Top IRS Audit "Red Flags"

While audits of individual tax returns are relatively uncommon, the rate has been increasing recently. According to recent statistics, 1.11% of individual returns were audited last year, the highest rate since 1997. If you've ever wondered what kinds of things might get you audited, check out this list of "red flags" from Kiplinger.

Summary of the December 2010 Tax Act

The newly passed and signed 2010 Tax Act, formally named the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, includes several provisions that will affect taxpayers. Here is the information you need to know now about this legislation, formally named the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

Major Provisions
The new law

• postpones the sunset of the 2001 and 2003 tax cuts;
• reduces the estate tax;
• extends unemployment benefits;
• includes an alternative minimum tax (AMT) patch;
• continues through 2012 the lower capital gains tax rate introduced by the Jobs and Growth Tax Relief Reconciliation Act of 2003; and
• extends for two years the repeal of the itemized deduction phase-out and the personal exemption phase-out.

Provisions That May Affect You
Estate Tax
The Act temporarily reinstates the estate tax, with an estate tax rate of 35% and an estate tax exemption of $5 million (adjusted for inflation after 2011).

Payroll Tax
For 2011, the Act reduces the rate for the Social Security portion of payroll taxes to 10.4% by reducing the employee rate from 6.2% to 4.2%. The employer’s portion remains 6.2%.

Family
The Act extends several expired or expiring provisions affecting families, including the following:

• • The increased standard deduction for married taxpayers filing jointly, which is scheduled to expire after 2010, continues for two years.
• • The $1,000 child tax credit amount continues for two years instead of reverting to $500.
• • The increased starting and ending points for the earned income credit continues for two years.
• • The $3,000 amount for the child and dependent care credit, which was scheduled to revert to $2,400 after 2010, continues for two years.
• • The American Opportunity Tax Credit continues for two years.

The Act also makes adjustments to the gift exclusion and generation-skipping transfer (GST) tax that will affect family giving:

• The federal gift tax exemption is increased to $5 million for 2011 and 2012, up from $1 million in 2010.
• The GST tax exemptions are set at $5 million for 2011 and 2012. The exemption limit is scheduled to drop to $1 million beginning in 2013.

Business
The Act extends the 100% bonus depreciation for business property acquired after September 8, 2010, before January 1, 2012, and placed in service before January 1, 2012 (or before January 1, 2013, in the case of certain property). It also sets the expensing limitation under IRC §179 at $125,000 and the phase-out threshold amount at $500,000 for 2012. The Act then reduces these amounts to $25,000 and $200,000 for tax years beginning after 2012.

The temporary 100% exclusion of gain from the sale of certain small business stock under IRC §1202, enacted by the Small Business Jobs Act of 2010, is extended through 2011.

AMT
The Act includes an AMT patch for 2010 and 2011.

Needless to say, the 2010 Tax Act is still very new. It is only just being analyzed by professional advisers. The law is potentially subject to modifications by technical correction acts. In addition, provisions of the law may be interpreted by the Treasury Department issuing regulations and by the IRS issuing forms and instructions.

Returns Won't Be Accepted Before Mid-February

Due to the spate of last-minute changes to the tax rules, the IRS has said they need until mid-February to reprogram their computers before they can accept some returns. Returns for anyone who itemizes deductions or claims certain other deductions cannot be filed until that time. So, if you have to wait longer for your refund, thank a congressman!

IRS Issues 2011 Mileage Rate Update

Beginning on Jan. 1, 2011, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:

• 51 cents per mile for business miles driven
  
• 19 cents per mile driven for medical or moving purposes
  
• 14 cents per mile driven in service of charitable organizations
  

The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs as determined by the same study. Details from the IRS

Summary of the Small Business Jobs Bill of 2010

There's still a lot of work to be done before we have the certainty we need for tax planning in 2011 and beyond, but the Congress got a start with the Small Business Jobs Bill of 2010. ADP/CCH have a nice summary of the provisions on their site.

A quick synopsis:

• Section 179 expense limits are restored to their higher levels
• Bonus depreciation is back
• Sole proprietors now save SE tax on their health premiums
• Some sales of small business stock become tax-exempt

Here's a Tax Simplification Proposal to Watch

Tax simplification is on the minds of legislators these days. It might not be the best thing for a CPA's business, but I'd love to see the tax code become more understandable. Here's one proposal that's being considered.

• Only three tax brackets: 15% for the first $75,000 of taxable income for couples, 25% on the next $65,000, and 35% over $140k. Cut those brackets in half for singles.
  
• Bigger standard deductions: $30,000 for married, $15,000 for singles. That means far fewer people will itemize deductions.
  
• Alternative minimum tax is eliminated, as are phaseouts of itemized deductions and personal exemptions on higher income taxpayers.
  
• 35% of your dividends and capital gains would be excluded. That would put those items at a maximum 22.75% tax rate, versus the current 15% rate that's already set to expire at year end.
  
• Municipal bonds would be less favored. You'd get a credit for 25% of the interest on new bonds, instead of the full exemption they enjoy now.
  
• Some tax breaks would be eliminated. These include flex plans, miscellaneous itemized deductions, moving expenses, the foreign income exclusion, and some tax-free benefits like group term life insurance, employer-provided meals and employee awards.
  

Some S Corporations To Incur Additional Taxes

Owners of small S corporations will begin paying some self-employment tax on the corporate earnings under a Senate bill expected to pass shortly. Personal service corporations who have three or fewer employees will face the 15% SE tax in addition to regular income tax, as will any S corporations who are partners in a service business.

S Corporations have long been a popular tool for saving self-employment tax. They can still serve this purpose in larger settings or in non-service businesses. Set up correctly, the owner is paid a "reasonable wage" that is subject to payroll taxes. Any remaining profits can be distributed to the owner, who pays only regular income tax on those profits.

The problem? Too many hogs screwed up the whole deal for the rest of us. The IRS notes 35,000 one-employee S corporations with income of more than $100,000 who showed no wages. Another 40,000 S firms with income of $50k-$100k also paid no wages, and therefore, no payroll taxes. The IRS has long argued about what is "reasonable compensation," but no one can argue that zero is reasonable.

As is often the case in tax law, pigs get fed, but hogs get slaughtered. The hogs who thought they could abuse the SE tax provisions are on their way to the slaughterhouse.

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