Special Tax Benefits for Armed Forces Personnel

Military personnel and their families face unique life challenges with their duties, expenses and transitions. The IRS wants active members of the U.S. Armed Forces to be aware of all the special tax benefits that are available to them.
Here are 10 of those special tax benefits:
1. Moving Expenses If you are a member of the Armed Forces on active duty and you move because of a permanent change of station, you may be able to deduct some of your unreimbursed moving expenses.
2. Combat Pay If you serve in a combat zone as an enlisted person or as a warrant officer for any part of a month, all your military pay received for military service during that month is not taxable. For officers, the monthly exclusion is capped at the highest enlisted pay, plus any hostile fire or imminent danger pay received. You can also elect to include your nontaxable combat pay in your "earned income" for purposes of claiming the Earned Income Tax Credit.
3. Extension of Deadlines The deadline for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS is automatically extended for qualifying members of the military.
4. Uniform Cost and Upkeep If military regulations prohibit you from wearing certain uniforms when off duty, you can deduct the cost and upkeep of those uniforms, but you must reduce your expenses by any allowance or reimbursement you receive.
5. Joint Returns Generally, joint income tax returns must be signed by both spouses. However, when one spouse is unavailable due to military duty, a power of attorney may be used to file a joint return.
6. Travel to Reserve Duty If you are a member of the US Armed Forces Reserves, you can deduct unreimbursed travel expenses for traveling more than 100 miles away from home to perform your reserve duties.
7. ROTC Students Subsistence allowances paid to ROTC students participating in advanced training are not taxable. However, active duty pay – such as pay received during summer advanced camp – is taxable.
8. Transitioning Back to Civilian Life You may be able to deduct some costs you incur while looking for a new job. Expenses may include travel, resume preparation fees, and outplacement agency fees. Moving expenses may be deductible if your move is closely related to the start of work at a new job location, and you meet certain tests.
9. Tax Help Most military installations offer free tax filing and preparation assistance during and/or after the tax filing season.
10. Tax Information IRS Publication 3, Armed Forces’ Tax Guide, is an excellent resource as it summarizes many important military-related tax topics. Publication 3 can be downloaded from IRS.gov or may be ordered by calling 1-800-TAX-FORM (800-829-3676).

Keep the Child and Dependent Care Tax Credit in Mind for Summer Planning

During the summer many parents may be planning the time between school years for their children while they work or look for work. The IRS wants to remind taxpayers that are considering their summer agenda to keep in mind a tax credit that can help them offset some day camp expenses.
The Child and Dependent Care Tax Credit is available for expenses incurred during the summer and throughout the rest of the year. Here are six facts the IRS wants taxpayers to know about the credit:

1. Children must be under age 13 in order to qualify.

2. Taxpayers may qualify for the credit, whether the childcare provider is a sitter at home or a daycare facility outside the home.

3. You may use up to $3,000 of the unreimbursed expenses paid in a year for one qualifying individual or $6,000 for two or more qualifying individuals to figure the credit.

4. The credit can be up to 35 percent of qualifying expenses, depending on income.

5. Expenses for overnight camps or summer school/tutoring do not qualify.

6. Save receipts and paperwork as a reminder when filing your 2012 tax return. Remember to note the Employee Identification Number (EIN) of the camp as well as its location and the dates attended.

For more information check out IRS Publication 503, Child and Dependent Care Expenses. This publication is available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Obamacare: Seven New Taxes on Citizens Earning Less than $250,000
Robert Allen Bonelli
29 Jun 2012
While we were all debating the cost to our liberty due to the Patient
Protection and Affordable Care Act (Obamacare), we were ignoring the
cost to our pockets. There are twenty - yes, twenty - hidden new
taxes of this law. Making matters even more relevant is that seven of
these taxes are levied on all citizens regardless of income.
 The first, and best known, of these seven taxes that will hit all Americans as a result of Obamacare is the Individual Mandate Tax (no longer concealed as a penalty). This provision will require a couple
to pay the higher of a base tax of $1,360 per year, or 2.5% of adjusted growth income starting with lower base tax and rising to this level by 2016. Individuals will see a base tax of $695 and families a
base tax of $2,085 per year by 2016. Next up is the Medicine Cabinet Tax that took effect in 2011. This tax
prohibits reimbursement of expenses for over-the-counter medicine,  with the lone exception of insulin, from an employee’s pre-tax dollar funded Health Saving Account (HSA), Flexible Spending Account (FSA) or
Health Reimbursement Account (HRA). This provision hurts middle class earners particularly hard since they earn enough to actually pay federal taxes, but not enough to make this restriction negligible.
The Flexible Spending Account (FSA) Cap, which will begin in 2013, is perhaps the most hurtful provision to the middle class.. This part of the law imposes a cap of $2,500 per year (which is now unlimited) on
the amount of pre-tax dollars that could be deposited into these accounts. Why is this particularly hurtful to the middle class? It is because funds in these accounts may be used to pay for special needs
education for special needs children in the United States. Tuition rates for this type of special education can easily exceed $14,000 per year and the use of pre-tax dollars has helped many middle income
families. Another direct hit to the middle class is the Medical Itemized Deduction Hurdle which is currently 7.5% of adjusted gross income. This is the hurdle that must be met before medical expenses over that
hurdle can be taken as a deduction on federal income taxes. Obamacare raises this hurdle to 10% of adjusted gross income beginning in 2013. Consider the middle class family with $80,000 of adjusted gross income and $8,000 of medical expenses. Currently, that family can get some relief from being able to take a $2,000 deduction (7.5% X $80,000 = $6,000; $8,000 –$6,000 = $2,000). An increase to 10% would eliminate the deduction in this example and if that family was paying a 25% federal tax rate, the real cost of that lost deduction would be $500. The fifth new tax on the middle class, and all Americans, is the
Health Savings Account (HSA) Withdrawal Tax Hike. This provision  increases the additional tax on non-medical early withdrawals from an HSA from 10% currently to 20% beginning in 2013. This provision
actually sets these accounts apart from Investment Retirement Accounts (IRAs) and other tax advantaged accounts, all of which remain with a 10% early withdrawal tax. Another regressive tax that is part of this law began in 2010 and that is the Indoor Tanning Services Tax, which places a 10% excise tax on
people using tanning salons. While some may regard this as insignificant, the broader implication is that this act of taxation is a blatant move by the federal government to control the behavior of citizens.. This provision, as does the Individual Mandate and as Justice Kennedy said during the oral arguments on the constitutionality of the law said, “….fundamentally changes the relationship between the federal government and the citizen.” The seventh new tax that directly impacts the middle class, along with all citizens, is the Excise Tax on Comprehensive Health Insurance Plans or the “Cadillac” Health Insurance Plan Tax. These are plans that provide extensive coverage and that are generally fully paid for,  or largely paid for, by employers. This provision imposes a 40% excise tax on the employer-paid premium on taxpayers who are covered by such plans, beginning in 2018. The reason it begins in 2018 is because most  unionized workers are covered by plans that fall under this definition  and a deferral was made to spare union members from this tax for at least a period of time. There are thirteen other taxes that apply to businesses and that apply
to high income (over $250,000 per year) households. While these additional provisions will not impact the middle class directly, they can have serious indirect consequences for middle and low income earners. Beginning in 2014, the Employer Mandate Tax will impose an annual non-deductible tax on employers with more than 50 employees who do not provide health insurance for their employees. The impact of this provision on low and middle income earners, and really all working Americans, is that employers will be confronted with three choices. The first is provide some level of health  insurance, as many do today, and there would be no impact on employees. The second choice is to pay the penalty, which would most
likely be less expensive than providing health insurance, and force employees to seek their own health insurance or purchase it through federal government controlled state exchanges. Studies have estimated
that 20 million Americans will lose their employee funded health insurance as a result of this provision and employers electing this option. The third choice is for employers to lay off employees, or not
hire additional employees, because Obamacare forces them to either provide health insurance or pay the new tax. Another new tax, the Tax on Medical Device Manufacturers that begins in 2013, places a 2.3% excise tax on all items retailing for more than $100. This provision will not only drive up the cost of various
medical devices ranging from mobility assistance devices to personal testing supplies, but will also impact an industry that employs 360,000 people in 6,000 plants across our country. This tax, while not a direct tax, would have significant negative impact on the middle class. The Surtax on Investment Income for households earning $250,000 and more, beginning in 2013, will raise the Capital Gains Tax from 15% to 23.8% on investment income for these households and will raise Taxes on Dividends from 15% to 43.4% for the same households. Aside from the impact on retired citizens dependent on dividends, this provision will pull income from the private economy. In addition, the tax rate on Other Investment Income earned by Subchapter S Corporation (which many small business are organized as, allowing the owners to claim all business income as personal income) will rise from 35% to 43.4%. This part of the provision would place additional pressure on small businesses resulting in more layoffs and less hiring, impacting all American workers. All but one of the remaining new taxes in Obamacare are directed at health industry businesses and while they will not impact middle income families directly, the additional costs will most likely be passed on to the public. The last new tax is really interesting, it is a tax on certain biofuels! These are the facts. It does not matter if you support Mr. Obama and his new law or if you oppose it, the new taxes on the middle class or real and all Americans should understand their impact on their families and the economy.

Automated IRS System Helps College-Bound Students with Financial Aid Application Process

College-bound students and their parents typically want to make every dollar and every minute of the college experience count including money spent on tuition and time spent on the college financial aid application process. The Internal Revenue Service is helping minimize the time spent on the completion of the Free Application for Federal Student Aid (FAFSA) form by automating access to federal tax returns with the IRS Data Retrieval Tool. This tool provides the opportunity for applicants to automatically transfer the required tax data onto the FAFSA form.
Here are some tips on using the IRS Data Retrieval Tool:

• Benefits The IRS Data Retrieval tool is an easy and secure way to access and transfer tax return information directly onto the FAFSA form, saving time and improving accuracy. Also, the increased accuracy reduces the likelihood of being selected for verification by the school’s financial aid office.
• Eligibility Criteria Taxpayers who wish to use the tool to complete their 2012 FAFSA form must:
  • have filed a 2011 tax return;
  • possess a valid Social Security Number;
  • have a Federal Student Aid PIN (individuals who don’t have a PIN, will be given the option to apply for one through the FAFSA application process);
  • have not changed marital status since Dec. 31, 2011.
• Exceptions If any of the following conditions apply to the student or parents, the IRS Data Retrieval Tool can not be used for the 2012 FAFSA application:
  • an amended tax return was filed for 2011;
  • no federal tax return for 2011 has been filed ;
  • the federal tax filing status on the 2011 return is married filing separately; a Puerto Rican or other foreign tax return has been filed.
• Alternatives If the IRS Data Retrieval Tool can not be used and if the college requests verification documentation, it may be necessary to obtain an official transcript from the IRS. To order tax return or tax account transcripts, visit www.irs.gov and select  Order a Transcript  or call the Transcript toll-free line at 1-800-908-9946.

In addition to helping reduce the time and effort involved in completing and submitting the FAFSA form through the IRS Data Retrieval Tool, the IRS offers money-saving information to college students and their parents.  Important information regarding tax credits and deductions for qualifying tuition, materials and fees is available at the IRS Tax Benefits for Education: Information Center and in IRS Publication 970, Tax Benefits for Education both of which are available at www.IRS.gov.

Links:

• IRS Data Retrieval Tool/FAFSA 
• IRS Tax Benefits for Education: Information Center 
• IRS Publication 970, Tax Benefits for Education (PDF)
• Order a Transcript

Reasonable salary for S corporation owners

 

By Debra M. Johnson, CPA, J.D.

May 2012

Besides its single level of taxation as a passthrough entity, an advantage of an S corporation over a C corporation is that a shareholder’s share of the corporation’s net income is not considered self-employment earnings and therefore is not subject to self-employment tax (13.3% in 2011 and 2012). This treatment is in contrast to that of a general partner, LLC member, or sole proprietor, for whom net earnings from self-employment include any trade or business income and a partner’s distributive share of income from a trade or business carried on by the partnership (Sec. 1402(a)).
However, if the S corporation shareholder provides services to the S corporation, he or she must receive an adequate or reasonable amount of compensation for these services. The S corporation may deduct the compensation expense and must pay the employer share of employment taxes: 6.2% Social Security tax and 1.45% Medicare tax. The shareholder-employee is responsible for 4.2% Social Security tax (in 2011 and 2012) and 1.45% Medicare tax. The S corporation is also responsible for Federal Unemployment Tax Act (FUTA) taxes. Minimizing these taxes provides an incentive to keep the S corporation shareholder’s wages low and to characterize most of the passthrough income as distributions.
The U.S. Government Accountability Office reported in 2009 on employment tax noncompliance among S corporation shareholders. The IRS has been pursuing this perceived abuse of inadequate compensation in favor of dividend distributions to shareholder-employees and has won a number of cases. (See, for example, Watson, No. 11-1589 (8th Cir. 2/21/12), described in Tax Matters, page 62.)
The IRS has the authority to reclassify dividends, distributions, or payments to the shareholder-employee, including loan repayments, as compensation if it deems compensation inadequate or unreasonable. The courts have held that the question of reasonable compensation is one of fact, determined on a case-by-case basis. The IRS has posted on its website (tinyurl.com/7kp3yrf) three major sources of gross receipts it will consider when determining reasonable compensation: the services provided by the shareholder, the services of nonshareholder employees, and the capital and equipment of the corporation.
IRS fact sheet FS-2008-25, Wage Compensation for S Corporation Officers, lists the following factors in determining reasonable compensation: training and experience, duties and responsibilities, time and effort devoted to the business, dividend history, payments to nonshareholder employees, timing and manner of paying bonuses to key people, what comparable businesses pay for similar services, compensation agreements, and the use of a formula to determine compensation. Sources of information on comparable compensation for services include the U.S. Department of Labor’s Bureau of Labor Statistics, employment agencies, and a market analysis. The key in defending a claimed compensation amount is to document all research to support the amount.
Shareholders who are officers of a corporation who do not perform any services or perform only minor services in that capacity and who do not receive or are not entitled to receive direct or indirect compensation are not considered employees of the corporation. Thus, since most shareholder-officers of closely held corporations do provide more than minor services to the corporation, they most likely are considered employees. If a shareholder is an officer who is considered an employee, Section 530 of the Revenue Act of 1978, P.L. 95-600, does not apply as a safe harbor for recharacterizing the shareholder’s compensation because, under Sec. 3121(d)(1), corporate officers are statutory employees (see Joseph M. Grey, P.C., 119 T.C. 121).
The S corporation entity form provides planning opportunities to avoid payroll taxes or self-employment taxes on distributions that are instead a return on capital and assets. With the increase in Medicare tax of an additional 0.9% for high-wage earners scheduled to begin in 2013, this may represent a larger opportunity. The key in defending against a possible audit and recharacterization of dividends is to document all research and analysis of the determination of the shareholder-employee salary.
By Debra M. Johnson, CPA, J.D., (djohnson@msubillings.edu) associate professor, Montana State University–Billings in Billings, Mont.

Federal Tax Provisions Not Applicable for 2012 Tax Returns

As we move towards the 2013 Filing Season you will need to keep an eye out on what Congress does with regard to the “Extender” tax provisions that expired at the end of 2011.
Here are two lists of the provisions that will have the most impact on individual Tax Year 2012 Federal returns.



Provisions that are no longer applicable for Tax Year 2012 Federal returns:

• $250 Educator Expense Deduction – Form 1040, line 23
  
• Tuition and Fees Deduction – Form 8917
  
• Itemized Deduction for Sales Tax
  
• All personal nonrefundable tax credits allowed when calculating Alternative Minimum Tax
  
• Residential energy credits on Form 5695
  
• 5 year depreciation for farming business machinery and equipment
  
• 15 year straight line depreciation allowed for qualified leasehold restraint and retail improvements
  
• Tax-free distributions from IRAs for charitable purposes
  
• Contributions of capital gain real property made for conservation purposes (50% limitation applied instead of 30% limitation)
  

Provisions that changed significantly for Tax Year 2012 returns:

• Alternative Minimum Tax (AMT) exemption amounts revert to what they were for Tax Year 2000
  

Tax Year 2012 AMT exemption amount is:

• Single/Head of Household: $33,750
  
• Married Filing Joint: $45,000
  
• Married Filing Separate: $22,500
  
• Maximum Section 179 Deduction amount has been reduced to $139,000 for Tax Year 2012
  
• Bonus Depreciation percentage is reduced to 50% for Tax Year 2012
  
• Adoption Credit
  
  • Will revert to being a nonrefundable credit with any excess allowed to be carried forward for 5 years
    
  • Maximum credit is reduced to $12,170 per child
    

As in the past there is the possibility that Congress will extend some or all of these provisions sometime before the end of 2012 (most likely in the November/December timeframe). Check back for more information as to what action Congress takes on these provisions later this year and what impact these late legislative changes will have on the start of the 2013 Filing Season.

Tax Professional Earns Registered Tax Return Preparer Status

Patricia Brackin (Pat), a member of our staff,  has reached a personal and professional milestone in her career by passing the Internal Revenue Service’s (IRS’) Registered Tax Return Preparer (RTRP) competency exam. The award of the RTRP designation recognizes demonstrated knowledge of all aspects of federal individual taxation and assures clients that the preparer is up-to-date on the latest tax law changes and ethics requirements.

To retain the status of a registered tax return preparer, individuals must complete a minimum of 15 continuing education credits (CPEs) per year. RTRPs are also governed under stringent rules set forth by the IRS.

If you need assistance with any taxation issue, you should seek the help of a tax professional. As a professional tax preparer Pat can assist you with a review of your tax history and answer questions on how taxation issues may impact your future.