Key developments during the first quarter of 2010


While the new law tax changes in the health reform legislation and the hiring legislation were the most significant developments in the first quarter of 2010, many other tax developments may affect you, your family, and your livelihood. These other key developments in the first quarter of 2010 are summarized below.

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, there 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.

Reporting of uncertain tax positions. IRS has released a draft schedule and instructions under which, beginning with the 2010 tax year, certain business taxpayers with both uncertain tax positions and assets of $10 million or more will be required to file Schedule UTP if they or a related party issued audited financial statements. Currently, the reporting requirement applies to corporations required to file a Form 1120, insurance companies required to file a Form 1120L or a Form 1120 PC and foreign corporations required to file a Form 1120F. The schedule is filed together with the taxpayer’s annual tax return and includes a concise description of each uncertain tax position and information on the maximum amount of potential federal tax liability attributable to each uncertain tax position.

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.

IRS honoring medical resident FICA refund claims for pre-April 1, 2005 periods. The IRS made an administrative determination to accept the position that medical residents are excepted from FICA taxes based on the student exception for tax periods ending before April 1, 2005, when new IRS regulations went into effect. The IRS intends to contact hospitals, universities and medical residents who filed FICA (Social Security and Medicare tax) refund claims for these periods with more information and procedures. The period of limitations for filing a claim for tax periods before April 1, 2005 has expired. An individual who is or was a medical resident, and did not file an individual FICA refund claim, may be covered by a FICA refund claim filed by his employer for the period he was a medical resident. The individual should contact his employer (or former employer) to see if it filed a FICA refund claim. On April 1, 2005, new IRS regulations regarding the student FICA exception became effective. Under these regulations, an employee including a medical resident who works 40 hours or more for a school, college or university is not eligible for the student exception.

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 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 IRC §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 IRC §6707Aan 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 IRC §6707A’s application has passed the Senate and has been introduced in the House.

Government seeks input on annuitization of retirement plan payments. The Department of Labor and the Department of the Treasury are currently reviewing the law to determine whether (and, if so, how) they could or should enhance the retirement security of participants in employer-sponsored retirement plans and IRAs by facilitating access to, and use of, lifetime income or other arrangements designed to provide a lifetime stream of income after retirement. To that end, they are seeking input on this subject from plan participants, employers and other plan sponsors, plan service providers, and members of the financial community, as well as the general public. The concern is that many employers no longer provide fixed lifetime pensions but rather provide 401(k) plans. With these plans, employees bear investment risks and can choose lump sums. Accordingly, employees are not only increasingly responsible for the adequacy of their savings at the time of retirement, but also for ensuring that their savings last throughout their retirement years.

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About Don James, CPA/PFS, CFP
Don is the Tax & Financial Planning partner with Kiplinger & Co., CPAs headquartered in sunny Cleveland, Ohio since 1982. He partners with business owners and families and specializes in goal achievement solutions, tax minimization strategies and serves in the role of gatekeeper of sound financial advice.

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