is how to reflect this new centralized audit regime within partnership agreements, especially when some of the procedural issues within the new regime are yet to be ironed out.

Issues for many partnerships that have either been generated or heightened by the new regulations include:

• Selecting a method of satisfying an imputed underpayment;
• Designation of a partnership representative;
• Allocating economic responsibility for an imputed underpayment among partners including situations in which partners’ interests change between a reviewed year and the adjustment year; and
• Indemnifications between partnerships and partnership representatives, as well as among current partners and those who were partners during the tax year under audit.

Election out

Starting for tax year 2018, virtually all partnerships will be subject to the new partnership audit regime …unless an “election out” option is affirmatively elected. Only an eligible partnership may elect out of the centralized partnership audit regime. A partnership is an eligible partnership if it has 100 or fewer partners during the year and, if at all times during the tax year, all partners are eligible partners. A special rule applies to partnerships that have S corporation partners.

Consistent returns

A partner’s treatment of each item of income, gain, loss, deduction, or credit attributable to a partnership must be consistent with the treatment of those items on the partnership return, including treatment with respect to the amount, timing, and characterization of those items. Under the new rules, the IRS may assess and collect any underpayment of tax that results from adjusting a partner’s inconsistently reported item to conform that item with the treatment on the partnership return as if the resulting underpayment of tax were on account of a mathematical or clerical error appearing on the partner’s return. A partner may not request an abatement of that assessment.

Partnership representative

The new regulations require a partnership to designate a partnership representative, as well as provide rules describing the eligibility requirements for a partnership representative, the designation of the partnership representative, and the representative’s authority. Actions by the partnership representative bind all the partners as far as the IRS is concerned. Indemnification agreements among partners may ameliorate some, but not all, of the liability triggered by this rule.

Imputed underpayment, alternatives and "push-outs"

Generally, if a partnership adjustment results in an imputed underpayment, the partnership must pay the imputed underpayment in the adjustment year. The partnership may request modification with respect to an imputed underpayment only under the procedures described in the new rules.

In multi-tiered partnership arrangements, the new rules provide that a partnership may elect to "push out" adjustments to its reviewed year partners. If a partnership makes a valid election, the partnership is no longer liable for the imputed underpayment. Rather, the reviewed year partners of the partnership are liable for tax, penalties, additions to tax, and additional amounts plus interest, after taking into account their share of the partnership adjustments determined in the final partnership adjustment (FPA). The new regulations provide rules for making the election, the requirements for partners to file statements with the IRS and furnish statements to reviewed year partners, and the computation of tax resulting from taking adjustments into account.

Retiring, disappearing partners

Partnership agreements that reflect the new partnership audit regime must especially consider the problems that may be created by partners that have withdrawn, and partnerships that have since dissolved, between the tax year being audited and the year in which a deficiency involving that tax year is to be resolved. Collection of prior-year taxes due from a former partner, especially as time lapses, becomes more difficult as a practical matter unless specific remedies are set forth in the partnership agreement. The partnership agreement might specify that if any partner withdraws and disposes of their interest, they must keep the partnership advised of their contact information until released by the partnership in writing.

If you have any questions about how your partnership may be impacted by these new rules, please feel free to call our office.

With the release of regulations on centralized partnership audits, many taxpayers hope that it will signal the re-start of a regular flow of much-needed guidance from the Treasury Department and the IRS that has been virtually stopped dead in its tracks since January 20. Others caution that the floodgates have not been opened and that the impact of several Executive Orders in discouraging guidance will be felt well into next year. Also bearing upon the recent lack of guidance are the critical vacancies within Treasury’s Office of Tax Policy that have been taking longer than usual to fill.

With the release of regulations on centralized partnership audits, many taxpayers hope that it will signal the re-start of a regular flow of much-needed guidance from the Treasury Department and the IRS that has been virtually stopped dead in its tracks since January 20. Others caution that the floodgates have not been opened and that the impact of several Executive Orders in discouraging guidance will be felt well into next year. Also bearing upon the recent lack of guidance are the critical vacancies within Treasury’s Office of Tax Policy that have been taking longer than usual to fill.

Reports are that Treasury officials have been working behind-the-scenes in drafting a new guidance plan. The plan not only includes prospects for new guidance but also a fresh look at recent guidance that may need to be withdrawn or streamlined. A June 21 deadline set by Executive Order 13777, for Treasury, among other federal agencies, to show progress in "identifying regulations for repeal, replacement or modification," reportedly has been met but details will not be made public.

Likewise, a 60-day deadline within Executive Order 13789 also ended June 21 for Treasury to review all significant tax regulations issued since January 1, 2016. That latter report consists of an interim report to the President that identifies those regulations that (i) impose an undue financial burden on United States taxpayers; (ii) add undue complexity to the federal tax laws; or (iii) exceed the statutory authority of the Internal Revenue Service. No indication has been made regarding whether that report will be made public. A full report is due in another three months.

In the meantime, Treasury on June 12 requested public comments and recommendations for Treasury, pursuant to Executive Order 13777, on regulations "that can be eliminated, modified, or streamlined in order to reduce burdens," carrying a 45-day deadline. Based on the Executive Orders, consensus is also that the IRS’s next "Priority Guidance Plan" will carry significant amendments from the last one.

What’s on the chopping block?

In an effort to preview what recommendations and action may result from the EOs, here is a list of some of the regulations that are most likely to be amended or withdrawn, based upon feedback from a variety of stakeholders that have weighed in so far with public comments: .

Comment. Stakeholder responses have not always been negative, with the recognition that complexity is inherent in certain rules that are the result of complex legislative provisions that only Congress can change.

Debt/Equity: TD 9790. Final regulations under Code Sec. 385 address the recharacterization of debt as equity in certain situations with the purpose of minimizing erosion of the federal income tax base. These regs are at the top of many stakeholders’ lists of those rules that should be withdrawn. Complaints focus on both the scope of the regulations being too broad and the documentation and analysis requirements that begin in 2018 as being too burdensome for intercompany debt issuance.

Serial inverters: TD 9761. Final and temporary regulations under Code Sec. 7874 are designed, in particular, to prevent "serial inverters" in which a foreign entity completes a number of U.S. domestic acquisitions in a manner that circumvents the application of Code Sec. 7874. Some taxpayers complain that the rules are overly complex and present risks and burdens on taxpayers engaged in “run-of-the-mill” cross border mergers and acquisitions.

Spin-offs: REG-134016-15. These proposed regulations would tighten the requirements for corporations to spin off controlled corporations tax-free to their shareholders, along with providing new bright-line standards for triggering the device test and for satisfying the active trade or business test. These regs are criticized as being susceptible to being applied too broadly by the IRS. In addition, asset valuation rules set forth in those regs have not been drafted to reflect other legitimate concerns, according to critics.

Estate tax valuation: REG-163113-02. These regulations would change the valuation of interests in family-owned business for estate, gift and generating-skipping transfer tax purposes. Many stakeholders report that these regs under Code Sec. 2704 go too far in preventing abuse of existing rules by being too broad and preventing valuation discounts for lack of control and marketability.

Consistent basis for estates/beneficiaries: REG-127923-15. These regulations under Code Secs. 1014(f) and 6035 require consistent basis reporting between estates and the person acquiring property from the descendent by requiring basis reporting. Complaints lodged against these proposed regs include overreaching on the zero basis rule and supplemental filings that can span over many years.

Leveraged partnership/disguised sales: TDs 9787 and 9788. These regulations address disguised sales and allocation of liabilities and introduce restrictions on leveraged partnership transactions. Criticism of these regs focuses primarily on the fact the rules no longer allow a partner full basis on guaranteed debt for purposes of determining if there has been a taxable event when debt is transferred to the partnership, even when that guarantee meets the requirements of the new final rules concerning debt guarantees.

Foreign partner transfers: TD 9814, REG-127203-15. Temporary and proposed regulations under Code Sec. 721 address transfers of appreciated property by U.S. persons to partnerships with foreign partners related to the transferor. Complaints against these regs include their overly-broad reach when anti-abuse rules would suffice, their retroactive application, and their required use of the remedial method under Code Sec. 704(c).

Withholding on foreign investors: TD 9815. Effective January 1, 2018, regulations would impose withholding tax on what critics have characterized as a broad universe of transactions that have generally been viewed as non-abusive. Critics have said that these prospective dividend equivalent rules are costly for the financial industry, making U.S.-issued stocks and securities much less attractive to international investors.

Tax-exempt bonds: REG-129067-15. These proposed reliance regulations provide a new definition of a political subdivision for tax-exempt bonds. Critics say the rules impose overly broad restrictions that may limit infrastructure projects.

No. The IRS continues to treat virtual currency as property for U.S. federal tax purposes. However, last year, a government watchdog, and this year, a group of lawmakers, urged the IRS to clarify its virtual currency guidance.

No. The IRS continues to treat virtual currency as property for U.S. federal tax purposes. However, last year, a government watchdog, and this year, a group of lawmakers, urged the IRS to clarify its virtual currency guidance.

The IRS has described virtual currency as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Virtual currency is sometimes referred to as “cryptocurrency” or “digital currency.” Virtual currency does not have legal tender status in the U.S., even though many people use virtual currency. “Real” currency, such as the U.S. dollar, is defined by the Treasury Department as "the coin and paper money of the United States or of any other country designated as legal tender and circulates and is customarily used and accepted as a medium of exchange in the country of issuance."

Virtual currency may have an equivalent value in real currency. This type of virtual currency is referred to as “convertible” virtual currency. “Bitcoin” is an example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars and other real or virtual currencies.

The growth in virtual currency has brought tax questions. In 2014, the IRS announced that virtual currency is treated as property for U.S. federal tax purposes.  General tax principles that apply to property transactions apply to transactions using virtual currency.  The IRS explained that:

• Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
• Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply.  Normally, payers must issue Form 1099.
• The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
• A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. 

Since the IRS issued guidance in 2014, the agency has been largely quiet on the subject of virtual currency. The IRS did state, in court documents filed in a lawsuit this year, that less than 1,000 individual income tax returns in 2015 reported using a transaction using virtual currency.

Last year, a government watchdog, the Treasury Inspector General for Tax Administration (TIGTA), recommended that the IRS revisit virtual currency.  TITGA noted the growing use of virtual currency. “However, some virtual currencies are also popular because the identity of the parties involved is generally anonymous, leading to a greater possibility of their use in illegal transactions,” TIGTA cautioned.

In June, several lawmakers asked the IRS to describe the agency’s virtual currency strategy. The lawmakers also asked the agency what outreach and education it has done for stakeholders. In their letter, the lawmakers directed the IRS to reply to their questions. As of the date this article was prepared, the lawmakers have not released the agency’s response, if there was a reply.

If you have any questions about the federal tax treatment of virtual currency, please contact our office.

Every year, millions of post-secondary students access the IRS Data Retrieval Tool (DRT) to complete the Free Application for Federal Student Aid (FAFSA). This year, the DRT is unavailable for FAFSA filers because of cybersecurity concerns. The information needed to complete the FAFSA can be found on a previously filed federal income tax return.

Every year, millions of post-secondary students access the IRS Data Retrieval Tool (DRT) to complete the Free Application for Federal Student Aid (FAFSA). This year, the DRT is unavailable for FAFSA filers because of cybersecurity concerns. The information needed to complete the FAFSA can be found on a previously filed federal income tax return.

FAFSA

To apply for federal student aid, an individual must complete and submit the FAFSA. He or she will automatically be considered for federal student aid. In addition, the individual's post-secondary institution may use his or her FAFSA information to determine eligibility for nonfederal aid. The DRT provides tax data that automatically fills in information for part of the FAFSA form.

Individuals who plan to attend post-secondary schools from July 1, 2017 to June 30, 2018 must submit the 2017-2018 FAFSA. Individuals will need tax information from 2015 to complete the 2017-2018 FAFSA.

Suspicious activity

Earlier this year, the IRS reported that cybercriminals may have tried to obtain tax information through the DRT. The agency's security filters identified fraudulent returns using information obtained from the DRT. According to the IRS, as many as 100,000 taxpayer accounts may have been compromised through the DRT by cyberthieves. In response, the IRS took the DRT offline.

Work-around

FAFSA filers can manually provide their tax return information, the IRS has instructed. Our office can help you prepare a FAFSA while the DRT is offline.

FAFSA filers can also use the IRS's online Get Transcript Tool. Individuals can obtain a Tax Return Transcript, which reflects most line items including adjusted gross income (AGI) from the original tax return filed, along with any forms and schedules. This transcript is only available for the current tax year and returns processed during the prior three years. Individuals can also obtain a Tax Account Transcript, which reflects basic data such as return type, marital status, adjusted gross income, taxable income and all payment types. This transcript is available for the current tax year and up to 10 prior years. Keep in mind that a transcript is not a photocopy of the return. A transcript can be confusing to read. Again, please contact our office for assistance.

Income-driven repayment plan

The DRT also provides tax data that automatically fills in information for the income-driven repayment (IDR) plan application for federal student loan borrowers. The DRT is online for DRT applications.

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important federal tax reporting and filing data for individuals, businesses and other taxpayers for the month of July 2017.

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important federal tax reporting and filing data for individuals, businesses and other taxpayers for the month of July 2017.

July 6
Employers. Semi-weekly depositors must deposit employment taxes for Jun 28, 29 and 30.

July 7
Employers. Semi-weekly depositors must deposit employment taxes for Jul 1, 2, 3 and 4.

July 10
Employees who work for tips. Employees who received $20 or more in tips during June must report them to their employer using Form 4070.

July 12
Employers. Semi-weekly depositors must deposit employment taxes for Jul 5, 6 and 7.

July 14
Employers. Semi-weekly depositors must deposit employment taxes for Jul 8, 9, 10 and 11.

July 17
Employers. For those to whom the monthly deposit rule applies, deposit employment taxes and nonpayroll withholding for payments in June.

July 19
Employers. Semi-weekly depositors must deposit employment taxes for Jul 12, 13 and 14.

July 21
Employers. Semi-weekly depositors must deposit employment taxes for Jul 15, 16, 17 and 18.

July 26
Employers. Semi-weekly depositors must deposit employment taxes for Jul 19, 20 and 21.

July 28
Employers. Semi-weekly depositors must deposit employment taxes for Jul 22, 23, 24 and 25.

July 31
Employers. Form 941, Employer’s Quarterly Federal Tax Return, due for the second quarter of 2017.

Deposit FUTA owed through June if more than $500.

File Form 5500 or 5500-EZ for calendar year 2017 employee benefit plan.

August 2
Employers. Semi-weekly depositors must deposit employment taxes for Jul 26, 27 and 28.

August 4
Employers. Semi-weekly depositors must deposit employment taxes for Jul 29–Aug 1.

One month after the presidential election, taxpayers are learning more about President-elect Donald Trump’s tax proposals for his administration. Although exact details, including legislative language, are likely months away, taxpayers have a snapshot of the president-elect’s tax proposals for individuals and businesses.

One month after the presidential election, taxpayers are learning more about President-elect Donald Trump’s tax proposals for his administration. Although exact details, including legislative language, are likely months away, taxpayers have a snapshot of the president-elect’s tax proposals for individuals and businesses.

Note. At the time this article was prepared, the primary descriptions of President-elect Trump’s tax proposals are on his campaign and transition websites. The materials on these websites are not the same as legislation, which would amend the Tax Code. Rather, they discuss the President-elect’s tax proposals in very general and broad language.

Tax reform

Tax reform has been a regular topic in recent years. While numerous tax reform proposals were unveiled during the Obama administration, an overhaul of the Tax Code remained elusive. President Obama released a tax reform framework that called for a reduction in the corporate tax rate in exchange for the elimination of some energy tax preferences and other unspecified business tax preferences. Former House Ways and Means Chair Dave Camp, R-Mich., made a detailed tax reform proposal several years ago. Many members of Congress have also introduced tax reform bills. The election of Trump, along with GOP majorities in the House and Senate, is expected to give momentum to tax reform in 2017.

Proposals

During the campaign, President-elect Trump described a number of tax reform proposals, including (not an exhaustive list):

• Reduce the number of individual income tax rates from seven to three with rates at 12, 25 and 33 percent
• Eliminate the alternative minimum tax (AMT) for individuals and businesses
• Create new Dependent CARE Savings accounts
• Provide “spending rebates” for lower-income taxpayers for childcare expenses through the earned income tax credit (EITC)
• Increase standard deduction to $15,000 for single individuals and $30,000 for married couples filing a joint return
• Enhance Code Sec. 179 small business expensing
• Reduce the top corporate tax rate to 15 percent
• Tax carried interest as ordinary income
• Eliminate head of household filing status
• Cap itemized deductions for higher-income taxpayers

Affordable Care Act

The Affordable Care Act (ACA) includes a number of taxes, such as the excise tax on medical devices and the excise tax on high-dollar health insurance plans (often called the “Cadillac plan” tax), the net investment income (NII) tax, and the additional Medicare tax. The ACA also created new health-related tax incentives, including the Code Sec. 36B premium assistance tax credit and the Code Sec. 45R small employer health insurance tax credit.

During the campaign, President-elect Trump proposed to repeal the ACA. Post-election, it appears that the president-elect is open to retaining some of the ACA. The president-elect has mentioned coverage for children under age 26 as one provision of the ACA that he views favorably.

Congress

The 115^th Congress will convene in January. Republicans have majorities in the House and Senate. Being the majority means that Republicans will chair the tax writing committees in the 115^th Congress: the House Ways and Means Committee and the Senate Finance Committee.

Looking to 2017, tax reform legislation will likely have its start in the House Ways and Means Committee. In the House, Republicans have already unveiled a tax reform blueprint. There are similarities between the House GOP blueprint and President-elect Trump’s tax proposals. For example, both call for reducing the federal income tax rates for individuals along with lowering the corporate tax rate.

Please contact our office if you have any questions about these or any other tax proposals. Our office will keep you posted of developments.

Virtual currency – often referred to as ‘bitcoin” -- is a mystery for many people but an everyday currency for others. As virtual currency grows in popularity, questions arise about its taxation. The IRS treats virtual currency as property and not as currency. This means that general tax principles that apply to property transactions apply to transactions using virtual currency.

Virtual currency – often referred to as ‘bitcoin” -- is a mystery for many people but an everyday currency for others. As virtual currency grows in popularity, questions arise about its taxation. The IRS treats virtual currency as property and not as currency. This means that general tax principles that apply to property transactions apply to transactions using virtual currency.

Virtual currency

Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account or a store of value. Many types of virtual currencies have been created recently for use in lieu of currency issued by a government to purchase goods and services in the real economy. Bitcoin is one example.

A 2015 federal government report described how virtual currency is generally obtained. An individual can exchange conventional money for virtual currency a fee on an online exchange. An individual can obtain virtual currency in exchange for the sale of goods or services. An individual can also acquire virtual currency by serving as “miner.” This approach requires significant computer’s processing power.

Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. While virtual currency may operate like “real” money, it does not have legal tender status in the U.S.

IRS guidance

In Notice 2014-21, the IRS announced that it will treat virtual currency as property. The IRS explained that transactions using virtual currency must be reported in U.S. dollars for U.S. tax purposes. Taxpayers must determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied, the IRS explained.

More guidance possibly coming

In November 2016, the Treasury Inspector General for Tax Administration (TIGTA) asked the IRS review its approach to virtual currency. The IRS has established a virtual currency task force but TIGTA reported that the IRS could better coordinate some of its intra-agency activities. TIGTA also found that the while employers and businesses are required to report taxable virtual currency transactions, current third-party information reporting documents did not provide the IRS with any means to ascertain whether the taxable transaction amounts being reported were specifically related to virtual currencies.

TIGTA recommended that the IRS provide updated virtual currency guidance. TIGTA also recommended that the IRS revise third-party information reporting documents to identify the amounts of virtual currencies used in taxable transactions. The IRS agreed with the recommendations. The IRS did not identify when more guidance may be issued. Our office will keep you posted of developments.

An early glimpse at the income tax picture for 2017 is now available. The new information includes estimated ranges for each 2017 tax bracket as well as projections for a growing number of inflation-sensitive tax figures, such as the tax rate brackets, personal exemption and the standard deduction. Projections – made available by Wolters Kluwer Tax & Accounting US – are based on the relevant inflation data recently released by the U.S. Department of Labor. The IRS is expected to release the official figures by early November. Here are a few of the more widely-applicable projected amounts: 

An early glimpse at the income tax picture for 2017 is now available. The new information includes estimated ranges for each 2017 tax bracket as well as projections for a growing number of inflation-sensitive tax figures, such as the tax rate brackets, personal exemption and the standard deduction. Projections – made available by Wolters Kluwer Tax & Accounting US – are based on the relevant inflation data recently released by the U.S. Department of Labor. The IRS is expected to release the official figures by early November. Here are a few of the more widely-applicable projected amounts:

Tax Brackets

For 2017, for married taxpayers filing jointly and surviving spouses, the maximum taxable income for the:

• 10-percent bracket is $18,650, (up from $18,550 for 2016);
• 15-percent tax bracket, $75,900 (up from $75,300 for 2016);
• 25-percent tax bracket, $153,100 (up from $151,900 for 2016);
• 28-percent tax bracket, $233,350 (up from $231,450 for 2016);
• 33-percent tax bracket, $416,700 (up from $413,350 for 2016);
• 35-percent tax bracket, $470,700 (up from $466,950 for 2016); and
• 6 percent for all taxable income above that 35-percent bracket’s maximum income level.

For heads of household, the maximum taxable income for the:

• 10-percent bracket is $13,350 (up from $13,250 for 2016);
• 15-percent tax bracket, $50,800 (up from $50,400 for 2016);
• 25-percent tax bracket, $131,201 (up from $130,150 for 2016);
• 28-percent tax bracket, $212,500 (up from $210,800 for 2016);
• 33-percent tax bracket, $416,700 (up from $413,350 for 2016);
• 35-percent tax bracket, $446,700 (up from $441,000 for 2016);
• 6 percent for all taxable income above that 35-percent bracket’s maximum income level.

For unmarried, single filers who are not heads of household or surviving spouses, the maximum taxable income for the:

• 10-percent bracket is $9,325 (up from $9,275 for 2016);
• 15-percent tax bracket, $37,950 (up from $37,650 for 2016);
• 25-percent tax bracket, $91,900 (up from $91,150 for 2016);
• 28-percent tax bracket, $191,650 (up from $190,150 for 2016);
• 33-percent tax bracket, $416,700 (up from $413,350 for 2016);
• 35-percent tax bracket, $418,400 (up from $415,050 for 2016); and
• 6 percent for all taxable income above that 35-percent bracket’s maximum income level.

For married taxpayers filing separately, the maximum taxable income for the:

• 10-percent bracket is $9,325 (up from $9,275 for 2016);
• 15-percent tax bracket, $37,950 (up from $37,650 for 2016);
• 25-percent tax bracket, $76,550 (up from $75,950 for 2016);
• 28-percent tax bracket, $116,675 (up from $115,725 for 2016);
• 33-percent tax bracket, $208,350 (up from $206,675 for 2016);
• 35-percent tax bracket, $235,350 (up from $233,475 for 2016); and
• 6 percent for all taxable income above that 35-percent bracket’s maximum income level.

Standard Deduction

The 2017 standard deduction will rise $50, to $6,350 for single taxpayers. For married joint filers, the standard deduction will rise $100, to $12,700. For heads of household, the standard deduction will rise to $9,350, up from $9,300 for 2016. The additional standard deduction for blind and aged married taxpayers will remain at $1,250. For unmarried taxpayers who are blind or aged, the amount of the additional standard deduction will also remain the same ($1,550).

For 2017 the so-called "kiddie" deduction used on the returns of children claimed as dependents on their parents’ returns remains $1,050 or $350 plus the individual’s earned income.

Personal Exemptions

The personal exemption will be $4,050 for 2017, the same as for 2016. The phaseout of the personal exemption for higher-income taxpayers will begin after taxpayers pass the same income thresholds set forth for the limitation on itemized deductions.

Limitation on Itemized Deductions

For higher-income taxpayers who itemize their deductions, the limitation on itemized deductions will be imposed as follows:

• For married couples filing joint returns or surviving spouses, the income threshold will begin to phase out at income over $313,800, up from $311,300 for 2016.
• For heads of household, the beginning threshold will be $287,650 in 2016, up from $285,350 for 2016.
• For single taxpayers, the beginning threshold will be $261,500, up from $259,400 for 2016.
• For married taxpayers filing separate returns, the 2016 threshold will be $156,900, up from $155,650 for 2016.

Estate and Gift Tax

Gift Tax. The 2017 gift tax annual exemption will remain the same as for 2016, at $14,000.

Estate Tax. The estate and gift tax applicable exclusion will increase from $5,450,000 in 2016 to $5,490,000 in 2017.

Gifts to Noncitizen Spouses. The first $149,000 of gifts made in 2017 to a spouse who is not a U.S. citizen will not be included in taxable gifts, up $1,000 from $148,000 for 2016.

AMT Exemptions

The American Taxpayer Relief Act of 2012 provided for the annual inflation adjustment of the exemption from alternative minimum tax (AMT) income. Previously, this inflation adjustment had to be enacted by Congress each year. For 2017, the AMT exemption for married joint filers and surviving spouses is projected to be $84,500 (up from $83,800 for 2016). For heads of household and unmarried single filers, the exemption will be $54,300 (up from $53,900 for 2016). For married separate filers, the exemption will be $42,250 (up from $41,900 for 2016).

On June 26, the U.S. Supreme Court held that Section 3 of the federal Defense of Marriage Act (DOMA) is unconstitutional (E.S. Windsor, SCt., June 26, 2013). Immediately after the decision, President Obama directed all federal agencies, including the IRS, to revise their regulations to reflect the Court's order. How the IRS will revise its tax regulations - and when - remains to be seen; but in the meantime, the Court's decision opens a number of planning tax opportunities for same-sex couples.

On June 26, the U.S. Supreme Court held that Section 3 of the federal Defense of Marriage Act (DOMA) is unconstitutional (E.S. Windsor, SCt., June 26, 2013).  Immediately after the decision, President Obama directed all federal agencies, including the IRS, to revise their regulations to reflect the Court's order.  How the IRS will revise its tax regulations - and when - remains to be seen; but in the meantime, the Court's decision opens a number of planning tax opportunities for same-sex couples.

Background

The Supreme Court agreed in 2012 to hear an appeal of a federal estate tax case.  Due to DOMA, the surviving spouse of a same-sex married couple was ineligible for the federal unlimited marital deduction under Code Sec. 2056(a). The survivor sued for a refund of estate taxes. A federal district court and the Second Circuit Court of Appeals found unconstitutional Section 3 of DOMA, which defines marriage for federal purposes as only a legal union between one man and one woman as husband and wife.

Supreme Court's decision

In a 5 to 4 decision, the Supreme Court held that Section 3 of DOMA is unconstitutional as a deprivation of the equal liberty of persons that is protected by the Fifth Amendment.  Writing for the five-justice majority, Justice Anthony Kennedy said that "DOMA rejects the long-established precept that the incidents, benefits, and obligations of marriage are uniform for all married couples within each State, though they may vary, subject to constitutional guarantees, from one State to the next."  Kennedy explained that "by creating two contradictory marriage regimes within the same State, DOMA forces same-sex couples to live as married for the purpose of state law but unmarried for the purpose of federal law, thus diminishing the stability and predictability of basic personal relations the State has found it proper to acknowledge and protect."

Chief Justice John Roberts, who would have upheld DOMA, cautioned that "the Supreme Court did not decide if states could continue to utilize the traditional definition of marriage." Roberts noted that the majority held that the decision and its holding "are confined to those lawful marriages-referring to same-sex marriages that a State has already recognized."

Tax planning

The Supreme Court's decision impacts countless provisions in the Tax Code, covering all life events, such as marriage, employment, retirement and death.  The affect on the Tax Code cannot be overstated. It is expected that the IRS will move quickly to clarify how the decision impacts many of the more far-reaching provisions, such as filing status and employee benefits. Other provisions, especially the complex estate and gift tax provisions, will likely require more time from the IRS to issue guidance.

For federal tax purposes, only married individuals can file their returns as married filing jointly or married filing separately. Because of DOMA, the IRS limited these married filing statuses to opposite-sex married couples. The IRS is expected to issue guidance. Same-sex couples who filed separate returns may want to explore the benefits of filing amended returns (as married filing jointly), if applicable. Our office will keep you posted of developments.

Among the other provisions in the Tax Code affected by the Supreme Court's decision are:

• Adoption benefits
• Child tax credit
• Education tax credits and deductions
• Estate tax marital deduction
• Estate tax portability between spouses
• Gifts made by spouses
• Retirement plans

Looking ahead

Will the federal government look to where the same-sex couple was married (state of celebration) or where the same-sex couple reside (state of residence) for purposes of federal benefits? The Supreme Court did not rule on Section 2 of DOMA, which provides that no state is required to recognize a same-sex marriage performed in another state. At the time of the Supreme Court's decision, 12 states and the District of Columbia recognize same-sex marriage. 

In some cases, the rules for marital status are determined by federal regulations, which can be changed without action by Congress. In other cases, the rules are set by statute, which would require Congressional action. Sometimes, a federal agency follows one rule for some purposes but another rule for other purposes. Generally, the IRS has used place of domicile for determining marital status. Our office will keep you posted of developments.

If you have any questions about the Supreme Court's decision and its impact on tax planning, please contact our office.

For many individuals, volunteering for a charitable organization is a very emotionally rewarding experience. In some cases, your volunteer activities may also qualify for certain federal tax breaks. Although individuals cannot deduct the value of their labor on behalf of a charitable organization, they may be eligible for other tax-related benefits.

For many individuals, volunteering for a charitable organization is a very emotionally rewarding experience. In some cases, your volunteer activities may also qualify for certain federal tax breaks. Although individuals cannot deduct the value of their labor on behalf of a charitable organization, they may be eligible for other tax-related benefits.

Before claiming any charity-related tax benefit, whether for a donation or volunteer activity, you must determine if the charity is a "qualified organization."  Under the tax rules, most charitable organizations, other than churches, must apply to the IRS to become a qualified organization. If you are uncertain about an organization's status as a qualified organization, you can ask the charity. The IRS has a toll-free number (1-877-829-5500) for questions from taxpayers about charities and also maintains an online tool at www.irs.gov/charities.

Time or services

An individual may spend 10, 20, 30 or more hours a week volunteering for a charitable organization. Precisely because the individual is a volunteer, he or she receives no remuneration for his or her time or services and cannot deduct the value of his or her time or services spent on activities for the charitable organization. Unpaid volunteer work is not tax deductible.

Vehicle expenses

Vehicle expenses associated with volunteer activity should not be overlooked.  For example, many individuals use their personal vehicles to transport others to medical treatment or to deliver food to shut-ins. Taxpayers can deduct as a charitable contribution qualified unreimbursed out-of-pocket expenses, such as the cost of gas and oil, directly related to the use of their vehicle in giving services to a charitable organization. However, certain expenses, such as registration fees, or the costs of tires or insurance, are not deductible.  Alternatively, taxpayers can use a standard mileage rate of 14 cents per mile to calculate the amount of their contribution. Do not confuse the charitable mileage rate, which is set by statute, with business mileage rate (56.5 cents per mile for 2013), which generally changes from year to year. Parking fees and tolls are deductible whether the taxpayer uses the actual expense method or the standard mileage rate.

Uniforms

Some volunteers are required to wear a uniform, such as a jacket that identifies the wearer as a volunteer for the charitable organization, while engaged in activity for the charity. In this case, the tax rules generally allow taxpayers to deduct the cost and upkeep of uniforms that are not suitable for everyday use and that the taxpayer must wear while performing donated services for a charitable organization.

Hosting a foreign student

Qualifying expenses for a foreign student who lives in the taxpayer's home as part of a program of the organization to provide educational opportunities for the student may be deductible. The student must not be a relative, such as a child or stepchild, or dependent of the taxpayer and also must be a full-time student in secondary school or any lower grade at a school in the U.S. Among the expenses that may be deductible are the costs of food and certain transportation spent on behalf of the student. The cost of lodging is not deductible. If you are planning to host a foreign-exchange student, please contact our office and we can explore the possible tax benefits.

Travel

Volunteers may be asked to travel on behalf of the charitable organization, for example, to attend a convention or meeting. Generally, qualified unreimbursed expenses may be deductible subject to complicated rules. Very broadly speaking, there must not be a significant element of personal pleasure, recreation, or vacation in the travel. Special rules apply if the charitable organization pays a daily travel allowance to the volunteer. There are also special rules for attendance at a church meeting or convention and the capacity in which the volunteer attends the church meeting or convention. If you plan to travel as part of your volunteer activity for a charitable organization, please contact our office and we can review your plans in greater detail.

If you have any questions, please contact our office.

Vacation homes offer owners tax breaks similar-but not identical-to those for primary residences. Vacation homes also offer owners the opportunity to earn tax-advantaged and even tax-free income. This combination of current income and tax breaks, combined with the potential for long-term appreciation, can make a second home an attractive investment.

Vacation homes offer owners tax breaks similar-but not identical-to those for primary residences. Vacation homes also offer owners the opportunity to earn tax-advantaged and even tax-free income. This combination of current income and tax breaks, combined with the potential for long-term appreciation, can make a second home an attractive investment.

Homeowners can deduct mortgage interest they pay on up to $1 million of "acquisition indebtedness" incurred to buy their primary residence and one additional residence. If their total mortgage indebtedness exceeds $1 million, they can still deduct the interest they pay on their first $1 million. If one mortgage carries a substantially higher rate than the second, it makes sense to deduct the higher interest first to maximize deductions.

Vacation homeowners don't need to buy an actual house (or even a condominium) to take advantage of second-home mortgage interest deductions. They can deduct interest they pay on a loan secured by a timeshare, yacht, or motorhome so long as it includes sleeping, cooking, and toilet facilities.

Gains from selling a vacation home are generally taxed as short-term or long-term capital gains.  While gain on the sale of a principal residence can be excludable, gain on the sale of a vacation home is not. Recent rules limit the amount of prior gain on a vacation residence that can be sheltered if a vacation home is converted into a primary residence.

Vacation home rentals. Many vacation home owners rent vacation homes to draw income and help finance the cost of owning the home. These rentals are taxed under one of three sets of rules depending on how long the homeowner rents the property.

• Income from rentals totaling not more than 14 days per year is nontaxable.
• Income from rentals totaling more than 14 days per year is taxable and is generally reported on Schedule E (Form 1040), Supplemental Income and Loss. Homeowners who rent their properties for more than 14 days can deduct a portion of their mortgage interest, property taxes, maintenance, utilities, and other expenses to offset that income. That deduction depends on how many days they use the residence personally versus how many days they rent it.
• Owners who use their home personally for less than 14 days and less than 10% of the total rental days can treat the property as true "rental" property if certain rules are followed.

If you are considering the purchase of a vacation home, our offices can help compute your true, "after-tax" cost of ownership in determining whether such a purchase makes sense.

The government continues to push out guidance under the Patient Protection and Affordable Care Act (PPACA). Several major provisions of the law take effect January 1, 2014, including the employer mandate, the individual mandate, the premium assistance tax credit, and the operation of health insurance exchanges. The three agencies responsible for administering PPACA - the IRS, the Department of Labor (DOL), and the Department of Health and Human Services (HHS) - are under pressure to provide needed guidance, and they are responding with regulations, notices, and frequently asked questions.

The government continues to push out guidance under the Patient Protection and Affordable Care Act (PPACA). Several major provisions of the law take effect January 1, 2014, including the employer mandate, the individual mandate, the premium assistance tax credit, and the operation of health insurance exchanges. The three agencies responsible for administering PPACA - the IRS, the Department of Labor (DOL), and the Department of Health and Human Services (HHS) - are under pressure to provide needed guidance, and they are responding with regulations, notices, and frequently asked questions.

The health law provisions interact. Individuals are supposed to carry health insurance or pay a tax. Employers are supposed to offer coverage or pay a tax. The exchanges will provide information about the availability of different health care plans and will certify individuals eligible for the premium assistance tax credit. Individuals who cannot obtain affordable coverage may purchase insurance through an exchange and may be entitled to a premium assistance tax credit.

Exchanges

The DOL, in a technical release, provided temporary guidance to employers about their obligation to notify their employees of the availability of health insurance through an exchange and of the potential to qualify for the premium assistance tax credit if they purchase insurance through an exchange. Exchanges will begin operating January 1, 2014 and will provide open enrollment for their coverage beginning October 1, 2013. DOL provided model notices for employers to send out beginning October 1, 2013. Notices must be issued to all employees, whether or not the employer offers insurance and whether or not the employee enrolls in the employer's insurance.

Employer mandate

As part of the regulatory process, the IRS recently held a hearing on proposed regulations regarding the employer mandate, which imposes a penalty on employers who fail to provide adequate health insurance coverage in certain circumstances. The employer mandate takes effect January 1, 2014. Twenty different groups testified on relevant issues, including: the definition of a large employer subject to the penalty, the definition of a full-time employee who must be offered coverage, and the determination whether the coverage is affordable.

Minimum value

The IRS issued proposed regulations to clarify the minimum value requirement for employer-provided health insurance. The regulations provide additional guidance on how to determine whether an individual is eligible for the premium assistance tax credit. Taxpayers will not be eligible for the credit if they are eligible for other "minimum essential (health insurance) coverage" (MEC). MEC includes employer-sponsored coverage that is affordable and that provides minimum value. Employer coverage fails to provide minimum value if the employer pays less than 60 percent of the cost of plan benefits. Taxpayers may rely on the proposed regulations for years ending before January 1, 2015.

Medical loss ratio (MLR)

The IRS issued proposed regulations on MLRs. Insurance companies must provide premium rebates to their customers if they fail to spend at least 80 percent (85 percent for large companies) of their premiums directly on health care, as opposed to executive salaries and other expenses. The provision took effect in 2012; and the first round of MLR rebates was distributed in 2012. The IRS issued several notices to implement the program; the proposed regulation would apply to tax years beginning after December 31, 2013.

Annual limits on benefits

PPACA generally prohibits group health plans and health insurance issuers that offer group or individual health insurance from imposing annual or lifetime limits on the value of essential health benefits. Although some limits are allowed for plan years beginning before January 1, 2014, HHS regulations provide that HHS may waive the limits if they would cause a significant decrease in benefits or significant increase in premiums. IRS, DOL, and HHS issued frequently asked questions (FAQs) to clarify that plan or issuer receiving a waiver may not extend the waiver to a different plan or policy year.

Summary of benefits and coverage

PPACA generally requires insurers, employers and other health care plan providers to give a Summary of Benefits and Coverage (SBC) to participants and other affected individuals. In recent FAQs, the three government agencies advised that an updated SBC template and a sample SBC are available on the DOL's website. These documents can be used for coverage beginning in 2014. The agencies also extended certain enforcement relief. The agencies issued final regulations in 2012, and indicated that providers can continue to use coverage examples in current guidance, without adding new examples to their SBC.

Employer reporting

The Treasury Inspector General for Tax Administration (TIGTA) issued a recent report on some of the new information reporting requirements that PPACA has imposed on employers. For example, health insurance providers must report information for each individual who receives coverage. Large employers must report details about the coverage offered to employees and their dependents, including the premiums and the employer's share of costs. Employers must also report the cost of coverage to employees on their Forms W-2. The IRS will use these reports to administer PPACA's requirements.

PPACA is a complicated law. Many of its most important provisions take effect in 2014. The IRS and other responsible federal agencies continue to issue guidance and to take comments on the administration of the law.

If you have any questions about PPACA and what strategies you or your business might adopt, please contact our office.

Did you owe tax on your 2012 tax return? Did you receive a sizeable refund? Or, conversely, did you receive a smaller refund than you expected? If so, take another look at your tax return from this past year. It is quite possible that by making a few changes, you could put more money in your pocket in the short term. And by examining your investments as they are reported on your tax return, you may be able to strategize for the long-term future. Trying to implement this type of plan may seem difficult at first. However, just by looking at your tax return, you can start the critical planning that can lead you to broader goals of financial independence and a comfortable retirement.

Did you owe tax on your 2012 tax return? Did you receive a sizeable refund? Or, conversely, did you receive a smaller refund than you expected? If so, take another look at your tax return from this past year. It is quite possible that by making a few changes, you could put more money in your pocket in the short term. And by examining your investments as they are reported on your tax return, you may be able to strategize for the long-term future. Trying to implement this type of plan may seem difficult at first. However, just by looking at your tax return, you can start the critical planning that can lead you to broader goals of financial independence and a comfortable retirement.

Federal withholding

If you received a large tax refund, it might be time for you to adjust the amount of tax the federal government withholds from your paycheck. Although next year your refund check may not be as large, you will have the advantage of seeing a larger sum deposited directly into your pocket every month. To adjust your withholding, fill out and sign a Form W-4, and submit it to your employer. You would want to do this in cases where your adjustments to income, exemptions, and deductions remain relatively steady from year-to-year, and where the government consistently is required to give you a large refund.

If you do not change your withholding allowances, the government essentially is holding your money for a year without paying any interest on it. You may lose some potential investment opportunity or, at the very least, the ability to increase your monthly discretionary income. On the other hand, many taxpayers prefer to receive the large refund check after tax filing season because it is a no-hassle way to ensure large savings at the end of the year.

Conversely, many taxpayers may want to change their withholding allowances because they owe the government a significant amount of money at the end of the year. Taxpayers who expect to owe at least $1,000 in tax for the 2013 tax year, after subtracting withholding and any refundable credits, and who also expect their 2013 withholding and credits to be significantly less than the projected tax owed for 2013, may need to file estimated taxes. Failure to do so could result in penalties. Alternatively, taxpayers should consider making quarterly estimated tax payments, especially if they anticipate a significant amount of investment gains for the year or other income unrelated to wage compensation.

State withholding

Some people are entirely exempt from state tax, but it is withheld from their paychecks nevertheless. At the end of each year, they may include the amount of their state taxes in their itemized deductions, but then receive a refund which they have to declare as income in the next year. This problem particularly applies to active duty military families, many of whom are posted in states other than their state of residency. Military families can check with their state income tax authority to see if there is an appropriate form that can be completed and filed, which would exempt them from withholding. A higher adjusted gross income (AGI), even if it is subsequently reduced by itemized deductions, can erode other adjustments to income, such as a deduction for student loans, IRA contributions, higher education expenses, and more because of certain AGI caps on these benefits.

Tax rates and adjusted gross income

As you may have heard, Congress allowed the Bush-era tax cuts to expire for higher-income earners. That means joint filers with more than $450,000 of adjusted gross income ($400,000 for single individuals) are now in the 39.6-percent tax bracket. Taxpayers at this level of income or above are also subject to a higher long-term capital gains tax rate: 20 percent, up from 15 percent paid by other taxpayers.

In addition, for tax years beginning in 2013, the 33-percent tax bracket for individual taxpayers ends at $398,350 for married individuals filing joint returns, heads of households, and single individuals. If you were hovering near the bottom of the 35-percent bracket for the 2012 tax year, then you might want to see if you can readjust your income so that you fall within the 33-percent category.

Higher-income taxpayers also have two new taxes to worry about for 2013 and beyond. Joint-filing taxpayers with modified adjusted gross income of $250,000 ($200,000 for single filers) are also subject to the 3.8-percent surtax on net investment income and a .9-percent Additional Medicare Tax. Look at your adjusted gross income for last year. Does it approach these figures? Is it on the edge of the income brackets? Will stock market increases this year put you over the top of those income thresholds? If so, it may be time to find ways to reduce your income for 2013.

Investments

At some point in your efforts over the years to accumulate a savings nest egg, you will need to consider diversification, the process of putting your money in the right kind of investment vehicles to satisfy your personal risk strategy and achieve your goals. Looking at your tax return will help you decide whether the investments you now have are the right ones for you. For example, if you are in a high tax bracket and need to diversify away from common stocks, investing in tax-exempt bonds might help, especially if you have state income taxes to worry about, too.

Reviewing the Schedule D and Form 8949, which cover Capital Gains and Losses from last year's return and from the past three or four years, can be an eye-opener for many. Did you hold stocks long enough to be entitled to the long-term capital gains rate? Did you try to balance short-term gains with short-term losses? Are you bouncing from one investment trend to another without a long-term investment plan that achieves long-term needs? Are your mutual funds "tax smart"? Become familiar with different types of banking institutions and their products. Find out about CDs, money-market funds, government securities, mutual funds, index funds, and sector funds and how they interrelate with the determination of your tax liability each year. You may want to put that knowledge to work in your investment strategy.

Medical costs

Should you be taking advantage of the medical expense deduction? Many people assume that with the 10 percent adjusted gross income floor on medical expenses now imposed for tax years starting in 2013 (7.5 percent for seniors) that it doesn't pay for them to keep track of expenses to test whether they are entitled to itemize. But with the premiums for certain long-term care insurance contracts now counted as a medical expense, some individuals are discovering that along with other health insurance premiums, deductibles and timing of elective treatments, the medical tax deduction may be theirs for the taking.

Retirement planning

Don't forget to protect for eventualities. Are you maximizing the amount that Uncle Sam allows you to save tax-free for retirement? A look at your W-2 for the year, and at the retirement contribution deductions allowed in determining adjusted gross income should tell you a lot. Should your spouse set up his or her own retirement fund, too? Are you over-invested in tax-deferred retirement plans? If so, you may lose a significant amount of your nest egg to tax after retirement.  

When you are reviewing last year's tax return, it may help to review some of what you've learned from it. This could foster an important conversation with your tax advisor about how to establish or modify your plan for your financial future. If you would like to review last year's completed tax return with future planning in mind, please feel free to give us a call and set up a time when we can meet and discuss this matter.

Questions over the operation of the new 3.8 percent Medicare tax on net investment income (the NII Tax) continue to be placed on the IRS's doorstep as it tries to better explain the operation of the new tax.  Proposed "reliance regulations" issued at the end in 2012 (NPRM REG-130507-11) "are insufficient in many respects," tax experts complain, as the IRS struggles to turn its earlier guidance into final rules.

Questions over the operation of the new 3.8 percent Medicare tax on net investment income (the NII Tax) continue to be placed on the IRS's doorstep as it tries to better explain the operation of the new tax.  Proposed "reliance regulations" issued at the end in 2012 (NPRM REG-130507-11) "are insufficient in many respects," tax experts complain, as the IRS struggles to turn its earlier guidance into final rules.

A public hearing on the existing regulations, held at IRS headquarters in Washington, D.C., in early April 2013, only confirmed how the application of the NII Tax to certain categories of income—particularly income arising from "passive activities"—is challenging even the experts. Nevertheless, taxpayers are not getting a reprieve from the immediate application of this new tax.  The 3.8 percent Medicare surtax on net investment income (NII) became effective January 1, 2013. Current confusion over exactly how the 3.8 percent operates can impact on tax strategies that should be put into motion in 2013. Any misinterpretation can also bear on 2013 estimated tax that may be due to cover any 3.8 percent NII Tax liability.

NII Tax Thresholds

For tax years beginning after December 31, 2012, the NII surtax on individuals equals 3.8 percent of the lesser of: net investment income for the tax year, or the excess, if any, of:

• the individual's modified adjusted gross income (MAGI) for the tax year, over
• the threshold amount.

The threshold amount in turn is equal to:

• $250,000 in the case of a taxpayer making a joint return or a surviving spouse,
• $125,000 in the case of a married taxpayer filing a separate return, and
• $200,000 in any other case.

Trusts and estates are also subject to the NII surtax, to the extent of the lesser of: (i) undistributed net investment income, or (ii) the excess of adjusted gross income over the dollar amount at which the highest tax bracket begins (which, for 2013, is $11,950).

Net Investment Income

The primary confusion over application of the 3.8 percent NII Tax revolves around finding a precise definition of "net investment income" as enacted by Congress. To appreciate the complexity of the task, just look at the applicable Internal Revenue Code provision. Code Sec. 1411(c)(1) defines net investment income as the sum of:

• Category (i) income: Gross income from interest, dividends, annuities, royalties, and rents, other than such income which is derived in the ordinary course of a trade or business not described in Code Sec. 1411(c)(2);
• Category (ii) income: Other gross income derived from a trade or business described in Code Sec. 1411(c)(2); and
• Category (iii) income: Net gain attributable to the disposition of property, other than property held in a trade or business not described in Code Sec. 1411(c)(2); over

Deductions properly allocable to such gross income or net gain.

A Code Sec. 1411(c)(2) trade or business includes a passive activity under Code Sec. 469 with respect to the taxpayer or trading in financial instruments or commodities.

Comment.  Code Sec 1411 effectively creates a new tax and a new tax base, on top of the income tax, alternative minimum tax, self-employment tax and payroll taxes. Nevertheless the Preamble to the proposed regs states that, except as otherwise provided, the income tax rules should apply to Code Sec. 1411 unless good cause otherwise exists. Practitioners have asked the IRS that the final regulations give greater reassurance of this general rule.

Complexity

The IRS has stated that the principal purpose of Code Sec. 1411 is "to impose a tax on unearned income or investments of certain individuals, estates, and trusts." Unfortunately, Code Sec. 1411 is not so direct and simple, with its three categories of income (that is, (i), (ii) and (iii), above), complicating matters, albeit in an effort to close every door to those who try to "game the system."

Application of the 3.8 percent NII Tax to capital gains and dividends from a personal stock portfolio is clear under this rule of thumb. But clarity breaks down when a "trade or business" is thrown into the mix and the concept of "passive activity" is added to it.

If gain or other income is the result of an active business activity, it generally escapes NII Tax. However, when the "active" business is a passive activity (for example, a rental business), it may be deemed to generate income that is subject to the NII Tax. Furthermore, when a passive activity is not merely incidental to a business however otherwise active that business should be, the NII Tax also becomes an issue. 

Passive Activity

Any revised or additional rules from the IRS on the application of the NII Tax on passive activities should be made more user friendly to the broad middle range of taxpayers and their advisors, one expert at the hearing recommended.  The IRS should err on the side of explaining things clearly and simply, even at the expense of not covering every possible nuance of interpretation.

At the same time, however, other experts are asking for more detail, at least in the way of clarification. For example, the IRS has stated that passive activity for NII Tax purposes should be applied within a narrower scope than the passive activity loss rules under Code 469.  Those Code Sec. 469 rules restrict "passive losses" from reducing income that is not "passive income."  Experts want the IRS to explain exactly what they mean by a "narrower scope."

Self-Rental Activities/Grouping

The self-rental recharacterization rule under Code Sec. 469 affects taxpayers who rent property to a trade or business in which they materially participate. Concern has been expressed over the possibility of interpreting net investment income under Code Sec. 1411 to include rental income from a self-rental activity grouped with a trade or business activity in which the taxpayer materially participates.

The material participation and trade or business requirements should be tested on the grouped activity as a whole rather than on a component basis, one expert in particular stressed at the hearing. If that test is passed, he argued, the trade or business income and rental income from the grouped activity should be excluded from the reach of the NII Tax. For example, the owners of self-rental properties should not have that rent considered as separate from their overall business activity and subject to the net investment tax simply because properties are held in a separate LLC to avoid tort liability.

Regrouping deadline

The proposed regulations permit businesses subject to the NII Tax to elect to regroup their activities for passive-loss purposes in 2013 or 2014. This regrouping election allows taxpayers with a fresh start to accommodate the new NII surtax. Without permitting regroupings, taxpayers would be bound by their original grouping decisions, some of which may have been made as many as 20 years ago, only for purpose of Code Sec. 469 passive loss rules and not the NII Tax. Some small business representatives are also concerned that, because of the complexity of the rules, the final regulations should extend the deadline for a regrouping election through 2015.

Application of the net investment income tax is particularly difficult to get a handle on in a variety of situations.  Unfortunately, however, at 3.8 percent, it is costly enough not to be ignored. 

If you have any questions about how the NII Tax may apply to your business, rental operations, or overall investment strategy, please do not hesitate to call our office.