Quarles & Brady Tax Newsletter
October Edition 10/26/10 Thomas J. Phillips, David D. Wilmoth, Jeffrey B. Fugal, Terrence W. Stein, John T. Barry
This edition contains the following articles:
Welcome to the October 2010 edition of the Quarles & Brady Taxation Group's newsletter dedicated to keeping you apprised of newsworthy tax developments.
Taxpayers in the top 1 percent of adjusted gross income reported adjusted gross income of at least $388,806 for 2006 and accounted for 39.9 percent of the total income tax reported. Taxpayers in the top 5 percent of adjusted gross income reported adjusted gross income of at least $153,542 for 2006 and accounted for 60.1 percent of the total income tax reported.
(Source: Internal Revenue Service, Statistics of Income Bulletin, Winter 2010, Washington D.C.)
Of the 6,623,900 corporate income tax returns filed for 2007, 4,155,800 or 63 percent were S corporation returns. The number of partnership returns filed for 2007 was 3,147,000.
(Source: Internal Revenue Service, Statistics of Income Bulletin, Summer 2010, Historic Table 21, Washington D.C.)
At this time, there is uncertainty as to what Congress will do concerning individual income tax rates for 2011. The uncertainty arises from the sunset provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") and whether Congress will act to change any of the sunset provisions.
EGTRRA reduced the marginal ordinary income tax rates from 39.6 percent, 36 percent, 31 percent and 28 percent to
35 percent, 33 percent, 28 percent, and 25 percent, respectively. If the EGTRRA reduced rates are allowed to expire, the 2011 rates will return to the 39.6 percent, 36 percent, 31 percent and 28 percent rates.
President Obama has proposed that the EGTRRA sunset would only apply to the current 33 percent and 35 percent rates so the top two brackets would rise to 36 percent and 39.6 percent, respectively.
Under EGTRRA, the maximum capital gains rate on capital gains other than on collectibles and unrecaptured
section 1250 gain was 20 percent. The Jobs and Growth Tax Relief Reconciliation Act of 2003 ("JGTRRA") further
reduced the 20 percent capital gain rate to 15 percent and applied a 15 percent rate to dividends in lieu of the ordinary income rates. Although the JGTRRA rates were scheduled to expire for 2009, the sunset was extended to years after 2010 by the Tax Increase Prevention and Reconciliation Act of 2005. If the reduced capital gain and dividend rates are allowed to expire, the general capital gain rate will return to 20 percent and the maximum rate on dividends will return to 39.6 percent.
President Obama has proposed that a rate of 20 percent would apply to capital gains and dividends for joint taxpayers with incomes of $250,000 or more and single taxpayers with income of $200,000 or more and that a rate of 15 percent would apply to taxpayers below such income thresholds.
The Health Care and Educational Reconciliation Act of 2010 ("HCERA") imposes a 3.8 percent Medicare tax on unearned income of high income individuals or trusts beginning in 2013. In case of individuals, the tax is 3.8 percent of the lesser of (i) net investment income for such taxable year or (ii) the excess of adjusted gross income for such taxable year over $250,000 in case of taxpayers filing a joint return ($125,000 for married filing a separate return and $200,000 for singles). In the case of trusts, the tax is 3.8 percent of the lesser of (i) undistributed net investment income for such taxable year, or (ii) the excess of the adjusted gross income (as defined in Section 67(e) of the Code) for such taxable year over the dollar amount at which the highest tax bracket in Section 1(e) of the Code begins for such taxable year (currently $11,200). For this purpose, net investment income includes interest, dividends, capital gains, royalties, rents, annuities, trade or business income from passive activities and trading in financial instruments and commodities. The passive activity rules of Section 469 of the Code are to be used for determining whether an activity is passive and produces net investment income. Income or gain from a nonfinancial trade or business interest where the taxpayer is active in the business would not be subject to the 3.8 percent tax. For example, a S corporation shareholder who works full time in the S corporation's trade or business would not be subject to the 3.8 percent tax on such shareholders share of the S corporation income or on the gain on a sale of such shareholder's stock in the S corporation.
The HCERA and Patient Protection and Affordable Care Act of 2010 impose an additional .9 percent Medicare tax on the employee's portion of the Medicare tax on wages and on self employment income over $250,000 on a joint return ($200,000 for a single) beginning in 2013. As a result, a higher income employee's portion of the Medicare tax on wages in excess of the threshold will be 2.35 percent instead of 1.45 percent. Likewise, a higher income taxpayer subject to self employment tax will be taxed at 3.8 percent on self employment income in excess of the threshold instead of 2.9 percent.
For the year 2010 only, taxpayers subject to the self-employment tax may deduct the cost of their health care insurance in determining net earnings from self-employment. (IRC §162(1)(4)). Previously, the deduction was only allowed for income tax purposes.
On September 24, 2010, the IRS released the final Schedule UTP (Uncertain Tax Position Statement) and instructions together with Announcement 2010-75 which sets forth taxpayer favorable changes to the original IRS proposal.
On January 26, 2010, the IRS released Announcement 2010-9 which disclosed its proposal to require certain business taxpayers to report uncertain tax positions on their income tax returns and requested comments on such proposal. On April 19, 2010, the IRS released a draft Schedule UTP and instructions and Announcement 2010-30 which explained the draft Schedule UTP and requested comments. Numerous comments were submitted to the IRS.
On September 9, 2010, the IRS published a Notice of Proposed Rulemaking which contains a proposed rule requiring corporations to file a schedule disclosing uncertain tax positions. The IRS plans to issue final regulations by the end of 2010.
The final Schedule UTP and Announcement 2010-75 leave unchanged the general rule that the only corporations that are required to file Schedule UTP are those which have audited financial statements and file Form 1120, U.S. Corporation Income Tax Return; Form 1120-F, U.S. Income Tax Return of a Foreign Corporation; Form 1120-L, U.S. Life Insurance Company Income Tax Return; or Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return.
At least for taxable year 2010 no Schedule UTP is required to be filed by pass through entities and tax exempt entities.
The final Schedule UTP and Announcement 2010-75 make the following significant changes to the April draft Schedule UTP:
- A five-year phase in of the reporting requirement based on a corporation's asset size is adopted. Originally, the IRS proposed that the reporting requirement would apply to business taxpayers with total assets of $10 million or more. In the final Schedule UTP, corporations which have total assets of $100 million or more must file Schedule UTP commencing with 2010 tax years. The threshold is reduced to $50 million commencing with 2012 tax years and to $10 million commencing with 2014 tax years.
- No reporting of a maximum tax adjustment is required. Originally, the IRS proposed that a corporation report a maximum federal income tax liability for each tax position listed in the Schedule UTP assuming the position was not upheld upon examination by the IRS. Instead of the original proposal, the final Schedule UTP requires a corporation to rank all of the reported tax positions based on the federal income tax reserve recorded for the position taken in the return and to designate those tax positions for which the reserve exceeds 10 percent of the aggregate amount of the reserves for all of the tax positions reported on the Schedule UTP.
- No reporting of the rationale and nature of uncertainty in the description of the position is required. Instead, the final Schedule UTP requires a concise description of the tax position including relevant facts sufficient to apprise the IRS of the identity of the tax position and nature of the issue.
- No reporting of administration practice tax positions is required. Originally, the IRS proposed that a corporation report on Schedule UTP tax positions for which no reserve was recorded because the corporation determined it was IRS administrative practice not to raise the issue in an examination.
Generally any person engaged in a trade or business who makes payments aggregating $600 or more in any taxable year to a single payee in the course of such trade or business must file a information return (Form 1099) with the IRS and provide a copy thereof to the payee. Regulations, Section 1.6041-3(p) excepted payments to corporations from the reporting requirement. A person whose rental real estate is a trade or business is subject to this reporting requirement but a person whose rental real estate activity is not considered a trade or business is not subject to such requirement. Payments subject to reporting included rent, salaries, wages, premiums, annuities, compensations, remunerations or other fixed or determinable gains, profits and income but did not include payments for goods or certain payments subject to other specific reporting requirements.
Effective for payments made after December 31, 2011 payments to corporate (other than tax exempt) payees must be reported notwithstanding Regulations, Section 1.6041-3(p) unless excepted under other provisions of the Code.
Also effective for payments made after December 31, 2010, persons receiving rental income from real estate are subject to the same information reporting requirement (set forth above) as taxpayors engaged in a trade or business. Exceptions are provided for military personnel who rent their principal residence on a temporary basis, individuals who receive a de minimus amount of rent as determined by the IRS and individuals where the reporting requirement would cause hardship as determined by the IRS.
Also effective for payments after December 31, 2011, the payments subject to reporting will also include "amounts in consideration for property."
Generally a payor must request a taxpayer identification number ("TIN") from a payee and if the payee fails to furnish a TIN to the payor, the payor must withhold back up withholding currently at 28 percent on the payment to the payee.
A payor that fails to comply with the information reporting requirements is subject to penalties.
Effective for taxable years beginning after March 18, 2010, any individual who, during any taxable year, holds any interest in a "specified foreign financial asset" must attach an information disclosure statement to his or her income tax return for such taxable year with respect to each such asset if the aggregate value of all such assets exceeds $50,000. In addition, to the extent provided in IRS regulations or other guidance, the new reporting requirement will apply to any domestic entity formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner if such entity were an individual.
The term "specified foreign financial assets" means (i) with respect to any foreign financial institution, any financial account (depository or custodial accounts or any equity or debt interest in such financial institution (other than publicly traded interests)) maintained by such institution, and (ii) any stock or security issued by a foreign person, any financial instrument or contract held for investment that has an issuer or counterparty that is a foreign person, and any interest in a foreign entity.
A penalty of $10,000 is imposed for failing to provide the required information for a taxable year and an additional $10,000 can be imposed for certain periods for failing to provide the required information for each thirty day period after ninety days from the date the IRS notifies such person by mail of the failure to provide such information. The penalty is subject to a reasonable cause exception.
Under existing law, every U.S. person having a financial interest in or signature or other authority over a bank, securities or other financial account in a foreign country, which accounts aggregate $10,000 or more for a calendar is required to file a report on Form TDF 90-22.1 (Report of Foreign Bank and Financial Account) ("FBAR"). An FBAR is filed annually and is due on June 30th following the calendar year for which filed. Failure to file an FBAR can result in severe penalties.
The information required to be filed with the IRS under the new specified foreign financial asset reporting requirements is somewhat duplicative of the information required to be reported in an FBAR.
Only a minority of states (including Delaware and Illinois) currently authorize the formation of series limited liability companies, series partnerships or cell companies ("Series Organizations"). Consequently, the popularity of Series Organizations is currently limited.
The IRS recently proposed regulations governing the tax classification of a series or cell (a "Series") of a domestic Series Organization, or a foreign Series that conducts an insurance business. Once the proposed regulations are published in final form, each domestic Series generally will be treated as an entity for federal income tax purposes, and consequently, will be classified as a corporation, partnership or disregarded entity according to the rules which currently govern the tax classification of separate entities formed under local law. Additionally, once the proposed regulations are published in final form, every foreign Series that conducts an insurance business generally will be classified as a corporation for Federal income tax purposes.
The proposed regulations do not answer every question about the tax treatment of Series, but the clarification provided by those regulations is likely to prompt many more states to enact statutes authorizing the formation of Series Organizations. When that occurs, Series Organizations - particularly series LLCs and series partnerships - are certain to become more popular.
Questions about the subject matter of this communication should be addressed to Thomas J. Phillips at (414) 277-5831 / [email protected] or John T. Barry at (414) 277-5825 / [email protected] in Milwaukee, Jeffrey B. Fugal at (602) 229-5257 / [email protected] in Phoenix, Terrence W. Stein at (312) 715-5029 / [email protected] in Chicago or your Quarles & Brady attorney.