Over-the-Counter Medication and Medical Reimbursement Plans

For many years, taxpayers have not been able to deduct as a medical expense on their tax return the cost of unprescribed over-the-counter medications. However, taxpayers with Flexible Spending Arrangements (FSA), Health Reimbursement Arrangements (HRA), Health Savings Accounts (HSA) and Archer Medical Savings Accounts (Archer MSA) could reimburse themselves for the cost of over-the-counter drugs, and, as a result, pay for the medication with tax-deductible dollars.

As part of the new Health Care legislation, that benefit will go away in 2011 and the cost of over-the-counter drugs, except for insulin, will no longer be reimbursable unless they are prescribed by a physician. This essentially puts those with the tax-favored FSA, HRA, HSA and MSA plans on an equal status with other taxpayers with respect to over-the-counter medication after 2010.

Taxpayers with these plans should, where appropriate, stock up on essential over-the counter medication before the end of 2010.

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Is Your Business Ready for 2011 Credit Card Income Reporting?

Beginning for sales made in 2011, payment settlement entities (e.g., merchant card processing companies like American Express, Visa and MasterCard merchant banks) will be required to report each business's payment transactions to the IRS.

To facilitate this reporting, the IRS has developed Form 1099-K which will report a merchant's credit and debit card income for the year and will be issued to the merchant in the early part of the subsequent year just like 1099s for interest, dividends, pensions, etc., are. Unlike other 1099 forms, the 1099-K will actually break the income down by the month. The first 1099-Ks will be issued in early 2012.

Individuals and merchants with Internet sales (e.g., eBay and their online sales) that utilize an internet payment system such as PayPal can expect to see those sales included in this new reporting requirement if their annual third-party transactions total more than $20,000 and the number of transactions is over 200.

This new reporting requirement provides the IRS with a far-reaching compliance tool. It will allow them to determine a business's gross income from credit/debit card sales and make it easier to segregate those payment card sales from cash sales.

The IRS will then be in a position to see if the credit card dollar figure reported on the merchant's tax return matches the bank's information return. This also allows them to see if a business's other sales from cash and check payments makes sense in the context of the firm's overall business.

We can probably expect the IRS to develop statistics for various types of businesses related to the ratio of cash payments to credit payments, as a means of imputing cash payments for merchants that do not report a reasonable amount of income over and above that reported by the payment processors.

How Does This Affect You?

1. You can expect your bank or other payment settlement services to be verifying your tax ID number and contact information in the next few months leading up 2011. Be sure that the information you provide them is correct and matches the information on file with the IRS.
   
2. If you fail to provide the settlement entity with the information requested or the information does not match the information on file with the IRS, the settlement entity is authorized to withhold 28% of the payment as withholding. You will receive credit for the withholding when your tax return is filed, but, if the withholding is in excess of what you owe, you will have to wait until you file your return to get the excess back.
   
3. Make sure that your business has an appropriate accounting system in place to properly record card payments so that they can be reconciled with the 1099-K.
   

Payment Cards - A payment card, as defined by the IRS regulations, includes, but is not limited to, credit cards, debit cards, and stored-value cards (e.g., gift cards or similar cards with a prepaid value). A payment card also includes the acceptance as payment of any account number or other indicia associated with a payment card. The use of a payment card to obtain a loan or cash advance does not constitute a payment card transaction. The same holds true for the withdrawal of cash from an automated teller machine—it is not considered a payment card transaction.

If you have questions related to how the new reporting requirement for credit and debit card sales will impact your business, or what steps you should take to prepare for this new requirement, please give our office a call.

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Will You Be Hit by the AMT in 2010?

AMT is the acronym for Alternative Minimum Tax. It is a different (alternative), and generally punitive, method of computing income tax when either certain types of income receive preferential tax treatment or there are excessive deductions in certain categories. Congress originally implemented it to impose a minimum tax on higher-income taxpayers who were avoiding taxes though tax shelters and other legal means. However, years of inflation without corresponding adjustment to the AMT components have, each successive year, caused an increasing number of taxpayers to be subject to the AMT.

Much as the regular income tax allows personal exemptions, the AMT calculation allows an exemption but based upon filing status. For the past several years, the IRS has on a year-to-year basis increased that exemption for inflation. However, should they fail to provide an increase for 2010, the exemption amounts would revert to the 2001-2002 levels, which would result in an approximate 30% decrease in the exemption amount. This would snare a significant number of taxpayers (estimated around 28 million) for the first time in 2010. For example, the exemption amount for joint filers was $49,000 in 2002 and was $70,950 in 2009.

Other factors that can create an AMT for the average taxpayer include the following:

Medical Deductions – Medical deductions are allowed for the AMT computation, but only to the extent that they exceed 10% of a taxpayer's income. In contrast, the regular tax computation limit is a lesser 7.5%. When a taxpayer knows that they are going to be affected by the AMT, it sometimes is possible to defer or accelerate medical expenses from one year to another, such as paying the orthodontist in installments or all at once.
If your employer offers one, consider participating in a flexible spending plan. It allows you to pay medical expenses with pre-tax dollars and avoid both the regular tax and AMT deduction limitations.

Tax Deductions – When itemizing deductions, a taxpayer is allowed to deduct a variety of taxes, including real property, personal property and state income tax. But for AMT purposes, none of the itemized taxes are deductible. For most taxpayers, this represents one of their largest tax deductions and frequently triggers the AMT. If you are affected by the AMT, conventional wisdom would dictate deferring tax payments to a subsequent year when the AMT may not apply. When deferring, care should be exercised in regards to late payment penalties and interest on underpayments for certain taxes. In addition, taxpayers can annually elect to capitalize taxes on unimproved and unproductive real estate. This means foregoing the deduction currently and adding the tax paid to the cost basis of the real property.

Home Mortgage Interest – For both the regular tax and AMT computations, interest paid on a debt to acquire or substantially improve a home or second home is deductible as long as the debt limit (generally $1.1 million) is not exceeded. This is true of refinanced debt, except that any increase in debt is treated as equity debt. For regular tax purposes, the interest on up to $100,000 of equity debt on the two homes can also be deducted. However, equity debt is not deductible against the AMT; neither is the acquisition or equity debt interest on a motor home or boat that qualifies as a second home. Therefore, taxpayers should exercise caution when incurring home equity debt. Generally, loan brokers are not aware of these limitations, and there are numerous pitfalls.

Miscellaneous Itemized Deductions – The category of miscellaneous deductions that includes employee business expenses and investment expenses is not deductible for AMT purposes. For certain taxpayers with deductible employee business expenses, this can create a significant AMT. Employees with significant employee business expenses should attempt to negotiate an "accountable" reimbursement plan with their employer. Under this type of plan, the reimbursement for qualified expenses is tax-free. Because the employee has been reimbursed, he or she no longer claims a deduction for the expenses, thus eliminating the miscellaneous deduction. Another strategy would be to defer the expenses to a year not affected by the AMT.

Personal Exemptions – Personal exemptions for dependents provide no benefit when taxed by the AMT method. Therefore, divorced or separated parents should carefully consider which party should claim the exemption for a dependent child.

Standard Deduction – For AMT purposes, there is not a standard deduction as there is with the regular tax computation. Thus, taxpayers affected by the AMT should always itemize. Granted that the benefit of some deductions will be lost, there is still a partial advantage. Even the smallest of charitable deductions will benefit at a minimum of 26% (the lowest bracket for the AMT).

The AMT is an extremely complicated area of tax law that requires careful planning to minimize its effects. Please contact our office for further assistance.

Caution: Although not frequently encountered, incentive stock options (ISO) can have a profound impact on the AMT, and clients are strongly encouraged to seek advice prior to exercising incentive stock options.

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Time is Running Out for the Home Energy Property Credit

Planning to make an "energy-saving" improvement to your home? 2010 is the final year to take advantage of the tax credit available so you will need to act quickly as there are only three months left. Whether you simply want to cut your utility bills or winterize your home, do it soon!

The name "Home Energy Property Credit" given by Congress is not as descriptive as it could have been and is easily confused with other credits. This credit is for energy-saving improvements to a taxpayer's principal residence. The credit is limited to $1,500 (30% of up to $5,000 of qualified expenditures) for improvements made in 2009 and 2010. So, if you claimed this credit in 2009, the maximum that can be claimed in 2010 is the $1,500 maximum less any amount claimed in 2009.

Qualified improvements, the use of which must originate with the taxpayer, must have a reasonable expected life of at least five years, and include:

• Energy-efficient Exterior Windows and Skylights,
  
• Energy-efficient Exterior Doors,
  
• Energy-efficient Metal Roofs with appropriate pigmented coatings,
  
• Energy-efficient Asphalt Roofing with appropriate cooling granules,
  
• Energy-efficient Heating Systems,
  
• Energy-efficient Air Conditioning Systems and
  
• Insulation Materials or Systems designed to reduce heat loss or gain.
  

Credit is not allowed for on-site preparation, assembly or the installation of the component. It is a non-refundable personal credit; thus, the credit can only be used to bring your tax (including the alternative minimum tax) down to zero. Any excess is not refundable and cannot be carried over to a subsequent year.

Each manufacturer must comply with the government's established standards for the product to be qualified as "energy-efficient." And each manufacturer who meets those standards will provide a written certification that the product meets the definition of qualified property under IRC Sec 25C. Taxpayers cannot simply rely on an Energy Star label in claiming the Sec 25C credit for exterior windows and skylights.

Reliance on the certification is allowed only if installation of the component is consistent with the certification (for example, the item must be installed in the appropriate climate zone identified in the certificate statement).

Caution - At the time this article was prepared, it was uncertain if this credit will offset the alternative minimum tax (AMT). The law allowing it to offset the AMT in prior years expired for years after 2009 and will require Congressional action to extend.

Don't confuse this credit with the "Residential Energy-Efficient Property Credit" which also provides a 30% tax credit for energy-generation installations (such as solar, fuel cells, geothermal and wind energy). That credit offsets the AMT, is available through 2016, and has no annual maximum credit.

If you have questions related to this credit, please give our office a call.

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New Penalties for Failure to File or Furnish Information Returns

Tax law requires businesses to provide information returns, such a 1099s, to each payee that the business has paid $600 or more for the year. The law also includes penalties for failure to file the same information returns with the IRS.

To ensure compliance with these requirements, there are substantial penalties, and, as part of the recently passed Small Business Jobs Act of 2010, those penalties have been doubled. The penalties are generally based upon how late the returns are filed with the IRS or provided to the recipient of the income and are broken down into three tiers:

Tier 1 – Where the returns are filed or provided late but within 30 days of the prescribed due date.

Tier 2 – Where the returns are filed or provided more than 30 days after the prescribed due date and before August 1 of the calendar year in which the filing was required.

Tier 3 – Where the returns are filed or provided after August 1 of the calendar year in which the filing was required.

In addition, the maximum penalties for the year are based on business size determined by the business's gross receipts. Businesses with gross receipts of $5 million or less are subject to the small business penalty maximums.

The following table shows the penalties for information returns required to be filed in 2010 and those imposed for returns required to be filed after 2010.

	Small Businesses		General
	Filings in 2010	Filings after 2010	Filings in 2010	Filings after 2010
Tier 1	$15 (Max $25,000)	$30 (Max $75,000)	$15 (Max $75,000)	$30 (Max $250,000)
Tier 2	$30 (Max $50,000)	$60 (Max $200,000)	$30 (Max $150,000)	$60 (Max $500,000)
Tier 3	$50 (Max $100,000)	$100 (Max $500,000)	$50 (Max $250,000)	$100 (Max $1,500,000)

In addition, the minimum penalty for each intentional failure-to-file act increases from $100 to $250.

Rental Owners Included in the Reporting Requirement Effective in 2011 – Effective for 2011 filings due in 2012, the 2010 Small Business Act provides that solely for purposes of filing information returns, a person receiving rental income from real estate will be considered to be engaged in a trade or business of renting property. Thus, recipients of rental income from real estate generally are subject to the same information reporting requirements as taxpayers engaged in a trade or business. In particular, rental income recipients making payments of $600 or more to a service provider (such as a plumber, painter, or accountant) in the course of earning rental income are required to provide an information return (typically Form 1099-MISC) to IRS and to the service provider. The new law does provide the IRS with the ability to permit exceptions to the filing requirement for hardship cases and when minimal rental income is received, but neither "hardship" nor "minimal" are yet defined.

In order to comply with these requirements and avoid these substantial penalties requires collecting the payee's name, SSN number and contact information before making payment. If you need assistance setting up a procedure for collecting the required information or filing your information returns for the year, please give our office a call.

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New Breaks for Small Businesses

The 2010 Small Business Jobs Act enacted September 27, 2010 includes an assortment of incentives and tax breaks for small businesses. The following is a brief overview of some of the key provisions included in the new law. Watch for additional details in future newsletters.

• Cell Phones No Longer Listed Property - This means that cell phones can be deducted or depreciated like other business property, without the complicated recordkeeping required for listed property. This is effective for tax years beginning after Dec 31, 2009.
  
• Business Owners' Health Insurance Deduction Reduces Self-Employment Tax - The new law allows business owners to deduct the cost of health insurance incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.
  
• Boosted Deduction for Start-up Expenditures – For 2010, businesses can deduct up to $10,000 (was previously $5,000) in trade or business start-up expenditures. However, the $10,000 limit is reduced by the amount by which start-up expenditures exceed $60,000 (was previously $50,000).
  
• Increased Small Business Section 179 Expensing –Small business taxpayers can elect to write off the cost of certain capital expenses in the year of acquisition in lieu of recovering these costs over a period of years through depreciation.
  
  For tax years beginning in 2010 and 2011, the new law allows a taxpayer to expense up to $500,000 (up from $250,000 under prior law) of qualifying property which includes machinery, equipment and certain software placed in service during the year. For 2010 and 2011, the annual expensing limit is reduced by the cost of qualifying property that is placed into service during the year exceeding the $2 million (was $800,000) investment limit.
  
• Certain Real Property Can Be Expensed – The new law also makes certain real property eligible for Sec 179 expensing. For property placed in service in any tax year beginning in 2010 or 2011, the up-to-$500,000 deduction of property expensed can include up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).
  
• 50% Bonus First-Year Depreciation Extended - Businesses normally can only deduct the cost of capital expenditures over time through depreciation—most commonly at the rate of about 14% or 20% of the cost of machinery or equipment for the first year. For 2008 and 2009, businesses were permitted to write off 50% of the cost of new machinery and equipment placed in service during those years. In the new law, Congress extends the first-year 50% write-off to qualifying property placed in service in 2010 (2011 for certain property).
  
• General Business Credits for 2010 Can Be Carried Back 5 Years – Under the new law, for the first tax year beginning in 2010 (2010 for calendar year taxpayers), eligible small businesses (ESB) (generally one with $50 million or less in average annual gross receipts for the prior three years) can carry back unused general business credits for five years. ESBs include sole proprietorships, partnerships and non-publicly traded corporations.
  
• General Business Credits of Eligible Small Businesses in 2010 Aren't Subject to AMT - Under the Alternative Minimum Tax (AMT) rules, taxpayers can generally only claim allowable general business credits against their regular tax liability, and only to the extent that their regular tax liability exceeds their AMT liability. A few credits, such as the credit for small business employee health insurance expenses, can be used to offset AMT liability. The new law allows eligible small businesses, as defined above, to use all types of general business credits to offset their AMT in tax years beginning in 2010.
  
• Other Provisions With Limited Application – Calculations of the built-in gains tax on S-Corporations converted to C-Corporations, special rules for long term contract accounting and limitation on the penalty for failure to disclose certain reportable transactions (including listed transactions) on a return.
  

If you have questions related to any of these new tax benefits or wish to schedule a tax planning appointment to see how your business might benefit, please give our office a call.

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