New Taw Laws Affecting 2010 and Beyond

Richard Scrivanich - Partner, November 1, 2010
Dear Client:

This past year Congress and our President enacted several pieces of legislation which contain provisions that significantly impact the tax-landscape for 2010 and beyond. The following is a summary of the most important tax developments that have been recently enacted that may affect you, your family, your investments, and your livelihood.

Due to the sheer volume of changes, the topics which follow have been divided into three sections. The first section discusses a wide variety of topics affecting all types of taxpayers. The second section discusses the effects of the health care reform legislation, while the third section discusses a wide-ranging assortment of tax breaks and incentives for businesses.

Section I -- General

New opportunity to convert to Roth IRA. This year is a pivotal one for retirement planning, as it is the first year in which taxpayers may convert funds in regular IRAs (as well as qualified plan funds) to Roth IRAs regardless of their income level. Such a conversion may be desirable because distributions from Roth IRAs may be tax-free if several conditions are met, and a Roth IRA owner does not have to commence lifetime required minimum distributions (RMDs) from Roth IRAs after he or she reaches age 70 1/2. However, even if Roth distributions are tax-free, a 10% penalty may apply. Plus, the conversion itself will be fully taxed, assuming the rollover is being made with pre-tax dollars (money that was deductible when contributed to an IRA or money that wasn't taxed to an employee when contributed to the qualified employer sponsored retirement plan) and the earnings on those pre-tax dollars. For example, an individual in the 28% federal tax bracket who rolls over $100,000 from a regular IRA funded entirely with deductible dollars to a Roth IRA will owe $28,000 of tax. So the individual would be paying tax now for the future privilege of tax-free withdrawals, and freedom from the RMD rules. If you make a rollover to a Roth IRA in 2010, the tax that you'll owe as a result of the rollover will be payable half in 2011 and half in 2012, unless you elect to pay the entire tax bill in 2010. If you believe there's a strong chance your tax rates will go up after 2010, you may want to consider paying the tax on the Roth rollover in 2010.

Estate planning uncertainty. As of now, there is no estate or generation-skipping transfer tax for individuals who die this year. Because of changes to the income tax basis rules for property acquired from a decedent in 2010, some heirs could actually face higher combined estate and income tax costs if their loved one dies in 2010 than would have been the case if death had occurred in 2009. Congress could still retroactively reinstate the estate and generation-skipping transfer taxes to the beginning of this year and restore the favorable prior basis rules that wipe out income tax on pre-death appreciation in asset values. But, so far, this is no clear indication of what lawmakers will do. Apart from tax uncertainty, the continuing inaction could also pose a problem for individuals with wills using formula clauses. These clauses work well when the estate tax is in force but they may produce unintended consequences when there is no estate tax. Action may need to be taken if it becomes clear that Congress will not be addressing the situation.

Like-kind exchange relief for those snared by QIs in bankruptcy or receivership. In general, no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a like kind which is held either for productive use in a trade or business or for investment. When a taxpayer uses a qualified intermediary (QI), generally he will transfer the relinquished property to the QI, who will sell the property to a buyer. The QI will then take the proceeds of the sale of the relinquished property, purchase the replacement property, and transfer the replacement property to the taxpayer. If the taxpayer receives the replacement property within a specified period and meets other requirements, he is considered to have engaged in a like-kind exchange of property with the QI and he won't recognize gain on the exchange.

Unfortunately, many QIs went bankrupt in the last few years thus posing a problem for taxpayers who used them. However, the IRS has now granted relief for taxpayers who were unable to timely complete a like-kind exchange because their QI entered into bankruptcy or receivership. The IRS won't treat taxpayers as being in actual or constructive receipt of exchange proceeds if they can't complete an exchange because of a default of a QI in bankruptcy or receivership. Affected taxpayers may use a special safe harbor method to report gain or loss.

Homebuyer credit extended and liberalized. A new law enacted last November extended and generally liberalized the tax credit for first-time homebuyers, making it a much more flexible tax-saving tool. Before the new law, the credit was to have expired for homes purchased after November 30, 2009. The new law extended the credit to apply to a principal residence bought before May 1, 2010; it also applies to a principal residence bought before October 1, 2010 by a person who enters into a written binding contract before May 1, 2010, to close on the purchase of the principal residence before October 1, 2010. Also, effective for purchases after November 6, 2009, the new law allows existing homeowners who meet certain conditions to qualify for a reduced credit of up to $6,500. For purchases after November 6, 2009, the phase-out rules have been eased. These are the rules that cause the credit to be reduced or eliminated as modified adjusted gross income exceeds certain levels. Much higher income levels are now allowed before there is any reduction of the credit. On the negative side, a credit cannot be claimed for a home whose purchase price exceeds $800,000. In addition, the new law included some crackdowns designed to prevent abuse of the credit.

New Medicare Contribution Tax. To help cover the cost of the health care reform enacted earlier this year, for tax years beginning after December 31, 2012, a Medicare contribution tax is imposed on individuals, estates, and trusts. For an individual, the tax is 3.8% of the lesser of either (1) net investment income or (2) the excess of modified adjusted gross income (MAGI) over the threshold amount. Net investment income generally is income from interest, dividends, annuities, royalties, rents, and capital gains. MAGI is adjusted gross income (AGI) increased by the amount excluded from income as foreign earned income. The threshold amount is $250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others.

Additional Hospital Insurance Tax for High Wage Workers. Another revenue raiser was also enacted this year to help defray the cost of heath care reform. For tax years beginning after December 31, 2012, an additional 0.9% Hospital Insurance tax will be imposed on taxpayers (other than corporations, estates, or trusts) on wages received with respect to employment in excess of: $250,000 for joint returns, $125,000 for married taxpayers filing a separate return, and $200,000 in all other cases.

New lease on life for COBRA subsidy. In December of last year, the 65% COBRA premium subsidy that was enacted in February of 2009 got a new lease on life. Under the original provision, employees who were involuntarily terminated after August. 31, 2008 and before January 1, 2010, and who elected COBRA health continuation coverage, became entitled to receive a 65% subsidy on their COBRA premiums. For periods of COBRA coverage beginning after February 16, 2009, the involuntarily terminated employee was treated as having paid the required COBRA premium if the individual paid 35% of the premium amount. The employer (or, in some cases, multiemployer health plan or insurer) could recover the other 65% by taking the subsidy amount as a credit on its quarterly employment tax return. The December 2009 legislation added another six months to the maximum period that the COBRA subsidy can run (i.e., to a total of 15 months). In addition, it extended the up-to-15 month COBRA premium subsidy to workers (and their eligible family members) that lose their jobs during the first two months of 2010.

Standard mileage rates down for 2010. The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is 50¢ per mile for business travel after 2009. That's 5¢ less than the 55¢ allowance for business mileage during 2009. Further, the rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction is 16.5¢ per mile, down 7.5¢ from the 24¢ per mile allowance for 2010.

Indirect investors can benefit from Ponzi scheme safe harbor. A letter sent by the IRS to some members of the House of Representatives explains how indirect investors can benefit from a previously issued optional safe harbor which direct investors who suffered losses in Ponzi schemes can use to determine the proper time and amount of the loss. The letter indicates that the primary reason for the safe harbor's restriction to direct investors is because they are the party from which the perpetrator of the fraudulent arrangement stole money or property, and thus the proper party to compute and claim a theft-loss deduction. The letter stresses, however, that this restriction does not prevent indirect investors from benefitting from the safe harbor treatment or from deducting their share of a theft loss sustained by a pass-through entity. It notes that partnerships and LLCs taxed as partnerships that qualify as direct investors may use the safe harbor treatment and pass the loss through to the indirect investor (partner).

Proposed regulations on forthcoming stock reporting rules. The IRS has issued proposed regulations explaining the complex basis and character reporting requirements that will apply for most stock acquired after 2010, for shares in a regulated investment company (RIC, i.e., a mutual fund) or stock acquired in connection with a dividend reinvestment plan (DRP) after 2011, and other specified securities acquired after 2012. When these rules are implemented, the IRS will be in a much better position to monitor whether taxpayers are properly reporting investment gains and losses.

Chances of being audited. The IRS has issued its annual data book, which provides statistical data on its fiscal year 2009 activities, including how many tax returns it examines (audits), and what categories of returns it focuses its resources on. Of the 138,788,744 total individual income tax returns with a filing requirement (this excludes returns filed only to receive an economic stimulus payment) in calendar year 2008, 1,425,888 (1%) were audited. For business returns other than farm returns showing total gross receipts of $100,000 to $200,000, 4.2% of returns were audited. For business returns other than farm returns showing total gross receipts of $200,000 or more, 3.2% of returns were audited. For returns showing total positive income of $200,000 to $1 million, 2.3% of returns not showing business activity were audited, and 3.1% of returns showing business activity were audited.

Payments for use of trademarks. A prestigious Federal Appellate Court has ruled that a corporation that manufactured kitchen knives and tools could currently deduct the royalties it paid under trademark licensing agreements. In so deciding the Appeals Court rejected the IRS's position (which had been sustained in the lower court) that the payments had to be capitalized under complex statutory provisions. The immediate deduction produced a quicker tax break than would have been the case had the Appeals Court agreed with the IRS.

Boosted housing allowances for those working abroad in high-cost areas. Guidance from the IRS increases the maximum housing cost exclusion for some U.S. citizens and residents working abroad in specified high-cost locations in 2010. The increases are based on geographic differences in foreign housing costs relative to U.S. housing costs. For example, assume a U.S. taxpayer is posted to Tokyo, Japan for all of 2010. Under the new IRS guidance, his maximum housing cost exclusion is $93,260 ($107,900 full year limit on housing expense in Tokyo minus $14,640 base amount). Before the 2010 table was issued, the IRS had last issued a table for 2008, which is also used for 2009. However, the 2010 table can be used for 2009 if it produces a better result for the taxpayer. In some cases, the 2010 allowances are lower than the 2008 allowances.

Moratorium on selective enforcement of tax shelter penalty continues. Continuing a previously announced policy, the IRS has suspended through May 31, 2010 its efforts to collect penalties under Code Sec. 6707A in some cases. This provision imposes a penalty of $100,000 per individual and $200,000 per entity for each failure to make special disclosures with respect to a transaction that the IRS characterizes as a "listed transaction" or "substantially similar" to a listed transaction. The suspension applies where the annual tax benefit from the transaction is less than $100,000 for individuals or $200,000 for other taxpayers. The IRS originally implemented the suspension after Congressional leaders complained that Code Sec. 6707A can result in disproportionate penalties for small businesses that thought they were investing in legitimate benefits plans, but unknowingly invested in listed tax shelter transactions. Legislation that would ease Code Sec. 6707A's application has passed the Senate and has been introduced in the House.

Temporary regulations fill in statutory gaps on new indoor tanning tax. The IRS has issued temporary regulations on the health reform's legislation's new 10% excise tax on indoor tanning services provided on or after July 1, 2010. The regulations address practical considerations that may not have been contemplated when the law was drafted. For example, they address prepayments for tanning services and services provided as part of a gym membership.

Legislation ends foreign loopholes and advance EITC. The Education Jobs and Medicaid Assistance Act, which was signed into law on August 10, 2010, includes provisions closing a number of foreign-tax-credit related loopholes and repealing the advanced earned income tax credit (EITC). Specifically, this legislation tightens the rules on the use of foreign tax credits that multinationals use to lower their U.S. tax bill. In general, these provisions attempt to (1) make foreign tax credits (FTCs) available only when the income to which the FTCs relate is actually taxed by the U.S., (2) prevent artificial inflation of foreign source income, and (3) modify the resourcing rules to limit FTCs. Also, under the new law, starting in 2011, eligible low- and moderate-income workers who qualify for the EITC will no longer be able to elect to receive the credit in advance.

Financial reform package changes mark-to-market rule. The "Restoring American Financial Stability Act of 2010" was signed into law on July, 21, 2010. This landmark financial reform package contained a tax provision broadening the list of contracts that are excepted from mark-to-market treatment. Taxpayers must report gains and losses from regulated futures contracts and other "Section 1256 contracts" on an annual basis under the "mark-to-market" rule. The term Section 1256 contract means: regulated futures contracts, foreign currency contracts, non-equity options, dealer equity options, and dealer securities futures contracts. It does not include any securities futures contract or option on such a contract unless the contract or option is a dealer securities futures contract. Under the new law, for tax years beginning after July 21, 2010, all of the following also are excepted from the definition of a Section 1256 contract: any interest rate swap; currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement.

Relief for homeowners with corrosive drywall. The IRS is allowing individuals with corrosive drywall to apply a safe harbor formula to treat the costs of repairing the defective drywall as a casualty loss. The safe harbor applies for original and amended federal income tax returns filed after September. 29, 2010. Reported problems have occurred with certain imported drywall installed in homes between 2001 and 2008. Homeowners have reported blackening or corrosion of copper electrical wiring and copper components of household appliances, as well as the presence of sulfur gas odors. In the case of any individual who pays to repair damage to his personal residence or household appliances that results from corrosive drywall, the IRS won't challenge his treatment of damage resulting from corrosive drywall as a casualty loss (which might otherwise be difficult to achieve under the regular rules) if the loss is determined and reported under the safe harbor rule. A taxpayer who does not have a pending claim for reimbursement may claim as a loss all unreimbursed amounts paid during the tax year to repair damage to his personal residence and household appliances resulting from corrosive drywall. A taxpayer who has a pending claim (or intends to pursue reimbursement) may claim a loss for 75% of the unreimbursed amount paid during the tax year to repair damage to the taxpayer's personal residence and household appliances that resulted from corrosive drywall.

Over-the-counter drug costs will no longer be reimbursable. Effective January 1, 2011, unless prescribed or insulin, the cost of over-the-counter medicines cannot be reimbursed from flexible spending arrangements (FSA), health reimbursement arrangements (HRA), Health Savings Accounts (HSA) and Archer Medical Savings Accounts (Archer MSA). The IRS has issued guidance explaining that an individual may be reimbursed for over-the counter medicines or drugs, so long as the individual obtains a prescription for the medicines or drugs. It also makes clear that expenses incurred for over-the-counter medicines or drugs purchased without a prescription before January 1, 2011 may be reimbursed tax-free at any time by an employer-provided plan, including an FSA or HRA, under the terms of the employer's plan.

Section II - Health Care Reform

The recently enacted health overhaul legislation requires "large"employers to offer and contribute to their workers' health insurance or pay a penalty. Under the new law, effective for months beginning after December 31, 2013, a large employer that does not offer coverage for all its full-time employees, offers minimum essential coverage that is unaffordable, or offers minimum essential coverage that consists of a plan under which the plan's share of the total allowed cost of benefits is less than 60%, is required to pay a penalty if any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee. Here are the details:

Who is subject to the employer mandate? Only an "applicable large employer," defined as someone who employed an average of at least 50 full-time employees during the preceding calendar year, is subject to the requirement to offer coverage. Most small businesses, since they have fewer than 50 employees, are thus exempt from the employer requirement. In counting the number of employees for purposes of determining whether an employer is an applicable large employer, a full-time employee (meaning, for any month, an employee working an average of at least 30 hours or more each week) is counted as one employee and all other employees are counted on a pro-rated basis. However, even an employer with 50 or more employees isn't subject to the penalty for not offering coverage if the employer doesn't have any full-time employees who are certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee.

Penalty for employers not offering coverage. An applicable large employer who fails to offer its full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an employer-sponsored plan for any month is subject to a penalty if at least one of its full-time employees is certified to the employer as having enrolled in health insurance coverage purchased through a state exchange with respect to which a premium tax credit or cost-sharing reduction is allowed or paid to the employee. The penalty for any month is an excise tax equal to the number of full-time employees over a 30-employee threshold during the applicable month (regardless of how many employees are receiving a premium tax credit or cost-sharing reduction) multiplied by one-twelfth of $2,000. For example, if an employer fails to offer minimum essential coverage and has 60 full-time employees, ten of whom receive a tax credit for the year for enrolling in a state exchange-offered plan, the employer will owe $2,000 for each employee over the 30-employee threshold, for a total penalty of $60,000 ($2,000 multiplied by 30 (60 minus 30)). This penalty is assessed on a monthly basis.

Penalty for employers that offer coverage but have at least one employee receiving a premium tax credit. An applicable large employer who offers coverage but has at least one full-time employee receiving a premium tax credit or cost-sharing reduction is subject to a penalty. The penalty is an excise tax that is imposed for each employee who receives a premium tax credit or cost-sharing reduction for health insurance purchased through a state exchange. For each full-time employee receiving a premium tax credit or cost-sharing subsidy through a state exchange for any month, the employer is required to pay an amount equal to one-twelfth of $3,000. The penalty for each employer for any month is capped at an amount equal to the number of full-time employees during the month (regardless of how many employees are receiving a premium tax credit or cost-sharing reduction) in excess of 30, multiplied by one-twelfth of $2,000. For example, if an employer offers health coverage and has 60 full-time employees, 15 of whom receive a tax credit for the year for enrolling in a state exchange-offered plan, the employer will owe a penalty of $3,000 for each employee receiving a tax credit, for a total penalty of $45,000. The maximum penalty for this employer is capped at the amount of the penalty that it would have been assessed for a failure to provide coverage, or $60,000 ($2,000 multiplied by 30 (60 minus 30)). Since the calculated penalty of $45,000 is less than the maximum amount, the employer pays the $45,000 calculated penalty. This penalty is assessed on a monthly basis.

Requirement to offer "free choice vouchers." After 2013, employers offering minimum essential coverage through an eligible employer-sponsored plan and paying a portion of that coverage will have to provide qualified employees with a voucher whose value could be applied to purchase a health plan through the Insurance Exchange. Qualified employees would be those employees: who do not participate in the employer's health plan; whose required contribution for employer sponsored minimum essential coverage exceeds 8%, but does not exceed 9.8% of household income; and whose total household income does not exceed 400% of the poverty line for the family. The value of the voucher would be equal to the dollar value of the employer contribution to the employer offered health plan. Employers providing free choice vouchers will not be subject to penalties for employees that receive a voucher.

For owners of small businesses and their workers, the recently enacted health reform legislation has some key provisions to pay attention to. The major ones include: tax credits; excise taxes; and penalties. But whether a business will be affected by them depends on a variety of factors, such as the number of employees the business has. Here are the details:

Tax credits to certain small employers that provide insurance. The new law provides small employers with a tax credit (i.e., a dollar-for-dollar reduction in tax) for non-elective contributions to purchase health insurance for their employees. The credit can offset an employer's regular tax or its alternative minimum tax (AMT) liability.

Small business employers eligible for the credit. To qualify, a business must offer health insurance to its employees as part of their compensation and contribute at least half the total premium cost. The business must have no more than 25 full-time equivalent employees ("FTEs"), and the employees must have annual full-time equivalent wages that average no more than $50,000. However, the full amount of the credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages from the employer of not more than $25,000. The IRS has adopted a liberal approach to the new law's requirements, including three alternative methods for figuring total hours of service (important for determining how many FTEs an employer has), and it has also explained how small employers claim the credit if their State provides a credit or subsidy for employee health coverage. The IRS has released a state-by-state table of average health insurance premiums for the small group market for the 2010 tax year. This table is needed to calculate the credit for this year.

Years the credit is available. The credit is initially available for any tax year beginning in 2010, 2011, 2012, or 2013. Qualifying health insurance for claiming the credit for this first phase of the credit is health insurance coverage purchased from an insurance company licensed under state law. For tax years beginning after 2013, the credit is only available to an eligible small employer that purchases health insurance coverage for its employees through a state exchange and is only available for two years. The maximum two-year coverage period does not take into account any tax years beginning before 2014. Thus, an eligible small employer could potentially qualify for this credit for six tax years, four years under the first phase and two years under the second phase.

Calculating the amount of the credit. For tax years beginning in 2010, 2011, 2012, or 2013, the credit is generally 35% (50% for tax years beginning after 2013) of the employer's non-elective contributions toward the employees' health insurance premiums. The credit phases out as firm-size and average wages increase.

Special rules. The employer is entitled to an ordinary and necessary business expense deduction equal to the amount of the employer contribution minus the dollar amount of the credit. For example, if an eligible small employer pays 100% of the cost of its employees' health insurance coverage and the amount of the tax credit is 50% of that cost (i.e., in tax years beginning after 2013), the employer can claim a deduction for the other 50% of the premium cost.

Self-employed individuals, including partners and sole proprietors, two percent shareholders of an S corporation, and five percent owners of the employer are not treated as employees for purposes of this credit. There is also a special rule to prevent sole proprietorships from receiving the credit for the owner and their family members. Thus, no credit is available for any contribution to the purchase of health insurance for these individuals and the individual is not taken into account in determining the number of full-time equivalent employees or average full-time equivalent wages.

Most small businesses exempted from penalties for not offering coverage to their employees. Although the new law imposes penalties on certain businesses for not providing coverage to their employees (so-called "pay or play"), most small businesses won't have to worry about this provision because employers with fewer than 50 employees aren't subject to the "pay or play" penalty.

The "Cadillac tax" on high-cost health plans. The new law places an excise tax on high-cost employer-sponsored health coverage (often referred to as "Cadillac" health plans). This is a 40% excise tax on insurance companies, based on premiums that exceed certain amounts. The tax is not on employers themselves unless they are self-funded (this typically occurs at larger firms). However, it is expected that employers and workers will ultimately bear this tax in the form of higher premiums passed on by insurers.

The new tax, which applies for tax years beginning after December 31, 2017, places a 40% nondeductible excise tax on insurance companies and plan administrators for any health coverage plan to the extent that the annual premium exceeds $10,200 for single coverage and $27,500 for family coverage. An additional threshold amount of $1,650 for single coverage and $3,450 for family coverage will apply for retired individuals age 55 and older and for plans that cover employees engaged in high risk professions. The tax will apply to self-insured plans and plans sold in the group market, but not to plans sold in the individual market (except for coverage eligible for the deduction for self-employed individuals). Stand-alone dental and vision plans will be disregarded in applying the tax. The dollar amount thresholds will be automatically increased if the inflation rate for group medical premiums between 2010 and 2018 is higher than projected. Employers with age and gender demographics that result in higher premiums could value the coverage provided to employees using the rates that would apply using a national risk pool. The excise tax will be levied at the insurer level. Employers will be required to aggregate the coverage subject to the limit and issue information returns for insurers indicating the amount subject to the excise tax.

Section III -- Businesses

The recently enacted 2010 Small Business Jobs Act includes a wide-ranging assortment of tax breaks and incentives for businesses. Here's a brief overview of the tax changes in the Small Business Jobs Act.

Enhanced small business expensing (Section 179 expensing). To help small businesses quickly recover the cost of capital outlays, small business taxpayers can elect to write off these expenditures in the year they are made instead of recovering them through depreciation. Under the old rules, taxpayers could generally expense up to $250,000 of qualifying property-generally, machinery, equipment and software-placed in service in during the tax year. This annual limit was reduced by the amount by which the cost of property placed in service exceeded $800,000. Under the Small Business Jobs Act, for tax years beginning in 2010 and 2011, the $250,000 limit is increased to $500,000 and the investment limit to $2,000,000. The Small Business Jobs Act also makes certain real property eligible for expensing. Thus, for property placed in service in any tax year beginning in 2010 or 2011, the $500,000 amount can include up to $250,000 of qualified leasehold improvement, restaurant and retail improvement property.

Extension of 50% bonus first-year depreciation. Before the Small Business Jobs Act, Congress already allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property placed in service in 2008 or 2009 by permitting the first-year write-off of 50% of the cost. The Small Business Jobs Act extends the first-year 50% write-off to apply to qualifying property placed in service in 2010 (as well as 2011 for certain aircraft and long production period property).

Boosted deduction for start-up expenditures. The Small Business Jobs Act allows taxpayers to deduct up to $10,000 in trade or business start-up expenditures for 2010. The amount that a business can deduct is reduced by the amount by which startup expenditures exceed $60,000. Previously, the limit of these deductions was capped at $5,000, subject to a $50,000 phase-out threshold.

100% exclusion of gain from the sale of small business stock. Ordinarily, individuals can exclude 50% of their gain on the sale of qualified small business stock (QSBS) held for at least five years (60% for certain empowerment zone businesses). This percentage exclusion was temporarily increased to 75% for stock acquired after February 17, 2009 and before January 1, 2011. Under the Small Business Jobs Act, the amount of the exclusion is temporarily increased yet again, to 100% of the gain from the sale of qualifying small business stock that is acquired in 2010 after September 27, 2010 and held for more than five years. In addition, the Small Business Jobs Act eliminates the alternative minimum tax (AMT) preference item attributable to such sales.

General business credits of eligible small businesses for 2010 get five-year carryback. Generally, a business's unused general business credits can be carried back to offset taxes paid in the previous year, and the remaining amount can be carried forward for 20 years to offset future tax liabilities. Under Small Business Jobs Act, for the first tax year of the taxpayer beginning in 2010, eligible small businesses can carry back unused general business credits for five years instead of just one. Eligible small businesses are sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years.

General business credits of eligible small businesses not subject to AMT for 2010. Under the AMT, taxpayers can generally only claim allowable general business credits against their regular tax liability, and only to the extent that their regular tax liability exceeds their AMT liability. A few credits, such as the credit for small business employee health insurance expenses, can be used to offset AMT liability. The Small Business Jobs Act allows eligible small businesses to use all types of general business credits to offset their AMT in tax years beginning in 2010.

Deductibility of health insurance for the purpose of calculating self-employment tax. The Small Business Jobs Act allows business owners to deduct the cost of health insurance incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.

Cell phones no longer listed property. This means that cell phones can be deducted or depreciated like other business property, without onerous recordkeeping requirements.

S corporation holding period for appreciated assets shortened to five years. Generally, a C corporation converting to an S corporation must hold onto any appreciated assets for 10 years or face a built-in gain tax at the highest corporate rate of 35%. The 2010 Small Business Jobs Act temporarily shortens the holding period of assets subject to the built-in gains tax to 5 years if the 5th tax year in the holding period precedes the tax year beginning in 2011.

New tax break for long-term contract accounting. The Small Business Jobs Act provides that in determining the percentage of completion under the percentage of completion method of accounting, bonus depreciation in 2010 is not taken into account as a cost. This prevents the bonus depreciation from having the effect of accelerating income.

Limitation on penalty for failure to disclose certain reportable transactions. The Small Business Jobs Act generally limits the penalty to 75% of the decrease in tax resulting from the transaction, retroactively to penalties assessed after December 31, 2006. Minimum and maximum penalties apply.

Information Reporting Required for Rental Income from Realty After 2010. Generally, all persons engaged in a trade or business who make certain payments (including rent) in the course of that trade or business of $600 or more in any tax year to another person must report that information to IRS. For payments made after December 31, 2011, payments subject to information reporting will also include amounts in consideration for property and gross proceeds. A taxpayer whose rental activity is a trade or business is subject to this reporting requirement, but, under pre-Act law, a taxpayer whose rental real estate activity was not considered a trade or business wasn't subject to this reporting requirement.

For payments made after December 31, 2010, the Act provides that, solely for purposes of information reporting, a person receiving rental income from real estate will be considered to be engaged in a trade or business of renting property. Thus, recipients of rental income from real estate generally are subject to the same information reporting requirements as taxpayers engaged in a trade or business. In particular, rental income recipients making payments of $600 or more during the tax year to a service provider (such as a plumber, painter, or accountant) in the course of earning rental income are required to provide an information return (typically Form 1099-MISC) to the IRS and to the service provider. Of course, penalties can be imposed for non-filing.

In addition to the changes enacted under the 2010 Small Business Jobs Act, the IRS has issued its own guidance during 2010 affecting businesses, as follows:

ARC loan program has no tax consequences for small business borrowers. The IRS has concluded that qualifying small business borrowers who receive an interest-free loan under the America's Recovery Capital Loan Program (ARC Loan Program) don't have income on account of the loan and can't claim interest deductions for the loan. The ARC Loan program helps small businesses that are experiencing financial hardship. Under it, viable small businesses experiencing immediate financial hardship can receive an interest-free loan of up to $35,000 from a lender approved by the Small Business Administration (SBA) for the purpose of making payments on qualifying small business loans. The loan proceeds are used to make up to six months of principal and interest payments on qualifying small business loans (e.g., credit card obligations for the borrower's business, capital leases for major equipment and vehicles, and notes payable to suppliers or vendors) and repayment of the loan principal is deferred for at least 12 months after the last disbursement of the proceeds. Repayment of an ARC loan may extend up to five years, but the borrower must pay the principal over the repayment period. The SBA pays monthly interest to the lender, and provides a 100% guaranty of payment to the lender. The borrower has no obligation to pay any interest on the loan. The ARC Loan Program runs through September 30, 2010, or until appropriated funds run out, whichever comes first.

How small employers opt in or out of filing Form 944 for 2010. The IRS has explained how small employers eligible to file Form 944 (Employer's Annual Federal Tax Return), should request to file that form instead of Forms 941 (Employer's Quarterly Federal Tax Return), for tax years beginning on or after January 1, 2010. In addition, the IRS explained how employers who previously were notified to file Form 944, may request to file Forms 941 instead for tax years beginning on or after January 1, 2010. Employers whose estimated annual employment tax liability is $1,000 or less are eligible to file Form 944 rather than Form 941 (but not if they must file Form 943, Employer's Annual Federal Tax Return for Agricultural Employees, or Schedule H (Household Employment Taxes, Form 1040)). Beginning in tax year 2010, employers will be able to opt out of filing Form 944 for any reason if they follow certain procedures.

Tax breaks for hiring new employees. Employers are exempted from paying the employer 6.2% share of Social Security (i.e., OASDI) employment taxes on wages paid in 2010 to newly hired qualified individuals. These are workers who: (1) begin employment with the employer after February 3, 2010 and before January 1, 2011, (2) certify by signed affidavit, under penalties of perjury, that they haven't been employed for more than 40 hours during the 60-day period ending on the date the individual begins employment with the qualified employer; (3) do not replace other employees of the employer (unless those employees left voluntarily or for cause), and (4) aren't related to the employer under special definitions. The payroll tax relief applies only for wages paid from March 19, 2010 through December 31, 2010.

Employers may qualify for an up-to-$1,000 tax credit for retaining qualified individuals. The workers must be employed by the employer for a period of not less than 52 consecutive weeks, and their wages for such employment during the last 26 weeks of the period must equal at least 80% of the wages for the first 26 weeks of the period.

Regulations on election to defer COD income. For debt discharges in tax years ending after December 31, 2008, a taxpayer may elect to have any cancellation of debt (COD) income from the reacquisition of an applicable debt instrument after December 31, 2008, and before January 1, 2011, included in gross income ratably over five tax years. The IRS has issued two sets of regulations on this rule: one applies to C corporations, the other applies to partnerships and S corporations. The regulations cover many complicated issues that arise with the election. For example, the C corporation regulations cover topics such as acceleration of deferred cancellation of debt (COD) income and deferred original issue discount deductions, and the calculation of earnings and profits as a result of making an election.

Simplified per diem rates lowered effective October 1, 2010. Reimbursements of an employee's business travel costs (lodging, meal and incidental expenses (M&IE)) at a per diem rate are payroll-and income-tax free if simplified substantiation is provided and the daily rate doesn't exceed the federal per diem rate (the maximum amount that the federal government reimburses its employees) for the locality of travel for that day. While the per diem rates vary by travel destination, employers can make reimbursements at the simplified "high-low" per diem rates, which assign one per diem rate to high-cost areas within the continental U.S., and another to non-high-cost areas. The IRS has issued the "high-low" simplified per diem rates for post-September 30, 2010, travel. An employer may reimburse up to $233 for high-cost localities ($168 for lodging and $65 for M&IE) and $160 for other localities ($108 for lodging and $52 for M&IE). The list of high-cost areas is also updated.

Reporting of uncertain tax positions. The IRS has announced that it has developed a schedule to require certain business taxpayers to report uncertain tax positions on their tax returns. Schedule UTP (Form 1120), Uncertain Tax Position Statement will initially apply only to large corporations. This schedule will require a concise description of those positions and would be filed with the Form 1120, U.S. Corporation Income Tax Return. The IRS plans to require the filing of the new schedule for returns relating to the calendar year 2010 and for fiscal years that begin in 2010. In addition, the agency has taken steps to protect taxpayer communications with practitioners and to ensure that the program is properly applied by its own personnel.

These new developments coupled with Congress' failure to act on previously enacted legislation which expired during 2010 or is set to expire at the end of this year, create a new sense of urgency for year end tax planning. Please call us for more information about what steps you should implement to take advantage of the favorable changes and to minimize the impact of those that are unfavorable.