IRS Updates Disclosure Guidance for Understatement Penalties

 The IRS has made minor changes to its guidance describing when disclosure on a taxpayer’s income tax return is adequate to reduce an accuracy-related penalty for substantial understatement of income tax and to avoid a preparer penalty. For a copy of the update, see Rev. Proc. 2012-15.

Sales Tax Lower in 2011

Last year more states, counties and cities lowered their sales tax rates than in 2010, and the number of sales tax changes also went down. A new report by Thomson Reuters found that the average county sales tax was 1.15 percent in 2011, down from 1.23 percent in 2010; the average city sales tax was 1.67 percent in 2011, down from 1.72 percent in 2010. Sales tax software provider Vertex also released an End of Year Sales Tax Report that found the combined average sales tax rate and number of rate changes declined in 2011 compared to recent years. The highest city sales tax rate in 2011 was Wrangell, Alaska, at 7.00 percent. The highest combined sales tax rate of 13.725 percent is found in Tuba City, Coconino County, Ariz. 

The IRS has issued transitional relief from information reporting requirements under Section 6045B for stock reporting organizational actions taken in 2011. Notice 2011-18 indicates that the IRS will not penalize issuers for missing the deadline of Jan. 17, 2012, to file a return reporting the actions that changed the basis of their outstanding stock or other securities in 2011, such as a stock split or a distribution in excess of earnings and profits, or post the return on its Web site. This notice does not apply to an issuer’s requirement to furnish the same information to the issuer’s stockholders and nominees of its stockholders. Issuers of stock in a regulated investment company are not subject to the issuer reporting requirements for 2011 organizational actions.

Beginning on January 1, 2011, regulations issued under Section 6045B of the Internal Revenue Code required domestic and foreign corporations to file a statement with the IRS and furnish a similar statement to their security holders describing the effect of the reporting action on the basis of each share of their stock. Public and private companies were required to file:

• A description of the transaction and relevant Internal Revenue Code provisions;
• The quantitative effect of the transaction on the basis of the corporation’s stock as an adjustment per share or as a percentage of the old basis;
• The data supporting the calculation; and
• Other information necessary to implement the stock tax basis adjustment.

The information was to be filed with the IRS, or published on the corporate website on or before the 45th day following the organizational action or, if earlier, January 15 of the year following the calendar year of action. Reporting is not required for actions involving corporate subsidiaries if the security holders are “exempt recipients.”

Without the transitional relief, companies that failed to meet the Jan. 17, 2012, deadline faced penalties of up to $50 for each information return with a maximum of $250,000, or $100 per failure, with no maximum amount if the failure to file is the result of an intentional disregard of the filing requirement.

For more details, see the IRS Notice 2011-18

Temporary and Proposed Regs Address U.S.-Sourced Dividend EquivalentsTaxes will be required to be withheld on any payments of “dividend equivalents” to nonresident aliens and foreign corporations as a way to crack down on certain tax avoidance practices, IRS says in temporary (T.D. 9572) and proposed (REG-120282-10) rules. The IRS has released these temporary and proposed regulations for treatment of dividend equivalents under Code Sec. and 871(m). More details at T.D. 9572 and REG-120282-10.

IRS 2012 Auto/Truck Fringe Benefit Valuation Details Released IRS has released the 2012 maximum fair market values (FMVs) for employer-provided autos, trucks and vans, the personal use of which can be valued for fringe benefit purposes at the mileage allowance rate of 55.5¢ per mile for 2012. The IRS also released the 2012 maximum fleet-average vehicle FMVs for autos, trucks and vans for purposes of the annual lease value (ALV) fringe benefit valuation method. More detail can be found by downloading the Employer’s Tax Guide to Fringe Benefits.

Partners’ Interest Expense Allocation Subject of New Regulations
The IRS issued new temporary and proposed regulations that change the way partners allocate and apportion interest expense. The changes affect corporate partners with a 10% or more interest in a partnership and certain other partners. The regulations also address allocation and apportionment of interest expense using the fair market value method. Details can be found at Federal Register, T.D. 9571.

IRS Transitional Relief from Sec. 6045B Reporting RequirementsIn a notice, the IRS has provided relief from the Code Sec. 6045B reporting requirements for filing Form 8937, Report of Organizational Actions Affecting Basis of Securities. The requirements can be satisfied by either posting the Form or the required information in readily accessible format on the issuer’s primary public website. The IRS has provided penalty relief for issuers who make good faith efforts to comply with the eased reporting requirements. See Notice 2012-11 for details.

Many small businesses that accept credit cards as payment or accept payment from a third-party settlement organization, such as PayPal, may be receiving 1099-Ks this month. The 1099-K is new as of Jan. 1, 2012. Payment settlement entities (PSE) and third-party PSEs are sending out 1099-K forms to companies that receive payments from credit cards or third-party settlement agencies; a similar report is sent to the IRS.

Companies accepting credit cards in their business must report the revenue earned via credit card payments separately on their income tax return starting in 2012. Right now, many companies track revenue coming in but not specifically revenue paid by a credit card. Companies may need to change their operating system to track this information so that it can be readily accessible for reporting to the IRS. Companies will need to report revenue from credit cards at the gross amount and report the credit card transaction fees as a separate expense.

The new form is intended to collect taxes due from merchants that may have been under-reporting sales from credit card transactions. Previously, companies tracked revenues coming in, not specifically revenues that were paid by a credit card. “Companies need to change their system to track this information so it can be reported to the IRS,” TaxOps Director Dan DeLau says. “Gross receipts and credit card transaction fees are reported separately.” More details at 1099-K or call 720-227-0067 for a TaxOps consultation on 1099-K reporting.

The Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts get current with their taxes and announced the collection of more than $4.4 billion so far from the two previous international programs. The offshore program will be open for an indefinite period, and there is no set deadline for people to apply. Continuing taxpayer and tax practitioner interest in the Offshore Voluntary Disclosure Program (OVDP) prompted the IRS to reopen the program after the closure of the 2011 and 2009 programs. The 2009 and 2011 initiatives generated 33,000 voluntary disclosures. Penalties under the new program are substantially the same, except for the highest penalty category, and range from 5 to 27.5 percent for the eight full tax years prior to the disclosure. More details will be available within the next month on www.IRS.gov.

For a free consultation on this issue please contact Kristine Newkirk at 720-227-0067 or knewkirk@taxops.com.

IRS e-File System open to Business Tax FilersThe Internal Revenue Service electronic filing system is now open for business tax returns. The modernized e-File, or MeF, system, can now accept tax year 2011, 2010 and 2009 business-related tax returns. The MeF system for e-filing individual tax returns opens Jan. 17, 2012. System updates on the Modernized e-File service are available at http://www.irs.gov/efile/article/0,,id=168537,00.html.

FinCEN Sees Uptick in FBAR ReportingThe Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has reported an uptick in the number of filings of Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). FinCEN reported that 618,134 FBARs were filed in fiscal year 2011, up from 594,488 in fiscal-year 2010. The FBAR is used to report a financial interest in, or signature or other authority over, one or more financial accounts in foreign countries whose aggregate value is greater than $10,000. Read more about FBAR reporting at http://www.fincen.gov/statutes_regs/guidance/.

IRS FAQ Highlight 2011 Tax Benefit Changes
A new IRS fact sheet details changes made in 2011 that offer tax benefits and provides information on special tax payment and reporting requirements. The fact sheet, FS-2012-1, can be found at http://www.irs.gov/newsroom/article/0,,id=251837,00.html. A summary of the fact sheet follows.

Two Extra Days to File and PayIndividual taxpayers have until Tuesday, April 17, 2012, to file their 2011 income tax returns and pay any taxes due. Corporate taxpayers still have until March 15, 2012 to file returns or request an extension.

Limited Nonbusiness Energy Property Credit for 2011The credit is generally equal to 10 percent of what a homeowner spends on eligible energy-saving improvements, up to a maximum tax credit of $500. See Form 5695 at www.irs.gov/pub/irs-pdf/f5695.pdf.

Repayment of First-Time Homebuyer CreditReport second payments for first-time homebuyer credits for a home bought in 2008 on Form 1040 Line 59b. Report repayment requirements where a taxpayer purchased a home and claimed the credit on a prior year return and then sold it or stopped using it as a main home in 2011 on Form 5405, available at www.irs.gov/pub/irs-pdf/f5405.pdf.

New Way to Report Capital Gains and LossesFor securities bought and sold in 2011, the Form 1099-B, issued by the broker, normally shows the taxpayer’s basis, which will help taxpayers correctly fill out Form 8949. See the www.irs.gov/pub/irs-dft/i1040sd–dft.pdf for Form 8949 and Schedule D for details.

Reporting Roth ConversionsAll of the income resulting from a 2011 conversion must be included on the taxpayer’s 2011 return. See www.irs.gov/pub/irs-pdf/f8606.pdf and its instructions for details.

Standard Mileage Rates Up in 2011The 2012 standard mileage rate for business use of a car, van, pick-up or panel truck remains 55.5 cents a mile. Additional mileage rates are detailed in the fact sheet at http://www.irs.gov/newsroom/article/0,,id=251837,00.html.

Health Insurance Deduction for Self-Employed PeopleIn 2011, eligible self-employed individuals and S corporation shareholders can continue to use the self-employed health insurance deduction to reduce their income tax liability. Eligible taxpayers still claim this deduction on Form 1040 Line 29. The deduction from self-employment income for determining self-employment tax, which was available only in tax-year 2010, no longer applies. For details see Publication 17 and the instructions to Form 1040 (including a worksheet) at www.irs.gov/pub/irs-pdf/i1040.pdf.

Change for HSAs and MSAsIn 2011, the additional tax on distributions from a health savings account (HSA), not used for qualified medical expenses, increases from 10 percent to 20 percent. Report at www.irs.gov/pub/irs-pdf/f8889.pdf. The additional tax on distributions from an Archer medical savings account (MSA), not used for qualified medical expenses, rises from 15 percent to 20 percent. Report at www.irs.gov/pub/irs-pdf/f8853.pdf.

New Form for Reporting Foreign Financial AssetsTaxpayers must report specified foreign financial assets on new www.irs.gov/pub/irs-dft/f8938–dft.pdf, if the aggregate value of those assets exceeds certain thresholds. Form 8938 is separate from and does not replace the existing requirement that U.S. persons with financial accounts located in a foreign country report those accounts to the Treasury Department using Form TD F 90-22.1 at www.irs.gov/pub/irs-pdf/f90221.pdf.

IRS Extends Tax-Filing Deadline to April 17. The Internal Revenue Service is giving individual taxpayers two extra days to file their 2011 tax returns this year. Due to April 15 falling on a Sunday and a holiday, Emancipation Day, in the District of Columbia on April 16, all taxpayers will have until Tues., April 17 to file their 2011 tax returns and pay any tax due. The IRS will begin accepting e-file and Free File returns on Jan. 17, 2012.

Credit for Hiring Veterans Claims. The Three Percent Withholding Repeal and Job Creation Act, P.L. 112-56, extended the work opportunity tax credit (now called the returning heroes and wounded warriors work opportunity tax credits) for businesses that hire certain military veterans who begin work for the employer before Jan 1, 2013. Tax-exempt employers can also receive a payroll tax credit against Social Security tax for hiring “qualified veterans” who began work for the employer after Nov. 21, 2011 and before Jan. 1, 2013. Tax-exempt employers eligible to receive the credit on their fourth quarter 2011 Form 941 should file Form 941 by Jan. 31, 2012. Form 941, Employer’s Quarterly Federal Tax Return, can be downloaded at www.irs.gov/pub/irs-pdf/f941.pdf.

IRS Updated Covered Compensation Tables. IRS has issued tables of covered compensation for the 2012 plan year. The IRS tables provide covered compensation amounts and rounded covered compensation amounts. The tables can be found at http://www.irs.gov/pub/irs-drop/rr-12-05.pdf.

FBAR Reporting for Former Employees. The Financial Crimes Enforcement Network has issued additional guidance on the reporting requirements of former employees that had signature authority over a foreign financial account of a former employer. Although former employees do not need to maintain records of the foreign financial accounts of their former employers, minimum information must be provided regarding the signature authority on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). Read more at www.fincen.gov/statutes_regs/guidance/html/fin-2011-g003.html.

Temporary regulations alter cost treatment of tangible property. IRS has issued temporary regulations that provide guidance (Code sections 162(a) and 263(a)) on amounts paid to acquire, produce, or improve tangible property. The temporary regulations will affect all taxpayers that acquire, produce, or improve tangible property. The temporary regulations expand the current standards and provide certain threshold tests for applying these standards. Additional guidance is also provided for property subject to section 168. Read more in the Federal Register at http://www.federalregister.gov/articles/2011/12/27/2011-32024/guidance-regarding-deduction-and-capitalization-of-expenditures-related-to-tangible-property#p-3

The Internal Revenue Service has issued temporary and proposed regulations for individuals required to disclose on their tax return information on foreign financial assets in which they have an interest. While effective for tax years ending after Dec. 19, 2011, taxpayers can apply them to earlier years. The IRS will soon release the final version of Form 8938 (Statement of Specified Foreign Financial Assets), which taxpayers will use starting this coming tax filing season to report specified foreign financial assets for tax year 2011.

Under the temporary regulations, Form 8938 must be filed by persons with an interest in one or more specified foreign financial assets with an aggregate fair market value exceeding either $50,000 on the last day of the tax year or $75,000 at any time during the tax year ($100,000 and $150,000, respectively, for married specified individuals filing a joint annual return). The temporary and proposed regulations provide additional guidelines for joint interests, filers, and penalties.

Read more at www.irs.gov/irs/article/0,,id=251216,00.html.

The amount of total income tax expense or benefit shown on the income statement is computed by combining both the current tax expense or benefit and deferred tax expense or benefit.  The current portion is the amount of tax liability that the company expects to owe in each of its jurisdictions where it files a tax return plus such items as return to provision adjustments on permanent items and changes to the tax liability related to uncertain tax positions.  The deferred portion is calculated by analyzing changes to the deferred tax asset or liability and quantifying those changes that affect the income statement.

In a basic example, assume the company has pretax book income in the current period of $200,000, non-deductible meals and entertainment expense totaling $10,000, tax depreciation greater that book depreciation of $50,000, non-deductible increase to the bad debt reserve of $20,000, and net operating loss carryforward (NOL) of $60,000.  The company computes its current tax liability in the US & state jurisdictions as follows:

Pretax book income                                            $ 200,000

Non-deductible meals & entertainment               10,000 – Permanent Difference  

Tax over book depreciation                                    (50,000) -Temporary Difference

Non-deductible bad debt expense                           20,000 -Temporary Difference

Taxable income before NOL                               $ 180,000

Net operation loss carryforward                             (60,000)

Taxable income after NOL                                  $   120,000

Tax rate                 (Federal + State)                                40%

Tax                                                                          $     48,000

Also assume the non-current tax liability balance related to uncertain tax positions has increased by $20,000.  Total current tax expense would be $68,000 ($48,000+$20,000).

US and state deferred tax expense would be computed by analyzing the change in deferred tax asset/liability as follows:

The current and non-current portions on the net deferred tax liability above would be summarized as follows:

This analysis demonstrates the net deferred tax liability has increased resulting in a deferred tax expense related to the change of $36,000.

The total tax expense for the company is $104,000 ($68,000 current income tax expense plus $36,000 deferred income tax expense)

The journal entries to record the current and deferred portions of total income tax expense in this example are as follows:

Dr.           Income Tax Expense                         $68,000

Cr.           Current Tax Liability                                                          $48,000

Cr.           Non-Current Tax Liability                                                   20,000

Dr.           Income Tax Expense                         $36,000

Cr.           Current Deferred Tax Asset                                               $16,000

Cr.           Non-current Deferred Tax Liability                                 20,000                                

For question regarding ASC-740 provision matters, please contact Daniel DeLau at 720-227-0065 or delau@taxops.com or John Monahan at 720-227-0064 or jmonahan@taxops.com.

The company must determine the realizability of the deferred tax asset calculated in order to determine the amount of valuation allowance that a company should record.  A valuation allowance reduces the deferred tax asset to an amount that is “more likely than not” to be realized.  This can have a direct effect on the income statement through the amount of deferred tax expense or benefit recorded.  The effect of any recording or releasing a valuation allowance occurs discretely in the period that the determination is made.

All deferred tax assets should be evaluated to determine the need for a valuation allowance based on specific facts and circumstances.  The types of deferred tax assets that should be evaluated include not only tax attributes with finite carryforward periods such as net operating loss or tax credit carryforwards, but also other deferred tax assets that result from cumulative book and tax temporary differences.  These types of deferred tax assets may ultimately reverse and increase the amount of net operating loss carryforward in a future period.

When evaluating the need for a valuation allowance, all pertinent evidence should be considered, both positive and negative.  Generally evidence is based on the ability to objectively verify through current transactions, such as the ability for a company to carryback net operating loss to a period with taxable income.  The existence of future taxable temporary differences will reverse in the net operating loss carryforward period.  Evidence that cannot be objectively verified based on future events are subjective in nature and therefore not weighed as heavily.  Examples of this type of evidence include future taxable income based on projections and tax planning strategies that a company could initiate to avoid the expiration of a tax attribute, such as a net operating loss carryforward.

A history of cumulative losses (generally defined as book loss plus permanent differences for the current and two prior tax periods) is a particularly negative item of objective evidence. A company may be unable to justify not recording a valuation allowance that reduces or eliminates a deferred tax asset. 

Nevertheless, a cumulative loss history is not a bright line test; all evidence must be considered.  For example, if the company can demonstrate that it has taxable income in a prior period that can absorb net operating loss when carried back, a history of cumulative losses would not cause the company to record a valuation allowance.  Similarly if the company can make a compelling argument that it could employ a tax planning strategy that would be both prudent and feasible and would effectively create future income that would absorb a net operating loss carryforward, this also could outweigh the negative evidence of a cumulative loss history.

For question regarding ASC-740 provision matters, please contact Daniel DeLau at 720-227-0065 or delau@taxops.com or John Monahan at 720-227-0064 or jmonahan@taxops.com.