May 21, 2007

IRS Publication on Alternate Tip Reporting Program

IRS recently released Publication 1461, explaining the Attributed Tip Income Program (ATIP) for restaurant or beverage businesses.

Taxpayers may participate in the ATIP, a voluntary alternative tip reporting program for the food and beverage industry. This program, announced on July 28, 2006, provides benefits to employers and employees similar to those available under other tip reporting agreements but without requiring one-on-one meetings with IRS to determine tip rates or eligibility. ATIP reduces industry recordkeeping burdens, has simple enrollment requirements and promotes the reporting of tips on federal income tax returns.

Under ATIP, the amount of tips that must be reported by the restaurant is determined under a formula based on the restaurant's credit card sales. The employer determines a method for attributing the tips among all tipped employees and attributes tips to the employees at least monthly. The method should be fairly close to the actual distribution of the tips among employees, including tip-outs and amounts passed along to employees who are not directly tipped. The amount attributed to each participating employee is treated as wages for purposes of social security and unemployment taxes and income tax withholding. The employer reports the amounts attributed under the method, rather than have the individual employees keep records and report their tips to the employer.

Death & Tax Attributes

You are probably aware of how proper planning during life can reduce or eliminate federal or state estate taxes or state inheritance tax at death to the benefit of your heirs. However, you may not know of the many important income tax considerations that come into play in planning for death.

In many cases, your executor will be in a position to take actions that will save taxes on your final income tax return or save income taxes for your estate or beneficiaries. But, in other cases, the personal representative will be locked into choices you make during life and won't have the latitude to take actions that will save the most taxes. Therefore, it is imperative you have at least a basic understanding of the various choices and the kinds of planning you can take during life to optimize savings for all parties involved. Here are the more widely applicable topics to consider:

Choice of executor. The primary duties of your executor or other personal representative will be to collect your assets, pay your creditors and distribute the remaining assets to your heirs or other beneficiaries. The executor also will have to file various types of tax returns and make important choices on them. Therefore, it is imperative you choose someone who is both trustworthy and competent to serve as your executor or personal representative.

Income in respect of a decedent (IRD). Income that was due to a person but wasn't paid before his or her death will be taxed to his or her estate or beneficiaries. With proper planning, charitable-minded clients can wipe out the income tax bite on IRD.

Partners and S shareholders. Clients in this category need to know how they will be taxed on their share of the entity's income in the year of death and how their successors will be taxed.

Tax-favored medical accounts. An individual who has a health savings account, Archer medical savings account or Medicare advantage medical savings account is in a position to choose whether the account's assets will be taxed in his final return or to a named beneficiary or will escape tax if he is married and names his spouse as beneficiary.

Holders of Series E or EE savings bonds. Choices can be made before and after death to minimize taxes on the interest on these bonds.

Compensatory options. Individuals who have received compensatory options, statutory or nonstatutory, face various issues with respect to transferring them at death and the ultimate tax consequences to beneficiaries who receive the options. For example, incentive stock options are accorded favorable tax treatment, but this treatment is lost for disqualifying dispositions of the stock acquired on the option exercise. A transfer at death isn't a disqualifying disposition even though it might have been if made while alive.

IRAs and retirement plans. Owners of individual retirement accounts (IRAs) and participants in company-sponsored qualified retirement plans need to understand how their benefits will be taxed at and after death. For example, IRA distributions from an inherited traditional IRA are taxable to the beneficiary in the year received as IRD up to the IRA-owner-decedent's taxable IRA balance at death. If the estate is large enough, the IRA funds also will be subject to estate tax, but the recipient of the IRA distributions will get a special income tax deduction for the estate tax attributable to the IRA.

Deductions. A host of issues come into play with deductions at death. For example, unused net operating losses carryovers and capital loss carryovers expire if not used on an individual's final return—they can't be used on the estate's income tax return. Certain deductions may be allowed to recipients of IRD. Unpaid medical bills at death are subject to a special deduction choice for an executor.

This is just a sampling of the many different income tax rules that affect an individual at death. With proper planning during life, you can help to reduce taxes for the benefit of your heirs. You also can arm your executor with the key information he will need to make the best choices for them.

  May 14, 2007

Recent Retirement Plan Developments of Significance

A number of important pension and benefit developments have recently occurred:

Guidance on new rollover option for nonspouse beneficiaries of retirement plan accounts. The IRS has issued guidance on the new choice for nonspouse beneficiaries of an inherited qualified plan account. These beneficiaries may transfer part (or all) of the deceased employee’s account balance into an inherited IRA. Under the new guidance, a nonspouse beneficiary can, in most situations, receive payouts from the inherited IRA over his or her lifetime. This can make an inherited IRA a powerful tax-deferral tool, but expert help is a must to assure that key rules are met (such as when distributions from the inherited IRA must begin). The one downside is that under the IRS's latest guidance, company retirement plans may, but are not required to, offer the rollover option for nonspouse beneficiaries.

IRS explains new IRA-to-charity rollover options for older taxpayers. For 2006 and 2007, an IRA owner who is age 70½ or older can directly transfer tax free up to $100,000 per year from an IRA to an eligible charitable organization. Amounts transferred are not taxable, and a deduction can't be claimed for the amount given to the charity. Transferred amounts are counted in determining whether the owner has met the IRA required minimum distribution rules. The IRS's explanation of how this rollover rule works takes a decidedly liberal approach. For example, it permits each spouse to make an up-to-$100,000 tax-free transfer and allows an IRA owner either to make a direct transfer from the IRA to the charity or hand deliver a check from the IRA made out to the charity. The IRS also permits otherwise qualifying IRA beneficiaries (not just IRA owners) to make the nontaxable rollover.

Liberalized 401(k) rules for hardship withdrawals. You can take a distribution from a 401(k)-type plan only on account of certain events, such as disability, retirement or “hardship”—you need to withdraw cash to satisfy an immediate and heavy financial need. The rules used to say that to take a hardship payout, you (and, in some cases, your spouse or dependent) had to have the immediate and heavy financial need. But under a change mandated by the Pension Protection Act of 2006, the IRS has amended the rules to allow 401(k) payouts for a primary beneficiary's hardship. This primary beneficiary doesn't have to be your dependent. However, the hardship must be for certain specific expenses, such as medical bills or tuition costs.

  May 7, 2007

Industry Issue Focus Audit Approach

Businesses with total assets of $10 million or more (Large and Mid-sized Businesses, or LMSB) should be aware of a recent change in the IRS examination process. The new Industry Issue Focus (IIF) approach basically gives IRS LMSB agents no flexibility when dealing with “Tier I” issues. Accordingly, if a Tier I issue is discovered in an examination, essentially, the agent must pursue it. Further, IRS agents must report each incident to a national specialist. Tier 1 issues include all listed transactions, plus 13 others, including:

• Section 118 Abuse
• Section 162(f) DOJ Settlements
• Section 936 Exit Strategies
• Backdated Stock Options
• Domestic Production Deduction IRS Section 199
• Foreign Earnings Repatriation
• Foreign Tax Credit Generators
• International Instrument Transactions
• Mixed Service Costs
• Nonqualified Deferred Compensation (§409A)
• Research & Experimentation (R&E) Credit Claims
• Transfer of Intangibles Offshore/Cost Sharing
• Tax Shelter – Redemption Bogus Optional Basis

Several on the list are legitimate transactions, e.g., R&E credits, Section 199 deduction, etc. However, the IRS wants to coordinate the examination of these issues. For more information, see the IRS web site.

Tax Provisions in Emergency War Funding Bill

H.R. 1591, a piece of tax legislation meant to accompany a national minimum wage increase, was included in the recently-vetoed emergency war funding bill. House and Senate leaders are in negotiations with administration officials on the terms of a revised funding bill, which, according to Ways and Means Chairman Rangel, will include H.R. 1591. For the Joint Committee on Taxation’s explanation, click here. As with all proposed legislation, H.R. 1591’s future is far from certain, but it may benefit you to be aware of its provisions.