The Kiplinger Tax Letter

Circulated Biweekly to Business Clients Since 1925
1729 H. St. NW, Washington, DC 20006-3938 • 

Special Issue
Washington, September 2008

Dear Client:

Many new tax breaks for real estate were slipped into recently enacted legislation providing relief from the current mortgage crisis. Lawmakers approved tax cuts worth 12.4 billion over 10 years, as well as tax increases to offset them.

Nonitemizers can deduct property taxes in 2008 in addition to taking the standard deduction. The extra write-off is capped at $1,000 for marrieds and $500 for singles. This break lapses after 2008.

Fist-time home buyers get a tax credit of up to $7,500 for buying a main home after April 8, 2008 and before July 1, 2009. To be eligible, purchasers must not have owned a principal residence in the U.S. in the precious three years. The credit phases out between $150,000 and $170,000 of AGI for married couple and $75,000 to $95,000 for single filers. It is refundable to the extent that it exceeds regular tax liability, but it doesn’t offset the AMT. Home buyers in 2009 can elect to take the credit on their 2008 income tax returns.

But the tax credit is recaptured over 15 years, without any interest, starting two years after the year the credit is claimed. Thus a first-time home buyer who claims a $7,500 tax credit for a purchase in 2008 must pay an extra $500 of income tax in 2010 and later years. If the homeowner sells the residence before the credit is fully repaid, the seller is taxed that year on the lesser of the gain from the sale (if sold to an unrelated party) or the unrecaptured balance of the credit.

The credits for low-income housing and fixing up old buildings are juicier:

They now can offset the AMT. This rule applies to low-income projects that are put in service after 2007 and to rehabilitation expenses incurred after 2007.

Exempted from the minimum tax: Interest on more tax free bonds… those used for low-income housing and mortgages for veterans and low-incomers. This easing applies only to new nods issued after Bush signed the measure.

Victims of the 2005 hurricanes also get relief. Those whose casualty losses were later reimbursed can report the funds as if received in 2005. That helps folks whose income tax rate in 2005 was lower than in the year that they were reimbursed. IRS will charge only one year’s interest. 1040-Ss for 2005 are due by April 15, 2009.

Businesses that can’t benefit from 50% bonus depreciation get a break: They can elect to accelerate the use of their AMY and R&D credit carryovers instead.

Congress curbed a break for folks turning a second home into a main home:

Some of the gain will be ineligible for the home-sale exclusion if the house is converted to personal use after 2008 and is later sold. The portion of the profit is converted to personal use after 2008 and is later sold. The portion of the profit that’s taxed is based on the ration of the time after 2008 when the home was used as a second residence or rented out to the total time that the seller owned the house.

And credit card issuers will have to file 1099s on payments to merchants, starting with payments for 2011. That gives issuers time to gear up their computers.

Buyers of new heavy SUVs get showered with tax breaks this year.

Special 50% bonus depreciation is the reason. Here’s an example:

Your firm buys a new $50,000 SUV with a loaded weight over 6,000 pounds and placed it into service in 2008. The business can expense $25,000 of the cost. One-half of the remaining $25,000 cost, $12,500, is claimed as bonus depreciation. And 20% of the $12,500 balance of the cost can be deducted as regular depreciation. Assuming the SUV is used 100% for business, a total of $40,000 can be written off in year one…80% of the total cost. You can’t take this break on used heavy SUVs.

There’s a move in Congress to rein in the largesse. The House OK’d a bill that would restrict the total write-off in the first year for heavy SUVs to $11,260 for vehicles that are placed into service after the measure is signed into law.

But passage isn’t guaranteed. The Senate is still balking at the provision.

Watch out for excess personal use of your SUV in the first five years.

The IRS can recapture your tax break. It business use falls below 50% within that five-year period, starting with the year that the vehicle is put in use, any write-offs that are claimed over straight-line depreciation are taxed as income, according to the Tax Court (Birdsill, TC Summ. Op. 2008-55). Recapture applies both to special expensing for heavy SUVs and to bonus depreciation allowed in 2008.

A big win for IRS on payroll tax exemptions for severance pay:

Nearly all such payments are hit with FICA and Medicare taxes, an Appeals Court says. It reverses a lower court case that allowed a company to avoid payroll taxes on buyouts of employees who were let go involuntarily. For payroll tax purposes, payments to those workers are treated the same way as buyouts of employees who voluntarily lefty… taxes are due (CSX, Fed. Cir.).

There is an exception for supplemental unemployment benefit plans. Plan payments made to furloughed workers remain exempt from payroll taxes if they are tied to state unemployment benefits that are paid to laid-off employees.

Be careful if you use a payroll service firm to pay your employees:

You are on the hook if the company defaults, a district court says. One day after a business wired payroll funds to its agent, the IRS imposed a levy on the agent’s bank for unpaid taxes. The business paid it s employees directly and sued the Service to get its money back, claiming that the seizure was invalid. The court disagreed, saying the bank didn’t hold the funds in trust for the business, so the IRS levy was proper (DT Floormasters, D.C., Ind.). The payer’s only recourse is to sue the payroll firm, which, given the firm’s financial woes, probably won’t help.

Special withholding rules apply to severance pay, the Service says. Such compensation is treated as supplemental wages, so employers get a choice: They can withhold a flat 25% of each payment or they can aggregate the severance pay with any regular wages and compute withholding on the total (Rev. Rul. 2008-29).

Good news if you plan to convert a 401 (k) account directly to a Roth IRA:

New rules from the IRS offer a sweet deal for any after-tax contributions. The total amount of your after-tax contributions can be converted free of tax. This is a much more liberal rule than when converting a regular IRA to a Roth. In that situation, the portion of the rollover that is deemed to be tax free is based on the ration of your nondeductible payins to the total in your IRA accounts. If you have $60,000 in your IRA with $600 of it would escape income tax. The remaining $5,400 would be taxed. But in the same situation with a 401 (k), the full $6,000 would avoid tax. The same goes for 403(b) plans and 457 plans.

With airlines reinstating the Saturday night stayover rule for cheap fares…

Remember that an extra day tacked onto a business trop can be deductible if the total cost of the trip is lower as a result. This is so even if the additional day is used for sightseeing, shopping and the like. The extra meal and lodging expenses for the nonbusiness day must be less than the cost of flying without a Saturday stay. Reimbursement of the extra day’s food and lodging is also tax free to employees.

The IRS is ramping up its examination of tool reimbursement plans.

Firms involved in aviation, agriculture and construction will be audited, expanding a probe that began with auto dealers, car repair firms and body shops. IRS believes that many tool reimbursement plans are just shams that are designed to make a portion of the workers’ pay tax free and save payroll taxes for employers. Unless employees are required to substantiate tool expenses and return any excess to their employers, payments made under the plan are taxed and hit with payroll tax.

Claiming cell phones as a tax free fringe benefit will get easier soon. Congress is prodding IRS to loosed rules requiring taxation of personal use of employer-provided cell phones and requiring detailed records to be maintained on business usage. Workers now have to document the business purpose, time and place of calls they make. Lawmakers say cell phone usage should be on a par with employee use of company desk phones or e-mail, which needn’t be tracked. If the Service doesn’t act soon, taxwriters will take the initiative to change the law.

Note this break if you use a flexible spending plan for dependent care costs:

You can claim the depended care credit to the extent that your expenses are more than the amount that you fund through your flexible spending account. Although only $5,000 of dependent care expenses can be run through a flex plan, the credit is available for as much as $6,000 of eligible expenses for taxpayers with two or more children under the age of 13. In that case, $1,000 of expenses would be eligible for the dependent care credit on Form 2441. For most filers, the credit on that amount would generate an additional $200 in tax savings. Of course, no credit can be claimed for any dependent care costs that are paid out of the flexible spending account. That would be prohibited double-dipping.

The Service is easing the rules on some reimbursements by flex plans.

Prepaid orthodontist charges can be reimbursed up front, the IRS says in proposed regulations, even if the treatment lasts into the following tax year.

Newly employed workers are permitted to make retroactive elections for their flex accounts, as long as they do so within 30 days of their hiring date.

Workers who quit can tap unused funds to pay dependent care expenses that are incurred after they leave their jobs. This helps them avoid any forfeitures.

And individuals in flex plans who don’t have health insurance can buy it with their set-asides, effectively using pretax dollars to obtain medical coverage.

IRS is easing up on earnings on escrows in tax deferred exchanges.

Sellers will not woe tax if the exchange proceeds are $2 million or less, the IRS says in final regulations. Those swaps are exempt from the general rule, which makes sellers liable for taxes on all earnings on the sales proceeds, even if they pay part of all of the earnings to the exchange intermediary as a fee.

The change benefits small nonblank exchange facilitators by helping them to stay competitive with banks that perform the same service. Unlike the banks, the small nonblank businesses typically keep some earnings to augment the fee. Since most of the swaps they broker are $2 million or less, the ruling will let them avoid paying earnings to clients and raising their basic fee to make up the difference.

The IRS is on the warpath against firms that misclassify workers.

It has weapons for tracking down firms that violate the rules used to determine whether workers really are employees or independent contractors. The result: an increase in audits in a few months after IRS generates more leads.

Take a look at what the Revenue Service now has in its arsenal:

More help from the states. The IRS has signed up most of the states to share payroll tax exam data. Thousands more audit referrals will result.

Revved up document matching programs to pinpoint audit leads and lessen chances for no-change examinations. An electronic matching system, for example, enables the IRS to spot businesses issuing 10999 forms with payments of $25,000 or more to at least fie workers who have no other sources of income.

And audit leads from workers. Taxpayers can now file Form 8919 along with their tax returns to tell the Service that they believe their employer incorrectly pegged them as contractors. A flood of these forms is likely to come because filing the 8919 allows an individual to avoid paying self-employment tax.

Home builders will get special audit attention from the Service. Agents will be on the lookout for inappropriate income deferrals by builders that use the completed contract method of accounting. Among their targets: Developers who sell lots but don’t report income until the common improvements are finished. And those who use a subsidiary to build all the houses in a project so the company can say that the contract isn’t complete until all homes are built. Otherwise, the home builder would owe taxes after each house was completed.

IRS will clamp down on 529 plans this year and issue regulations that will target abuses. Under the microscope: Putting as much as $120,000 (the maximum 529 payin that’s free of gift tax) into accounts for different people, then quickly changing the beneficiary on all of the accounts to one individual. And another ploy…stuffing a lot of money into a 529 plan and later using the funds to pay for retirement. That allows contributors to circumvent the payin ceilings and distribution requirements that apply to qualified retirement plans.

Yours very truly,

The Kiplinger Washington Editors