Shauna Xpressions!

On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. How many more acronyms (EFTRRA or JCTRRA) do we have to know? This Act, in essence, is an extension of the Bush-era tax cuts for two years. Also, the legislation includes a payroll tax holiday for 2011 and a change in the exemption amount and maximum tax rate for estate taxation. The Act incorporates many business and individual extensions of the so-called “annual extenders.”  Here are some highlights:

INDIVIDUAL TAX HIGHLIGHTS

• Individual Tax Rates remain at 2010 levels –these lower rates will be in effect until 2012

• Repeal of the “phaseout” for personal exemptions and itemized deductions for taxpayers with an Adjusted Gross Income above certain levels

• Modifications to child tax credit:  The Act keeps the child tax credit amount at $1,000 per child, extends the allowance against the regular tax/AMT and maintains the refundability through 2012.

• Expansion of adoption credit and adoption assistance programs:  The credit increased to $13,170 (adjusted for inflation, the 2011 amount is $13,360).

• Dependant care credit:  The Act provides that the dependent care credit is extended so eligible expenses of $3,000 for one qualifying child/disabled dependent and $6,000 for two or more children/disabled dependents creates a tax credit for an additional two years, through 2012.

• Elimination of marriage penalty :  The Act extends the marriage penalty relief for the standard deduction and the tax rate schedules for an additional two years, through 2012.

• Marriage penalty relief for earned income credit: This will insure that more families qualify for the earned income credit and married couples are not penalized.

• Modifications to education individual retirement accounts (now Coverdell education savings accounts): Coverdell education savings accounts are tax-exempt savings accounts used to pay the higher education expenses of a designated beneficiary. EGTRRA increased the annual contribution amount from $500 to $2,000 and expanded the definition of education expenses to include elementary and secondary school expenses. The Act extends the changes to Coverdell accounts for an additional two years, through 2012.

• Extension of exclusion for employer-provided educational assistance: An employee may exclude from gross income up to $5,250 for income and employment tax purposes per year of employer-provided education assistance.  Now both under-graduate and graduate education tuition can be excluded. The Act extends the changes for an additional two years, through 2012.

• Elimination of 60-month limit and increase in income limitation on student loan interest deduction: Certain individuals who have paid interest on qualified education loans may claim an above-the-line deduction for such interest expenses up to $2,500. The 60-month limit was eliminated through 2012. 

• Deduction for higher education expenses: EGTRRA created an above-the-line deduction for qualified tuition and related expenses. Currently, subject to income phase-outs, taxpayers are allowed to deduct a maximum of $4,000. 

• Reduction in capital gains rates for individuals; repeal of 5-year holding period requirement:  The Act extends the lower capital gains rates of 0% or 15% for all taxpayers for an additional two years, through 2012.

• Dividends of individuals taxed at capital gain rates: JGTRRA lowered the dividend rates so that they were taxed the same as capital gains.  The Act extends the current dividends rates for all taxpayers for an additional two years, through 2012.

• American Opportunity Tax Credit: The 2009 ARRA created the American Opportunity Tax Credit as a temporary replacement of the HOPE credit. Generally, the credit is for up to $2,500 of the cost of tuition and related expenses paid during the taxable year. The credit is allowable for the first four year of post-secondary education. Under this tax credit, taxpayers receive a tax credit based on 100% of the first $2,000 of tuition and related expenses (including course materials) paid during the taxable year and 25% of the next $2,000 of tuition and related expenses paid during the taxable year. Further, 40% of the credit is refundable. However, the credit is subject to a phase-out for taxpayers with adjusted gross income in excess of $80,000 ($160,000 for married couples filing jointly). The Act extends the American Opportunity Tax Credit for an additional two years, through 2012.

• Child Tax Credit: Generally, taxpayers with income below certain threshold amounts may claim the child tax credit to reduce federal income tax for each qualifying child under the age of 17. The 2001 EGTRRA expanded the refundability of the child tax credit so that those who owe little or no tax still get a benefit.

• Earned Income Tax Credit: The 2009 ARRA increased the earned income tax credit to 45% of a working family’s first $12,570 of earned income for families with three or more children and increased the beginning point of the phase-out range for all married couples filing a joint return (regardless of the number of children). The Act extends for an additional two years, through 2012, the 2009 ARRA provisions that increased the credit for families with three or more children and increased the phase-out.

TEMPORARY EMPLOYEE PAYROLL TAX CUT

Temporary Employee Payroll Tax Cut: For 2011 only, the Act reduces the Social Security (OASDI) tax rate on employees to 4.2% (from 6.2%) and reduces the self-employment tax (SECA) rate to 10.4% (from 12.4%). The employer OASDI tax rate stays at 6.2%. Also, the Act does not reduce the OASDI contribution base, which is $106,800 for 2011.

TEMPORARY EXTENSION OF INVESTMENT INCENTIVES

  Bonus Depreciation: The Act provides for a temporary 100% bonus depreciation for property acquired and placed in service after September 8, 2010, and before January 1, 2012. This means that taxpayers are able to claim a 100% depreciation deduction for property acquired and placed in service in the latter third of 2010 and all of 2011 (and 2012, for certain property); property placed in service during 2012 (2013 for certain property) is eligible for 50% bonus depreciation.

Temporary Extension of Increased Small Business Expensing(Sec 179) For taxable years beginning in 2010 and 2011, small businesses may elect to expense up to $500,000 of capital investment. The Act provides a $125,000 maximum cost of §179 property that may be expensed rather than depreciated in tax years beginning in 2012.  The Act also provides a $25,000 maximum and $200,000 phase out threshold for tax years beginning after 2012; these figures are not to be adjusted for inflation.

These two provisions both provide a way to expense capital purchases of equipment and furniture in the year purchased rather than depreciate over the life of the asset.

Recently I made the visit to the downtown office of the IRS to assist a taxpayer through a very extensive audit.  The process of dealing with the IRS can cause stress and sleepless nights for the taxpayer.  The reason the IRS causes such fear is that they can be a real bully.  My client can attest that the auditor will ask pointed questions and make you feel frazzled and on edge.  IRS auditors are trained to find errors in your tax return and they will dig hard to find things that they determine to be non-deductible.  Statistically less than 2% of taxpayers are subjected to a full IRS audit but it is still worth the effort to be prepared for the worst case. 

Here are some tips for you should you ever receive the dreaded letter:

Don’t try to handle the audit yourself.  You may feel that you are saving some money by trying to handle the audit yourself, but you could get hit with a much higher tax deficiency (in other words you will owe much more to the IRS) than if you had the assistance of a professional who knows the tax laws. 

Keep good records.  The auditor will disallow your deductions if you don’t have good substantiation.  Keep cancelled checks, invoices, bank statements, receipts for meals and travel documenting business purpose, mileage logs, etc.  In this case, the IRS is not going paperless anytime soon!  Their systems are so antiquated that you can’t even send documents by email.  You will need paper proof.  Or you will need the ability to drag your computer with you to the audit. 

Keep check copies or use your debit/credit card.  The IRS will want to see that your payments cleared the bank and the best way to show that is with a cancelled check, bank statement or credit card statement.  The advantage to using your debit card or auto payment through your bank account is that your bank statement will show the payee right on the statement.  If you use a lot of checks you will need copies of those checks.  Most banks don’t send check copies any more.  You might want to check with your bank to see how best to store that information.  Most banks can send “copies” of the checks 10 to a page with your statement.  That is a good option.

Keep written contracts with those that you pay, especially your independent contractors.  You will need to prove that your relationship has a “business purpose” and that you pay for a service or product.

Stay away from audit “red flags” if possible.  Make sure your expenses are in line with your income.  Large travel and entertainment expenses are a favorite trigger for audits.  Auto expenses and auto depreciation can also be a trigger.  Be sure to document on your credit card statement the “business purpose” of your meals and travel expenses.

As the saying goes, if you are prepared you have no need to fear.  Simple practices now will save you a lot of headache if you ever become part of that 2% audited group.  You might sleep better too!