The House and Senate voted today to extend the payroll tax cut and unemployment benefits, while also avoiding a Medicare fee cut for doctors for the rest of the year. President Obama has promised to sign the legislation, which means Americans will continue to receive bigger paychecks through the rest of the year.
Cancelation of debt should generally be reported as an income on your tax return, but luckily there are three exceptions: 1) mortgage discharged after a foreclosure or debt reduced through mortgage restructuring on your principal residence 2) bankruptcy and 3) insolvency
Insolvency
For purposes of relief under the cancellation of debt income rules, you are insolvent if the total of all of your liabilities was more than the fair market value (FMV) of all of your assets immediately before the cancellation. For purposes of this calculation, your assets include the value of everything you own. Liabilities include the entire amount of recourse debts (debts that you are personally responsible for but not guaranteed with specific collateral, like your credit cards), the amount of nonrecourse debt (secured debt, like a mortgage).
How it works:
If under the tax laws, you were insolvent immediately before the cancellation of debt, you would not include that canceled debt in income. Generally, your canceled debt would be reported to you on a form 1099-C. Of course, the lending institution or bank which issued you the form 1099-C does not know that you qualify for an exception so you are going to have to let the IRS know why you are not including the amount of that 1099-C in income for tax purposes. You do this by completing a federal Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. The IRS also offers Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals) to assist you with the insolvency calculations.
Earned Income and adjusted gross income (AGI) must each be less than:
- $43,352 ($48,362 married filing jointly) with three or more qualifying children
- $40,363 ($45,373 married filing jointly) with two qualifying children
- $35,535 ($40,545 married filing jointly) with one qualifying child
- $13,460 ($18,470 married filing jointly) with no qualifying children
Tax Year 2010 maximum credit:
- $5,666 with three or more qualifying children
- $5,036 with two qualifying children
- $3,050 with one qualifying child
- $457 with no qualifying children.
Investment income must be $3,100 or less for the year.
About 77 percent of U.S. tax-payers received a refund on 2009 returns, averaging $2,994 each.
Social Security benefits are taxed depending on your total income from all sources. Here is how to calculate how much of your Social Security benefits is taxable.
Provisional Income
Provisional income is your total worldwide income, including tax-exempt income, plus half of your Social Security benefits.
Base Amounts
The following base amounts are used in figuring your taxable Social Security:
| Filing Status | Base | Additional |
| Single | $25,000 | $34,000 |
| Head of Household (HH) | $25,000 | $34,000 |
| Married Filing Jointly (MFJ) | $25,000 | $34,000 |
| Qualifying Widow(er) | $25,000 | $34,000 |
Taxable Social Security Benefits
- If your provisional income is below the base amounts for your filing status, then your Social Security benefits are not taxable.
- If you provisional income is between the base amount and the additional amount, then 50% of your Social Security benefits over the base amount are taxable.
- If your provisional income is over the additional amount, then $4,500 (or $6,000 if Married Filing Jointly) plus 85% of your Social Security benefits over the additional amount are taxable.
- The taxable portion of your Social Security benefits cannot exceed 85% of your total benefits.
New Tax Relief/Job Creation Act of 2010 bill extends Bush-era tax cuts, provides payroll tax relief, and reinstates the estate tax.
Extended Provisions
The bill extends these provisions, which had expired on December 31, 2009:
- State & local sales tax deduction
- Higher education tuition deduction
- $250 above-the-line teacher’s classroom expense deduction
- Charitable contributions of IRA
- Charitable contributions of appreciated property for conservation purposes
(Note: the additional standard deduction for property tax was not extended.)
The bill provides an AMT patch. The exemption amounts for 2010 and 2011 are:
| 2010 | 2011 | |
| Single/Head of Household | $47,450 | $48,450 |
| Married filing joint/surviving spouse | $72,450 | $74,450 |
| Married filing separate | $36,225 | $37,225 |
In addition, nonrefundable personal credits can be applied against AMT for two more years.
Here is a partial list of extensions of current law (these changes are effective through 2011 unless otherwise noted):
- 2010 individual tax rates (effective through 2012)
- 2010 rates on dividends and capital gains (effective through 2012)
- No phase-out of itemized deductions or personal exemptions
- Increased standard deduction and 15% bracket for married couples
- $1,000 Child Tax Credit will continue
- Earned Income Tax Credit enhancements
- Maximum expenses for the Child and Dependent Care Credit remain at $3,000/$6,000
- Deduction of mortgage insurance premiums
- American Opportunity Tax Credit
- Exclusion for employer educational assistance
- Student loan interest deduction
- Increased contributions to Coverdell Education Savings Accounts
- Adoption Credit and exclusion for employer adoption assistance
Payroll Tax Cut
The Act reduces the employee-share of the OASDI portion of Social Security tax from 6.2% to 4.2% for wages earned in calendar year 2011, up to the taxable wage base of $106,800. This reduction applies to all wage earners and self-employed individuals with no reduction for income (i.e., no AGI phase-outs).
Business incentives
The Act provides the following business incentives:
- 100% bonus depreciation for investments made after September 8, 2010, and before January 1, 2012
- The §179 threshold will be $125,000/$500,000 for tax years beginning in 2012 (the limits are set at $500,000/$2 million for 2010 and 2011 under SBJA)
- Extension of the R&D credit
- Extension of the 100% small business stock exclusion
- Extension of transit benefits
- Extension of a number of business extenders
Energy Incentives
Many business energy incentives were extended, and the individual credit for energy efficiency improvements was also extended. However, the amount allowed returns to the pre-2009 lifetime limit of $500 (rather than the 2009/2010 maximum of $1,500).
Estate Taxes
The federal estate tax exemption is increased to $5 million with a maximum rate of 35% for 2011 and 2012. For decedents dying in 2010, the executor may elect to use the $5 million exemption and 35% rate, or the no estate tax and carryover basis provisions under EGTRRA.
If the tax cuts are allowed to expire at the end of the year, stock dividends will be subject to a much higher tax.
Right now, the tax on stock dividends typically is a maximum 15%. But if the Bush tax cuts expire and we revert to previous levels, dividends would be subject to an income-tax rate of as much as 39.6%. For instance, if the cuts were to expire, a married couple filing jointly with $100,000 in taxable income would be in the 28% tax bracket – the rate prior to the tax cuts – and would be subject to that rate on dividends.
There is talk that the tax cuts may only be extended for families earning less than $250,000 a year, or individuals earning less than $200,000. If that happens, then those earning more than that amount might be subject to a higher dividend tax.
If you would like details on provisions that affect you, please contact Tax Advisors.
The Hiring Incentives to Restore Employment (HIRE) Act of 2010, created two new employer tax benefits to reward organizations for hiring and retaining unemployed or part-time workers.
Payroll tax exemption – provides employers with an exemption from the employer’s 6.2 percent share of social security tax on wages paid to qualifying employees, effective for wages paid from March 19, 2010 through December 31, 2010.
New hire retention credit – in addition, if the employee stays on for a full year, the business will also be eligible for a tax credit of up to $1,000.
As of August 4, FTB has received 31,460 applications. Because some of the applications are invalid or duplicates, FTB will continue to accept them through August 15, to ensure that enough valid applications are received to properly allocate the full $100 million of tax credit. FTB estimates that it can award approximately 17,500-20,000 credit certificates to unique and valid applicants. However, once the funds are exhausted, any remaining applications will be denied.
The State is providing $100 million in tax credits to first-time home buyers. The credit will be allocated on a first-come, first-served basis using the date and time stamp on the fax submission, until the money is exhausted. The tax credit is available to those who purchased a qualified principal residence and did not own one during the last three years. This credit is five percent of the purchase price or $10,000, whichever is less. Taxpayers must claim the credit on their tax return in equal amounts over the following three tax years.
To apply, the buyer must complete and fax an FTB Form 3549-A, Application for New Home / First-Time Buyer Credit, along with the final settlement statement. It must be faxed to FTB within two weeks (14 calendar days) after the close of escrow. The fax number is 916.855.5577.
Taxpayers must receive a certificate of allocation from FTB to claim the tax credit on their California personal income tax return. FTB expects to send the allocation certificates over the next few months starting in August.
California homebuyers still have time to qualify for the state’s other $100 million home tax credit for the purchase of a new home. The New Home Credit is available for taxpayers who purchase (close escrow) a new home on or after May 1, 2010, and before August 1, 2011, as long as they enter into an enforceable contract executed before January 1, 2011. The seller must certify that the home has never been previously occupied.
Corporate officers will sometimes attempt to disguise what should be payment for services as distributions of cash, dividends, and loans as a means of avoiding payroll taxes on the income. Because they are pass-through entities, Sub Chapter S corporations are especially prone to the misclassification of income attributable to a misunderstanding of the compensation rules or by deliberate attempts to reduce the payroll tax bite. Hence, the IRS and Congress are placing an increased emphasis on “reasonable compensation” and the collection of additional payroll taxes from the business and additional withholding from the officer or owner.
The Internal Revenue Code establishes that any officer of a corporation, including S corporations, is an employee of the corporation for federal employment tax purposes. S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.
Who’s an Employee of the Corporation? Generally, an officer of a corporation is an employee of the corporation. The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages. Courts have consistently held that S corporation officers/shareholders who provide more than minor services to their corporations and receive or are entitled to receive payment are employees whose compensation is subject to federal employment taxes.
Treasury regulations provide an exception for an officer of a corporation who does not perform any services or who performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration. Such an officer would not be considered an employee.
What’s a Reasonable Salary? The instructions for Form 1120S, U.S. Income Tax Return for an S Corporation, state that “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”
The amount of compensation will never exceed the amount received by the shareholder either directly or indirectly. However, if cash or property or the right to receive cash and property did go to the shareholder, then a salary amount must be determined and the level of salary must be reasonable and appropriate.
There are no specific guidelines for reasonable compensation in the Code or the Regulations. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.
In IRS Fact Sheet 2008-25, the IRS warns S corporations not to attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.
The following are some factors considered by the courts in determining reasonable compensation:
- Training and experience
- Duties and responsibilities
- Time and effort devoted to the business
- Dividend history
- Payments to non-shareholder employees
- Timing and manner of paying bonuses to key people
- What comparable businesses pay for similar services
- Compensation agreements
- The use of a formula to determine compensation
In a recent district court case (Watson v. U.S., (DC IA 05/27/2010)) in which the IRS claimed that a portion of the dividend distributions by an S corporation to its sole owner should be re-characterized as wages subject to employment taxes, the court sided with the IRS and rejected the corporation’s assertion that the IRS could not compel the corporation to pay a higher salary to the owner.
The American Jobs, Closing Tax Loopholes and Preventing Outsourcing Act of 2010, which passed the House on May 28, 2010 (currently awaiting Senate action), contains a provision that would clamp down on certain service professionals who try to minimize Medicare and Social Security taxes by routing their self-employment income through S corporations and then paying themselves nominal salaries.
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