February Spotlight Articles
Estate & Gift Tax Changes
By Lara Hunter, CPA, CCIFP
Tax Manager, SSA, P.C.
There have been some significant changes in the tax legislative arena in the last year – so many that it seems difficult to know where to start discussing them. One of the most significant areas of change is in the estate and gift tax arena. It is important to ensure that your business and other assets are protected as much as possible from tax and go to your heirs as intact as possible. With that in mind, here a few areas to be aware of regarding the change in taxation of estate and gift taxes.
As you probably know, there was no tax levied on the estates of individuals who passed away during 2010. The estate tax and its applicable exclusion amounts, which have been increasing each year for the past ten years, were eliminated for this one year. The estate tax exclusion was supposed to revert to pre- “Bush-Era” tax cut levels as of January 1, 2011.
While avoiding tax on your entire estate is a wonderful thought, even if you could time your death to take advantage of it, there was one major downside to this policy. Typically, the assets individuals hold on the day they die are taxed based on their fair market value at the date of their death. This allows their heirs to inherit this typically larger “basis.” When the heirs sell the property, they pay tax only on the basis appreciation between the decedent’s date of death and the date that they sell the property. In 2010, however, since there was no estate tax, the assets held by the decedent are not granted this “step-up” in basis and the heirs receive a basis that is the lesser of the cost of the property when the decedent purchased it, or the fair market value at the date of death. This means that when the heirs sell the property, they will pay tax on the gain in value from when the decedent first acquired the property.
There were a couple of mitigating factors, though. First, the personal representative for each decedent is allowed to allocate $1.3 million in basis to the assets, not to exceed the fair market value. There is no requirement to allocate this basis to all assets ratably, hence the personal representative could allocate all of the basis step-up to just one asset if they wish, possibly to the asset with the lowest basis to minimize potential income taxes. Secondly, if the decedent was married at the time he or she passed away, there is an additional $3 million in basis step-up for assets going to the surviving spouse.
For 2011 and 2012, Congress re-enacted the estate tax with a significantly higher exclusion amount of $5 million. Along with this higher exclusion amount, the maximum tax rate was capped at 35%. This means that the decedent’s estate will not have to pay tax on the first $5 million of assets and the tax paid on any assets in excess of this amount cannot exceed 35%. In addition, no matter what the value of the estate, the heirs will inherit the assets at the “stepped-up” basis as of the decedent’s date of death. Thus, if the value of the decedent’s estate is less than $5 million, then the estate pays no tax and the heirs get the stepped-up basis – the best of both worlds.
Furthermore, a provision was included in the law allowing the personal representative to choose which tax scheme to use for individuals who passed away in 2010. Starting on January 1, 2013, the exemption is reduced to $1 million and the maximum tax rate is 55%.
One of the most notable provisions in the law is the portability of the exclusion between spouses. Generally, if one spouse passes away and does not fully utilize the $5 million exclusion, then the surviving spouse can utilize the unused portion. The estate of the first spouse to pass is required to file a return stating that he or she is passing along a portion of the exemption to the surviving spouse. The one problem with this provision is that, currently, both spouses must pass away before 2013 to take advantage of it.
Another provision in the Tax Relief Act is the increase in the gift tax applicable exclusion amount. This amount was increased to $5 million for 2011 and 2012. In other words, you can gift up to $5 million during your lifetime, free of gift and estate taxes. This could be good for families that want to gift part of their business to their children, i.e., pass the business on to the next generation. One unknown with this provision is if the gift tax exclusion reverts to $1 million as it is supposed to in 2013, the gifts made in excess of the $1 million cap could become taxable at that time, potentially at the maximum estate tax rate of 55%.
This article highlights some of the most recent changes in the estate and gift tax arena in the next couple of years. I recommend a review of your estate plan every few years to ensure you are taking advantage of tax saving opportunities.
New Withholding Requirements to Take Effect
By Cord D. Armstrong, CPA, CCIFP
Tax Director, CBIZ MHM, LLC
You may have heard of the new withholding requirements currently set to take effect in 2012 on payments from the federal government and every state to any person who provides property or services to such governmental entities. The amount required to be withheld will equal 3% of the gross amount paid for the property or service and will be reported on Form 1099-MISC. Congress originally intended the withholding requirements to take effect on payments made after December 31, 2010. After proposed regulations were issued in 2008, the effective date was postponed for one year under the American Recovery and Reinvestment Act of 2009 so that it currently applies only to payments made after December 31, 2011.
The withholding rule was originally enacted in an effort to reduce the perceived tax compliance problem with government contractors. However, the 3% withholding will be extremely burdensome to construction contractors and will likely result in over-withholding in most situations. Assuming a 35% tax rate, a contractor would have to have pretax income of 8.6% of revenue in order for the withholding to approximate the contractor’s tax liability. In CFMA’s 2010 Construction Industry Annual Financial Survey, the average net earnings before income taxes was only 2.4%. In addition, the contractor will have to wait to file its income tax return in order to get a refund of the excess taxes withheld, severely restricting its cash flow normally used for the necessary labor, materials, and equipment for the job.
The IRS has recently provided some relief for any payments made by a payment card (including credit cards, debit cards, or prepaid value cards) for property or services. As stated in the proposed regulations, the withholding and reporting requirements include payments made by a payment card by a governmental entity. The IRS received numerous comments indicating that applying the withholding and reporting requirements on payment card transactions would be difficult to administer and also noted that all payment card transactions will already be required to be reported by the credit card companies after 2010. As a result, the IRS recently released Notice 2010-91 stating that the 3% withholding requirement by any governmental entity will not apply to payments made by a payment card for any calendar year beginning earlier than at least 18 months from the date further guidance is finalized. Thus, the 3% withholding will not apply on payments for property or services by payment cards for the 2012 calendar year.
There are numerous exceptions under the proposed regulations, including but not limited to the following:
- Any payment that is less than $10,000. This is to be determined on a per payment basis. However, if any governmental entity divides a payment into two or more payments primarily to avoid the $10,000 threshold, the divided payments would be treated as a single payment made on the date the first payment was made.
- Any payment already subject to backup withholding and backup withholding is actually being withheld from such payment.
- Payments for real property. This includes payments for the purchase and lease of real property. However, payments for the construction of real property such as buildings, roads, and other public works projects are not treated as “real property” under this section and are not exempt from the 3% withholding requirement.
- Payments by any political subdivisions of a state that makes less than $100 million of payments for property or services annually.
- Payments to governmental entities that are themselves subject to the withholding requirements.
- Payments made by a pass-through entity in which a government entity owns a direct or indirect ownership percentage of less than 80% as of the first day of the pass-through entity’s tax year.
- Payments made to a pass-through entity in which a government entity owns a direct or indirect ownership percentage of more than 80% as of the first day of the pass-through entity’s tax year.
The proposed regulations make a distinction as to who is providing the property or services and is subject to the withholding. If the government entity has a contract with a prime contractor, the determination of whether the payment meets the withholding threshold is based on the entire payment to the prime contractor, regardless of whether some of the payment relates to invoices from property or services provided by subcontractors. The payments from the prime contractor to the subcontractors would not be subject to withholding since the subcontractors are not parties to the contract between the prime contractor and the government entity. In cases where the government entity uses a payment administrator to disburse funds to providers, each payment made by the payment administrator is subject to withholding, provided the payment is $10,000 or more and is not otherwise excepted.
The IRS has not yet provided any guidance on how the withholding on payments to a pass-through entity will be allocated to the owners of S corporations and other pass-through entities, but presumably the withholding will be allocated to each owner on their respective K-1 forms. This might reduce or eliminate the need for many pass-through owners to make estimated tax payments, since many will be over-withheld on their share of the entities’ income, assuming the withholding will be allowed to be applied to the quarterly tax liabilities.
Increased Deductions for Energy Efficient Buildings
Here’s a summary of the Commercial Energy Efficient Deduction provided by CFMA’s Tax & Legislative Affairs Committee Co-Chair, George Parrott.
- A deduction of up $1.80 per square foot can be claimed for energy efficient improvements to commercial property, including rehabs and additions.
- If the property is owned by a federal, state, or local government, the deduction can be allocated to the entity primarily responsible for designing the property (contractor, architect, engineer, etc).
- Improvements must be part of interior lighting, HVAC or hot water, or the building envelope (roof, windows, etc.). Usually, all three of these components must be included in order to receive the full deduction of $1.80 per square foot.
- Property must be certified by a third party (using IRS-approved software) to reduce energy costs by at least 50% when compared to a similar structure.
- A reduced credit of $0.60 per square foot can be claimed for a reduction of at least 16.66% of energy costs.
- The allocation of the deduction among the various designers and contractors for the project must be in written form, signed by the owner and the contractor, and must contain the following items:
- The parties’ addresses and phone numbers.
- Address of the government-owned building.
- Cost of the property.
- Date property was placed in service.
- Amount of deduction allocated to the particular contractor.
- Affidavits of the parties signed under penalties of perjury.
The Commercial Building Tax Deduction Coalition’s Website
www.efficientbuildings.org) provides excellent information on the technical requirements for the deduction. The technical requirements from the IRS are the same for the building owner to qualify for the deduction or for a government entity to allocate the deduction to a contractor.
Can You Afford to Lose Grandfathered Status?
By Kevin J. Werkman, CPA, MBA
Jansen Valk Thompson Reahm PC
Provisions of the Patient Protection and Affordable Care Act do not apply to grandfathered health plans. A grandfathered plan is a group health plan or health plan coverage in effect on March 23, 2010 with one or more enrolled participants. Grandfathered status can be easily lost, and once lost, is lost forever.
The most significant provision that does not apply to a grandfathered plan is the nondiscrimination requirements of Internal Revenue Code Section 105(h), which otherwise takes effect on September 23, 2010. The IRS recently postponed the penalties associated with noncompliance until specific regulations dealing with public comments are resolved. Once the regulations are finalized, there may be a penalty of $100 per day for each highly compensated individual for which the noncompliance is related. The penalties are capped at $500,000 per year or 10% of the employer’s annual health expenses for the previous year.
The statute does not outline what changes may cause the plan to cease being a grandfathered plan; however, the final interim regulations provide that minor, routine changes do not cause a plan to lose its grandfathered status. To maintain grandfathered status, a plan cannot significantly cut or reduce benefits, raise coinsurance charges, significantly raise co-payment charges, significantly raise deductibles, add or tighten annual limit on what insurer pays, or significantly raise deductibles.
Amendments adopted on or before March 23, 2010 will not jeopardize a plan’s grandfathered status, even if the effective date is after March 23, 2010. However, amendments adopted after March 23, 2010 are subject to the new restrictions. Employers who have adopted amendments to their plans after March 23, 2010 which may cause grandfathered status to be lost have special transition relief to revoke and modify those amendments. Such an amendment must be effective as of the first day of the first plan year beginning on or after September 23, 2010.
The interim regulations provide, in part, that grandfathered status rules apply separately to each benefit package under a health plan. So, for example, if an employer maintains a group health plan with three medical options (two self-funded and one fully-insured) and the employer significantly raises the deductible regarding the fully-insured option, that would trigger a loss in grandfathered status with respect to the fully-insured option but would not cause grandfathered status to be lost with respect to the two self-funded options.
Before the Health Care Reform legislation, IRC 105(h) applied only to self-insured plans and prohibited discrimination in eligibility or benefits that favored “highly compensated individuals.” Highly compensated individuals are defined as the five highest paid officers, 10% or greater shareholders, and the highest paid 25% of employees.
Under IRC 105(h), a plan does not discriminate if it covers one of these three groups:
- 70% or more of all entitled employees,
- 80% or more of eligible employees when at least 70% of employees were entitled to enroll, or
- A nondiscriminatory classification of employees.
In determining eligibility, the plan may exclude employees with fewer than three years of service, employees under the age of 25, part-time and seasonal employees, and employees in a bargaining unit who were excluded through good-faith bargaining.
Employees of a controlled group of corporations; partnerships, proprietorships, etc., under common control; and employees of an affiliate service group are deemed to be employed by a common employer.
Under the Patient Protection and Affordable Care Act, an employer could easily lose its grandfathered status. Not only significant plan changes, but most plan changes, will put a health plan’s grandfathered status at risk under the new regulations. Plans that lose grandfathered status are subject to the nondiscrimination requirements of IRC 105(h) and steep penalties associated with noncompliance.