Tax Reform Could Distinguish Between Pass-Through Businesses

In April, the Trump Administration announced a broad outline for tax reform which included proposals to cut the top individual tax rate to 35% and reduce the top business tax rate to 15%.   This reduced business rate would also apply to "pass-through businesses" - the majority of U.S. businesses who report income on their owners' tax returns rather than paying corporate income taxes.

However, Treasury Secretary Steven Mnuchin recently indicated that the reduced pass-through rate may not be available to service companies.

From the Wall Street Journal:

The idea is to create a special tax rate that is equal to or higher than the corporate tax rate but lower than the tax rate that applies to wages. That new rate would apply to pass-through business income but with boundaries to prevent it from being used by people whose income from service businesses closely resembles wages. 

...

Under a system like the one Mr. Mnuchin described, the owners of an accounting partnership would pay the individual tax rate on both their salaries and their partnership distributions. But the owners of a manufacturing partnership would pay the individual tax rate on their salaries and the special, lower rate on their profits.
...

It could be a challenge to define which companies get the lower tax rate Republicans are planning and which owners of companies would continue paying higher individual tax rates on their business income. Creating that distinction would cut against another Republican goal for the tax code: simplification. Possibly affected industries include law, engineering, medicine, finance, architecture and consulting.

Although many details are still lacking from the proposal, such a distinction - if included in the proposed legislation - could have a major impact on closely held businesses. The White House and Republican congressional leaders hope to reveal the full tax reform plan by the end of September.

Property Tax Reductions Available for Ohio Farmers

Under Ohio's Current Agricultural Use Value (CAUV) program, "land devoted exclusively to commercial agriculture" is valued based on the agricultural use of the land rather than its "highest and best probable legal use." A CAUV valuation often results in a significant reduction in property taxes.

In order to qualify for the CAUV program, property larger than 10 acres must be devoted exclusively to commercial agriculture (such as animal husbandry, field crops, or commercial timber).  If the property devoted exclusively to commercial agriculture is smaller than 10 acres, it must generate a gross average income of $2,500.

An initial CAUV application must be filed with the county auditor prior to the first Monday of March.  Renewal applications must be filed each year.  The auditor's office annually inspects each property to determine if the property qualifies for the CAUV program.

If CAUV land is converted to a non-agricultural use, the property is removed from the CAUV program and the property owner is assessed a recoupment charge equivalent to the tax savings over the previous three years.

For more information about the CAUV program, visit the Ohio Department of Taxation or the Ohio State Bar Association.

Ohio Doubles Film Tax Credit

In good news for Ohio filmmakers, the General Assembly recently passed legislation to double Ohio's film making tax incentive in order to encourage big-budget films to be shot in the Buckeye State.

From the Columbus Dispatch:

The legislation, passed by the Ohio General Assembly and signed by Kasich last month, will go into effect at the end of September. In addition to doubling the incentive cap, the law removes the $5 million cap for each project and raises the incentive rate to 30 percent of production dollars spent in Ohio.

Since 2011, when the state increased the tax credit to $20 million, 1,729 full-time jobs have been created and more than $400 million in total economic impact has been generated, according to the Ohio Department of Development.

In addition to the state tax credit, Section 181 of the Internal Revenue Code includes various federal incentives for filmmakers. Congress has extended these incentives through the end of 2016.

A previous blog post has additional information on the tax incentives available to filmmakers.

Ohio Real Estate Tax Exemptions For Places Of Worship

Article XII Sec. 2 of the Ohio Constitution permits the enactment of general laws exempting from taxation public school houses, houses used exclusively for public worship, institutions used exclusively for charitable purposes, and public property used exclusively for any public purpose. Pursuant to this authority, the Ohio Legislature enacted Ohio Revised Code (the “ORC”) §5709, “Taxable Property – Exemptions.”

Church tax exemptions are found in ORC §5709.07. The ORC defines “Church” to mean a fellowship of believers, congregation, society, corporation, convention, or association that is formed primarily or exclusively for religious purposes and that is not formed for the private profit of any person. R.C. §5709.07(D)(1). A church can be exempt from taxation under ORC §5709.07(A)(3) if the real property owned and operated by the church is “used ordinarily for public worship.” Beth Hamidrosh Hagodol v. Kinney, 16 Ohio App. 3d, 474 N.E.2d 658 (1984).

There are a few important mentionables: (1) A church that is both a religious institution and a charitable institution cannot receive both tax exemptions under ORC §5709.12 and §5709.121. Mt. Calvary Evangelical Lutheran Church v. Kinney, 19 Ohio App. 3d 267, 483 N.E.2d 1199, 1984 Ohio App. LEXIS 11301 (Ohio Ct. App., Montgomery County 1984); (2) Property which is owned by a church and leased to another church for church purposes is exempt from taxation. New Jerusalem Soc. v. Richardson, 10 Ohio N.P. 214 (1910); (3) Partial exemptions are allowed - that is, ORC §5713.04 permits real property to be split into “exempt” and “nonexempt” if those parts can be precisely delineated (i.e., first floor and second floor). Faith Fellowship Ministries, Inc. v. Limbach, 32 Ohio St. 3d 432, 513 N.E.2d 1340, 1987 Ohio LEXIS 403 (Ohio 1987); (4) Where a church is being reconstructed (i.e., torn down and rebuilt) and if within a reasonable period of time, the church does not lose its tax exemption. In re Ohave Scholem Congregation, 156 Ohio St. 183, 46 Ohio Op. 56, 101 N.E.2d 767 (1951); (5) Lastly, if a church purchases vacant land with the intent to use the property exclusively for public worship and there is evidence of prepared plans and available funds that establish this intent, then that land is entitled to a tax exemption. Peoples Faith Chapel, Inc. v. Limbach, 18 Ohio St. 3d 236, 480 N.E.2d 781, 1985 Ohio LEXIS 442 (Ohio 1985).

Traditionally, places of “public worship” are often thought of as churches, synagogues, and the like. In other words, they are physical, tangible places where people go to worship. However, the Ohio Supreme Court recently ruled that “public worship” can also extend to property owned to further gospel through music, preaching and teaching radio programs. Specifically, Christian Voice of Central Ohio, most famously known for their radio station, WCVO’s 104.9 “The River,” was granted a tax exemption for the property upon which their radio stations existed upon. In the opinion, Justice Sharon Kennedy wrote that Christian Voice functioned as a place of “public worship” because the non-profit dedicates all its land and buildings to charity and religion -- it has all the necessary attributes of a church, minus the physical presence of a traditional church. Ultimately, the Court interpreted ORC §5709.07 broadly and held that institutions can embody and perpetuate the meaning of “public worship” even though they may not have the physical presence of a church on their property.

The information presented is for information purposes only and is not intended to be legal advice, and it should not be acted upon as such. It also does not constitute advertising or solicitation.

This post was prepared with the assistance of Lauren Augostini, a student at Capital University Law School.

Ohio Real Estate Tax Exemptions For Charitable Uses

Article XII Sec. 2 of the Ohio Constitution permits the enactment of general laws exempting from taxation public school houses, houses used exclusively for public worship, institutions used exclusively for charitable purposes, and public property used exclusively for any public purpose. Pursuant to this authority the Ohio Legislature enacted Ohio Revised Code (the "ORC") §5709, "Taxable Property -- Exemptions."

The exemption for charitable uses is found in ORC §5709.12 and §5709.112. To be exempted from taxation under ORC §5709.12, the property must (1) belong to an institution and (2) be used exclusively for charitable purposes. True Christianity Evangelism v. Zaino, 91 Ohio St.3d 117, 118, 2001-Ohio-295, 742 N.E.2d 638, 639 (2001) Black's Law Dictionary (6 Ed.1990) 800, defines “institution” as: “An establishment, especially one of eleemosynary or public character or one affecting a community. An established or organized society or corporation. It may be private in its character, designed for profit to those composing the organization, or public and charitable in its purposes, or educational (e.g. college or university)." Any institution, irrespective of its charitable or non-charitable character, may take advantage of a tax exemption if it is making exclusive charitable use of its property. Wehrle Foundation v. Evatt (1943), 141 Ohio St. 467,[26 O.O. 29], 49 N.E.2d 52.

Statutes granting tax exemptions are interpreted strictly (Cincinnati Community Kollel v. Testa, 135 Ohio St.3d 219, 2013-Ohio-396, 985 N.E.2d 1236, ¶ 17.), so it is critical to ensure that the charitable use is both exclusive and charitable. If any part of the property is used for the purpose of profit making, that part of the property will be denied the exemption. Exemptions can be split if there is both an exempt and non-exempt use, and such splits will usually be made on a pro-rata basis based on the square footage or acreage used.

Sometimes the charitable use being made of the property is being made by an institution other than the title holder. This might be the case if a tenant is making an exempt use. Ohio Revised Code §5709.12(B) states that “[r]eal and tangible personal property belonging to institutions that is used exclusively for charitable purposes shall be exempt from taxation.” The words "property belonging to institutions" means ownership. Humphries v. Little Sisters of the Poor, 29 Ohio St. 201, 207 (1876). Possessing a leasehold interest, even under a long-term lease, is not ownership. See, e.g., Toledo v. Jenkins, 143 Ohio St. 141, 158–159, 54 N.E.2d 656 (1944); Evans Invest. Co. v. Limbach, 51 Ohio App.3d 104, 106, 554 N.E.2d 941 (10th Dist.1988). However, separating ownership and use is not be fatal to the exemption if the situation fits under ORC §5709.112. There, in certain cases exemptions can be granted for the use tenants make of the property if the property belongs to a charitable institution.

Reminder: The information presented is for informational purposes only and is not intended to be legal advice, and it should not be acted upon as such. It also does not constitute advertising or solicitation.

Is Your Property Fairly Taxed?

Every year, Ohio counties assess a property’s real estate taxes based on the market value the county places upon the property. However, the county's assessed value does not always accurately reflect the property’s true market value.

Ohio law gives property owners the right to challenge the value the county has placed upon their property if they feel it is in excess of the true market value by filing a complaint against the property's value with the county auditor. That complaint must be submitted by March 31, 2016.

If you believe your property is not valued correctly, please contact our office to discuss whether it is in your best interest to file such a complaint, keeping in mind the deadline of March 31, 2016.

Blog Roundup: Star Wars and the Law

What does this week's much-anticipated opening of Star Wars: The Force Awakens have to do with the law? Perhaps more than you expect.  In fact, quite a few legal scholars and attorney bloggers have explored how the epic franchise illuminates many different aspects of the law, including the following.

Property Law: Who owns the rights to the blue lightsaber owned by Anakin Skywalker, collected by Obi-Wan Kenobi, given to and lost by Luke Skywalker, and apparently seen in trailers for The Force Awakens?  From The Legal Geek:

Yes, fans might want to know where that lightsaber is, but for that matter, who actually owns the lightsaber? For that answer the lightsaber must be analyzed through the intricate lense that is property law. 

Tax Law: Can tax policy change the galaxy?  From the BNA Federal Tax Blog:

Before there could be a clone war, a Skywalker losing some limbs in a light saber duel, a Death Star, a Death Star blowing up, another Skywalker losing a limb in a light saber duel and another Death Star blowing up, there was—and, believe me, the Star Wars fan in me wishes I was making this up—a tax controversy. 

Criminal Law: Can Darth Vader be held responsible for murder, false imprisonment, burglary, or other crimes? From The Findlaw Blotter:

The first scene in Star Wars opens with Darth boarding Princess Leia's ship, looking for stolen structural plans of the Death Star. The crime of burglary is defined as the unauthorized breaking and entry into a building or occupied structure with the intent to commit a crime inside. Vader and other Imperial troops, like common thieves in the night, blast their way on to Leia's ship with the intent of stealing the Death Star's plans. 

Constitutional Law: How is the creation of Star Wars like the creation of constitutional law? From scholar Cass Sunstein:

[T]he composition, and its multiple twists and turns, tell us a great deal about the nature of the production of narratives in general, including those that have many authors, such as constitutional law. 

. . .

Whether Jedi or Sith, the authors of constitutional law are a lot like the author of Star Wars, disguising the essential nature of their own creative processes. 


Check back soon for our next post exploring judicial opinions involving Star Wars.

Lights - Camera - Taxes!

You might be surprised to learn that both federal and state tax codes offer incentives to encourage film and television production. In fact, Section 181 of the Internal Revenue Code gives most film and television productions a tax deduction of up to $15 million of production costs ($20 million for productions in economically distressed areas). The deduction can be taken during the first year of production and applies only to productions commenced before the end of 2014. Despite Congress's recent action to extend the provision, it remains to be seen whether the tax incentive will apply to productions begun in 2015.

In addition to the federal deduction, many states offer a variety of incentives to encourage filmmakers to produce somewhere other than Hollywood. States believe these incentives attract award-winning films to their locations, such as “Mud” (Arkansas) or “The Curious Case of Benjamin Button (Louisiana). However, at least some evidence exists that state film incentives may be falling out of favor.

For the time being, however, Ohio filmmakers may be able to take advantage of the Ohio Motion Picture Tax Credit, a refundable, non-transferable tax credit of 25-35% off the amount of a production company's qualifying expenditures that are incurred in producing a film or other media entertainment project in Ohio. More information on the state incentive is available from the Ohio Film Office, along with a map of Ohio’s famous television and movie filming locations.

Wealthy Giving Less to Charity; Poor Giving More

A recent report by the Chronicle of Philantrophy studied charitable giving in America, and the results were perhaps surprising. The study found that, as the country struggled out of a recession, wealthier Americans are giving away a smaller percentage of their income, while poorer Americans are giving more.

According to Forbes, Americans who earned at least $200,000 gave nearly 5% less to charity in 2012 than in 2006. In contrast, Americans who earned less than $25,000 increased their charitable giving by almost 17%.

The trend was similar in Central Ohio. The Columbus Dispatch reported that donors in the Columbus area gave about 2.6 percent of their income to charity in 2012, a 6.5 percent decline since 2006. This places Columbus 39th among America’s 50 largest metropolitan areas in giving, behind both Cleveland and Cincinnati. Area residents making less than $25,000 gave away 7.19% of their income; those making over $200,000 gave away only 2.43%.

Charitable giving should be carefully considered for both short- and long-term tax and estate planning purposes. Contact our attorneys for assistance.

Our Tax Exemption Was Revoked - Now What?

We recently received an inquiry from a small nonprofit organization that learned that the Internal Revenue Service had revoked its tax exemption for failure to file required notices. Among other consequences, this meant that the organization would be liable for corporate income tax, could face additional tax penalties, and would be unable to provide donors with a tax deduction for their gifts.

If your organization has received similarly discouraging news, take heart. Organizations who have had their exemption revoked can regain their tax-exempt status by re-filing IRS Form 1023.

As part of this process, your organization can apply to have its exemption retroactively reinstated. In most cases, the organization must include a reasonable cause statement (as outlined in IRS procedures) to establish that it exercised ordinary business care in attempting to comply with the annual reporting requirements.

While your application is pending, the Council of Nonprofits advises that you should be transparent with donors, staff, and board members about the loss of tax exemption, keep good records, and be patient with the lengthy IRS process.

IRS Streamlines Tax-Exempt Application Process for Most Charities

The Internal Revenue Service has recently released a new tax form to help small charitable organizations apply for tax-exempt status. Form 1023-EZ, introduced in July 2014, provides an alternative to the longer Form 1023 and will allow the IRS to more efficiently process applications for 501(c)(3) tax-exempt status.

From the IRS news release:

The new Form 1023-EZ, available today on IRS.gov, is three pages long, compared with the standard 26-page Form 1023. Most small organizations, including as many as 70 percent of all applicants, qualify to use the new streamlined form. Most organizations with gross receipts of $50,000 or less and assets of $250,000 or less are eligible.

"Previously, all of these groups went through the same lengthy application process -- regardless of size," [IRS Commissioner John] Koskinen said. "It didn't matter if you were a small soccer or gardening club or a major research organization. This process created needlessly long delays for groups, which didn’t help the groups, the taxpaying public or the IRS.”

The change will allow the IRS to speed the approval process for smaller groups and free up resources to review applications from larger, more complex organizations while reducing the application backlog. Currently, the IRS has more than 60,000 501(c)(3) applications in its backlog, with many of them pending for nine months.

To determine if your organization qualifies to file the new form, review the Form 1023-EZ Instructions and Revenue Procedure 2014-40, as well as consult an attorney. Form 1023-EZ must be filed online and requires a user fee of $400.

Forming an Ohio Nonprofit: An Overview

The Ohio Attorney General reports more than 42,000 registered nonprofit organizations in Ohio. How do you add your great idea to the list?

The first decision you must make is what type of nonprofit organization to form. Probably the most common is the nonprofit corporation, because it enables the founder(s) to limit liability. Under Ohio law governing nonprofit corporations, the founder must file articles of incorporation with the Ohio Secretary of State. In addition to an initial filing fee of $125, you will need, among other things, a distinctive name and a well-defined purpose for the organization.

Once your nonprofit corporation is formed, you must still meet additional requirements to continue operating. Ohio law requires you to regularly make filings. For example, every five years nonprofits must file a statement of continued existence. Additionally, the Ohio Attorney General requires an annual charitable registration filing.

In order for your organization to be tax-exempt, you must apply for tax-exempt status with the Internal Revenue Service, not the state of Ohio. The IRS lists a variety of different tax-exempt organizations  – each with slightly different rules – so it may be helpful to consult an attorney to ensure that your corporation meets the correct guidelines. Annually, you will have to file Form 990 with the IRS; if you do not, your tax-exempt status could be revoked.

More helpful nonprofit resources are available from the Ohio Secretary of State or the Ohio Attorney General.

A Tenant's Unpaid Water Bill: Who's Responsible?

Imagine this scenario. A tenant suddenly vacates her apartment and moves out of state, leaving her water bill unpaid. Who is liable for the outstanding bill?

Under Ohio law, landlords can be held responsible for a tenant’s unpaid water bills. A municipality has the power to place a lien on the property and collect the payment through property taxes or bring a lawsuit against the property owner to recoup the money.

Unpaid bills can mean a large financial loss for the city, so government leaders have a high incentive to collect. For example, a 2013 investigation in Toledo found that the city was owed almost $24 million in unpaid water bills.  If cities seek to recover these missing funds from property owners, a landlord's credit and bottom line can both be affected.

As a result, landlords should take some proactive steps to protect themselves and reduce their liability for a tenant's delinquent bills, such as:

1. Perform credit checks on prospective tenants as part of a background check. This can eliminate potentially risky tenants who might be unable to pay a bill. 
2. Consider requiring a co-signer for some tenants, such as students with limited income. 
3. Rather than putting water service in the tenant's name, put the service in the landlord's name and charge additional rent to cover the cost of water. 
4. Modify the lease to make a continued tenancy contingent on the payment of water bills. If the tenant does not pay the water bills, landlords may be able to begin eviction proceedings. 
5. In order to monitor and prevent potential problems, ask the utility company to send the landlord a copy of the tenant’s monthly bills.
6. Educate and encourage tenants to check for leaks or prevent wasteful water practices in order to reduce the possibility of unusually high bills.

New Tax Cut for Ohio Small Business Owners

Most Ohio small business owners are eligible for a 50 percent deduction on their first $250,000 of business income as part of tax cuts approved last year by the Ohio legislature.  As part of the tax cut, a business owner can exclude 50 percent of Ohio net business income from the adjusted gross income reported on the state personal income tax return.

Owners of and investors in, Ohio businesses structured as pass-through entities (such as sole proprietorships, partnerships, S-Corps, and Limited Liability Corporations) are eligible for the tax cut.  Owners and investors receiving income from the pass-through entity are required to pay personal income taxes on that income.

For more information, read the full tax alert issued by the Ohio Department of Taxation or check your eligibility for the deduction.

Detroit's Bankruptcy and Your Charitable Donations

Last month, federal proceedings began to determine whether the city of Detroit is eligible to file for bankruptcy. As part of the city’s process to review its assets, Detroit hired the renowned auction house Christie’s to appraise the priceless works of art by Picasso, Monet, Rembrandt, and others housed at the Detroit Institute of Arts.

This action is controversial because it could lead to an art sale and a potential violation of ethical guidelines prohibiting a museum from deaccessioning – selling art from its collection - for any purpose other than acquiring more art. Institutions who violate these guidelines risk losing accreditation and creating controversy in the art world.

Aside from affecting a museum’s collection, Detroit’s move is also extremely relevant to clients or donors. Clients often donate art to museums to meet their tax or estate planning goals, or simply to improve their community. Detroit’s bankruptcy filing is another warning that it is essential to have a carefully drafted agreement before donating property to a museum.

Most art is donated without strings or explicit constraints on sales, so a clearly written document ensures that the donor’s wishes are known and that the museum will abide by those wishes. For example, agreements may explicitly say that a particular piece may never be sold or may never be sold for operating expenses of the institution.

Attorneys and donors should also inquire about a museum’s deaccessioning policies. Since Detroit’s bankruptcy filing, the DIA has amended its deed of gifts to clearly state that the donated work can only be sold to buy more art. But most institutions are not so clear, relying only on ethical guidelines.

As museums face financial difficulties and courts may be more likely to allow the sale of donated artifacts, traditional ethical guidelines may no longer be enough to prohibit a sale. Attorneys and donors would be wise to seek additional protections.

New Markets Tax Credit Set to Expire

An important tax incentive for investments in economically distressed neighborhoods is set to expire at the end of 2013.

The New Markets Tax Credit (NMTC) is designed to increase the flow of capital and spur investment and job creation in communities with high unemployment and other measures of economic distress. The NMTC provides private investors with a 39 percent federal tax credit for investments made in businesses or economic development projects in some of the most distressed communities in the nation.

Since 2003, NMTC investments have directly created over 350,000 jobs -- including more than 40,000 in Ohio – and leveraged $55 billion in capital investment to credit-starved businesses in communities with high poverty and unemployment rates. In Columbus, for example, the NMTC helped investors purchase land and construct a grocery store in a distressed neighborhood.

Legislation sponsored by Sens. Jay Rockefeller (D-WV) and Roy Blunt (R-MO) is currently pending in Congress to make the NMTC permanent. S. 1133, The New Markets Tax Credit Act of 2013, would extend the Credit indefinitely by making it a permanent part of the Internal Revenue Code, and enhance the potential impact of the Credit by increasing the annual NMTC allocation. However, Congress must pass the legislation before the end of the year in order for the NMTC to continue.

Learn more about the credit or congressional efforts to extend it.

Comprehensive Tax Reform Unlikely Before 2015

Experts at this week’s American Institute of Certified Public Accountants National Tax Conference predicted that Congress is unlikely to pass comprehensive tax reform legislation in the near future despite ongoing positive discussions.

The House and Senate tax-writing committees are on track to produce bipartisan tax reform legislation that will receive lawmakers’ approval, but it is unlikely to occur until the next Congress, said tax experts on November 4. Speaking at the AICPA National Tax Conference, Donald R. Longano, former Democratic chief tax counsel to the House Ways and Means Committee, said tax reform is “more likely to come to fruition in 2015,” despite the intense activity going on behind the scenes. 

Observers also predicted that lawmakers would not extend $64 billion in energy and business tax provisions scheduled to expire at the end of 2013.

Any proposals not enacted into law by the end of 2014 would have to be reintroduced in the 114th Congress in January 2015.

Read the full report from the CCH Group Blog.

Individuals Limited by S Corporation Loss Limitation But Not Passive Loss Limitation

Interesting tax update from the CCH blog:

Individuals Limited by S Corporation Loss Limitation But Not Passive Loss Limitation; Testimony Established Wife Materially Participated; Late-Filing Penalty Applied (Montgomery, TCM)

An individual materially participated in the activities of a limited liability company (LLC) that she and her husband started and for which both taxpayers performed services. Therefore, her claimed share of a net operating loss (NOL) was not precluded on the ground that she was engaged in a passive activity. However, the taxpayers’ claimed loss from their S corporation was limited and their guarantee of a debt owed by that company did not affect that limitation. They were also subject to an addition to tax for the late filing of their return.

The wife participated in the LLC for more than 500 hours during the year at issue, and her participation was regular, continuous, and substantial. Although only the wife was a member of the LLC, the activities of her husband were also taken into account to determine participation. Daily time reports and other logs were not required to establish participation because the taxpayers testified credibly as to their activities in founding the company, negotiating contracts, hiring employees and conducting daily business. As a result, the wife’s share of the construction company’s loss was not a passive loss under Code Sec. 469 and the taxpayers were entitled to claim the NOL.

Read the entire post here.

Summary Of The American Taxpayer Relief Act Of 2012

Late in 2012, “fiscal cliff” was the political and economic term du jour in the United States. In short, the fiscal cliff was a combination of spending cuts and tax increases that were scheduled to automatically occur on January 1, 2013 (and in fact did occur). Many believed that such a sharp decline in the budget deficit would result in another recession. Congress and the President scrambled to reach a “deal” that combined tax relief with spending reform. On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012 (the “Act”), passed merely hours prior by the Senate and House of Representatives. The Act provides for many tax law changes but very little government spending reform. Congress and the President are expected to reform government spending at a later date.


This memorandum shall serve to summarize the tax provisions of the Act that we believe are most important to our clients, both as individual taxpayers and as small business owners. Please note that many of the tax provisions in the Act are “permanent.” A provision described below as “permanent” does not mean that Congress cannot or will not amend such provision, but rather that such provision has no set expiration date. This memorandum is not intended to provide tax or business planning advice. We would not presume to give planning advice without speaking directly with you and learning all facts relevant to you or your business.

INDIVIDUAL PROVISIONS

Individual Income Tax Rates

• Bush-era income tax rates are permanent for 2013 and beyond, except that taxpayers with taxable income above $400,000 ($450,000 for married taxpayers and $425,000 for heads of households) will be taxed at a 39.6% rate.
• The other marginal rates for 2013 and beyond are 10, 15, 25, 28, 33, and 35 percent.
• The 35% marginal rate applies to incomes between the top of the 33% rate (projected to be $398,350, or $199,175 for married taxpayers filing separately) and the $400,000/$450,000 threshold at which the 39.6% rate bracket now begins.
• The 35% income bracket ranges for 2013, therefore, are:
• $398,350 - $400,000 for single filers.
• $398,350 - $425,000 for heads of household.
• $398,350 - $450,000 for joint filers and surviving spouses.
• $199,175- $225,000 for married taxpayers filing separately.
• The $400,000/$450,000 threshold amounts are bottom-line taxable income, rather than adjusted gross income, as had been proposed by President Obama in the “fiscal cliff” negotiations.

As you can see, anyone with taxable income less than the $400,000/$450,000 thresholds will not see their income tax rates rise in 2013. Furthermore, those earning $200,000 ($250,000 for married taxpayers filing jointly) will remain in the 33% marginal bracket. This is important because there was a strong push to impose the top 39.6% rate on incomes above the $200,000/$250,000 threshold.

Capital Gains and Dividends

• The top rate for long-term capital gains and dividends is 20% (up from 15% in 2012).
• The top rate applies to the extent that a taxpayer’s income exceeds the $400,000/$450,000 thresholds.
• All other taxpayers will pay a maximum rate of 15% on long-term capital gains and dividends.
• Taxpayers that fall below the 15% marginal income tax bracket will pay no tax on long-term capital gains and dividends.
• Short-term capital gains will continue to be taxed at individual income rates. Short-term capital gain means gain realized on the sale or disposition of capital assets held for less than one year.
• Certain dividends do not qualify for the reduced tax rates and will continue to be taxed as ordinary income. Those include dividends paid by credit unions, mutual insurance companies, and farmers’ cooperatives (not an exhaustive list).

Absent any changes, the maximum rate for all capital gain would have been 20% in 2013 and beyond, expect for those below the 15% marginal tax bracket threshold. Therefore, taxpayers not in the top marginal income tax bracket will continue to enjoy a 15% tax on long-term capital gains and dividends.

Please also note that the Patient Protection and Affordable Care Act (“Obamacare”) imposes an additional 3.8% tax on Net Investment Income for individuals with taxable incomes above $200,000 ($250,000 for married taxpayers filing jointly and surviving spouses, and $125,000 for married taxpayers filing separately). This surtax applies to both short- and long-term capital gains and dividends, as well other types of investment income. Therefore, a taxpayer in the top marginal income tax bracket will pay 23.8% tax on long-term capital gains and dividends and 43.4% on short-term capital gains starting in 2013.

Alternative Minimum Tax (“AMT”)

• The AMT for 2012 has been “patched,” meaning the exemption amounts have been increased and nonrefundable personal credits to the full amount of an individual’s regular tax and AMT are allowed for tax year 2012.
• The new 2012 exemption amounts are as follows:
• $50,600 for unmarried individuals.
• $78,750 for married taxpayers filing jointly and surviving spouses.
• $39,375 for married individuals filing separately.
• The 2013 exemption amounts are expected to be approximately $1,000 - $2,000 higher for each above filing status.

Without the AMT “patch,” the exemption amounts would have been $33,750 for unmarried individuals, $45,000 for married taxpayers filing jointly and surviving spouses, and $22,500 for married individuals filing separately. Therefore, the “patch” greatly increases the exemption amounts and saves over 60 million taxpayers from being subject to the AMT for tax year 2012.

Although this patch is permanent, the future of the AMT remains uncertain. Some lawmakers have proposed that the AMT be abolished altogether. President Obama has proposed replacing the AMT with the so-called “Buffett Rule” which would, generally, ensure that taxpayers earning over $1 million annually would pay an effective tax rate of at least 30%. The Buffett Rule was included in the Paying a Fair Share Act, a bill rejected by the Senate in 2012. It is unclear if the Buffett Rule will be re-proposed in future legislation.

Pease Limitation

• The Act revives the “Pease” limitation on itemized deductions.
• The applicable threshold levels are as follows:
• $300,000 for married taxpayers and surviving spouses.
• $275,000 for heads of households.
• $250,000 for unmarried taxpayers.
• $150,000 for married taxpayers filing separately.

The “Pease” limitation is a limit on itemized deductions for higher income taxpayers. It was suspended in 2001 and again in 2010. The limitation reduces the taxpayer’s otherwise allowable itemized deductions by 3% of the amount by which the taxpayer’s adjusted gross income exceeds the applicable threshold. However, the amount of itemized deductions may not be reduced by more than 80%. Certain itemized deductions, such as medical expenses, investment interest, and casualty, theft or wagering losses, are excluded. Though the limitation has been revived, the applicable threshold amounts are much higher than they were before they suspended.

Personal Exemption Phase-out

• The Act revives the personal exemption phase-out rules.
• The new applicable threshold levels are as follows:
• $300,000 for married taxpayers and surviving spouses.
• $275,000 for heads of households.
• $250,000 for unmarried taxpayers.
• $150,000 for married taxpayers filing separately.

Under the phase-out, the total amount of exemptions that may be claimed by a taxpayer is reduced by 2% for $2,500, or portion thereof (2% for each $1,250 for married taxpayers filing separately) by which the taxpayer’s adjusted gross income exceeds the applicable threshold level.

Federal Estate, Gift, and Generation-Skipping Transfer (“GST”) Taxes

• The maximum federal estate tax rate is 40% with a $5 million annually inflation-adjusted exclusion for estates of decedents dying after December 31, 2012. The rate and exclusion are permanent.
• “Portability” between spouses is permanent. Portability allows the estate of a decedent who is survived by a spouse to make a portability election to permit the surviving spouse to apply the decedent’s unused exclusion to the surviving spouse’s own transfers during life and at death.
• The Act extends the deduction for state estate taxes.
• There is imposed a 40% tax rate and a unified estate and gift tax exemption of $5 million for gifts made after December 31, 2012.
• The Act extends numerous GST tax-related provisions that were scheduled to expire after December 31, 2012. Those provisions include the GST deemed allocation and retroactive allocation provisions, provisions allowing for a qualified severance of a trust for purposes of the GST tax, and relief from late GST allocations and elections.

The maximum estate tax rate of decedents dying after December 31, 2010 and before January 1, 2013 was 35% with a $5 million exclusion. Absent the changes enacted by the Act, the maximum rate would have been 55% with a $1 million exclusion for 2013 and beyond. The maximum gift tax rate was 35% with a $5 million exclusion for gifts made in 2011 and 2012.

Other Important Individual Tax Provisions

• The Act extends through 2013 the election to claim an itemized deduction for state and local general sales taxes in lieu of state and local income taxes.
• The Act permanently extends the $1,000 child tax credit. The credit was scheduled to revert to $500 per qualifying child after December 31, 2012.
• The Act extends the adoption credit and the income exclusion for employer-paid or reimbursed adoption expenses up to $10,000.
• The Act extends enhancements to the child and dependent care credit. The current 35% credit rate is made permanent along with the $3,000 cap on expenses for one qualifying individual and the $6,000 cap on expenses for two or more qualifying individuals.
• The Act extends through 2017 the American Opportunity Tax Credit (the “AOTC”). This credit gives qualified individuals a tax credit of 100% of the first $2,000 of qualified tuition and related expenses and 25% of the next $2,000, for a maximum credit of $2,500 per eligible student. The AOTC applies to the first four years of a student’s post- secondary education.
• The Act extends until December 31, 2013 the above-the-line deduction for qualified tuition and related expenses. This extension applies retroactively to 2012. This deduction and the AOTC cannot both be taken in the same year.
• The Act permanently repeals the 60-month rule for the $2,500 above-the-line student loan interest deduction. The 60-month rule limited the deduction for student loan interest to 60 months. In addition, the Act permanently repeals the restriction that makes voluntary payments of interest nondeductible.
• The Act reinstates the provision that treats mortgage insurance premiums as deductible interest that is qualified residence interest. This provision previously expired in 2011.

BUSINESS TAX PROVISIONS

Internal Revenue Code Section 179 Small Business Expensing

• The Act extends through 2013 the enhanced Internal Revenue Code Section 179 small business expensing.
• The Section 179 dollar limit for tax years 2012 and 2013 is $500,000 with a $2 million investment limit.

Without the Act, the Section 179 dollar limit for tax years beginning in 2012 would have been $125,000 with a $500,000 investment limit. In tax years after 2012, the dollar limit would have been $25,000 with a $200,000 investment limit. Unless Congress further acts, the $25,000/$200,000 limits will apply to tax years beginning in 2014.

Bonus Depreciation

• The Act extends 50% bonus depreciation through 2013.

To be eligible for bonus depreciation, qualified property must be depreciable under the Modified Accelerated Cost Recovery System (MACRS) and have a recovery period of 20 years or less. The qualified property must be new and placed in service before January 1, 2014 (January 1, 2015 for certain longer production period property and certain transportation property).

Subject to the investment limitations, Section 179 expensing remains a viable alternative, especially for small business because property qualifying under Section 179 expensing can be used or new.

Work Opportunity Tax Credit

• The Act extends through 2013 the Work Opportunity Tax Credit (“WOTC”), which rewards employers that hire individuals from targeted groups with a tax credit.

An individual from a “targeted group” is generally a “hard-to-employ” worker. But the Act also extends the WOTC for employers hiring qualified veterans. The credit is equal to 40% of first-year wages up to $6,000. The WOTC is part of the general business credit.

Qualified Leasehold/Retail Improvements and Restaurant Property

• The Act extends through 2013 the 15-year recovery period for qualified leasehold improvements, qualified retail improvements, and qualified restaurant property.

Reduction in S Corporation Recognition Period for Built in Gains

• For tax years beginning in 2012 and 2013, the recognition period for purposes of S corporations with built-in gains shall be 5 years.

When a corporation converts to an S corporation and then sells assets, any built-in gains in those assets will be taxed at the corporate tax rate (currently, 35%). Built-in gains are those gains that would exist if assets were sold upon conversion from a C corporation to an S corporation. The built-in gain amount is locked-in at the time of conversion. The Internal Revenue Code contains a rule that states that an S corporation that sells assets after conversion from a C corporation must pay the corporate tax on those built-in gains upon sale of such assets. Thus, a sale of assets with built-in gains by an S corporation could result in double taxation- the built-in gain is taxed at the 35% corporate rate and then any amount passed through to shareholders will be taxed at the shareholder’s personal rate. This rule, however, does not apply forever. Under previous law, the corporate tax liability is reduced by 10% per year that an asset remains unsold and any assets with built-in gain sold after 10 years will no longer be subject to the corporate tax. The Act replaces the 10 year recognition period with a 5 year recognition period for tax years beginning in 2012 or 2013. Therefore, if you have a company that started as a C corporation but you elected S corporation status in 2007, then by 2013 any built-in gains of the company’s assets sold in 2013 will not be taxed at corporate rate. This presents a great opportunity for S corporations that were converted from C corporations 5 or more years ago that wish to sell assets but have been hindered by the 10 year recognition period.

Please do not hesitate to call us with any questions about the American Taxpayer Relief Act of 2012 or to discuss any potential planning opportunities or concerns that may have arisen as a result of this Act.

Keeping Corporate Records Pays (Even If It Is A Hassle)

Interesting decision below:

Taxpayers Engaged in Horse Breeding Activity with Profit Objective; Losses Deductible (Dennis, TCM)

A married couple engaged in a horse breeding activity with the intent of making a profit and were entitled to deduct their losses from the activity for several tax years. Overall, the couple carried on the activity in a businesslike manner by having a business plan and executing it, by maintaining financial records and books for the activity and using accounting software to track expenses, by having separate personal and business accounts, by using different methods of advertising, and by changing operating methods and abandoning unprofitable ones.

In addition, the husband sought advice from knowledgeable individuals and developed veterinary and training skills; the couple did not derive pleasure from the activity yet spent vast amounts of time on it; and the couple did not have other substantial sources of income. Although the husband expected that the land used for the activity would appreciate, this one factor did not negate a finding of a profit objective. Finally, although the couple had a history of losses from the activity, the losses were incurred during the start-up phase of the operation and were impacted by an unforeseen drought that increased the cost of feeding the horses.

J.L. Dennis, TC Memo. 2010-216, Dec. 58,350(M)

The full decision can be found here.