Recently Enacted Tax Breaks for Small Businesses

As part of the Health Care Legislation passed earlier this year, the credit for expenses of adopting a child was increased and made refundable.  Prior to this change, the credit was non-refundable and could only be used to reduce the adoptive parent’s tax to zero, with any unused portion of the credit carried over for up to five years and used against future years’ tax.

What this means is that taxpayers with unused adoption credit carryovers will be able to get the full benefit of those carryovers in 2010, and depending on the amounts of their tax and carryovers, reducing their tax to zero and a refund of any excess credit.  Those who qualify for the credit in 2010 and 2011 also benefit from the new refundable provision, and any excess credit not used to reduce their tax for the year will be refundable.

The maximum amount of the credit was scheduled to drop to pre-2002 levels after 2010, but the reversion to the old law has been postponed until 2012, giving those who wish to adopt one additional year to take advantage of this substantial benefit at the higher amount.

For 2010, adoptive parents may be able to claim a credit against their federal tax for up to $13,170 of “qualified adoption expenses” for each adopted child.  That's a dollar-for-dollar reduction of tax, the equivalent, for someone in the 25% marginal tax bracket, of a deduction of over $52,000.  Where an adoptive parent’s employer has an adoption assistance program, the adoptive parent may exclude from their gross income up to $13,170 of qualified adoption expenses paid by an employer.  Adoptive parents may claim both a credit and exclusion for expenses of adopting a child, but not the credit and exclusion for the same expense.

Qualified adoption expenses - Qualified adoption expenses include reasonable and necessary adoption fees, court costs, attorney fees, traveling expenses (including amounts spent for meals and lodging) while away from home, and other expenses directly related to the legal adoption of an “eligible child.”

Qualified adoption expenses don't include expenses connected with the adoption of a child of a taxpayer's spouse, expenses of carrying out a surrogate parenting arrangement, expenses that violate state or federal law, or expenses paid using funds received from a federal, state, or local program.

Expenses in connection with an unsuccessful attempt to adopt an eligible child before successfully finalizing the adoption of another child can qualify.  Expenses connected with a foreign adoption (i.e., one in which the child isn't a U.S. citizen or resident) qualify only if the child is actually adopted.

Eligible child – Generally, an eligible child is under the age of 18 at the time the qualified adoption expense is paid.  A child who turned 18 during the year is an eligible child for the part of the year he or she is under age 18.  A person who is physically or mentally incapable of caring for himself is also eligible, regardless of age.

Credit phased out for higher-income taxpayers - The credit for 2010 is ratably phased out for taxpayers with adjusted gross incomes (AGI) over $182,520 and is completely phased out at $222,520.

If you are contemplating or in the process of an adoption and have additional questions or would like to determine how this credit will apply to your specific situation, please give this office a call.  You may also be able to reduce your current withholding and/or estimated taxes based upon your credit carryover or 2010 credit.  

On March 23, 2010, President Obama signed into law the new health care legislation.  The legislation will affect virtually every individual in one way or another and will significantly impact tax returns in the future.  The following overview of the tax-related provisions of the legislation is based upon the House of Representatives’ version and the one signed by President Obama on March 24, 2010.  The provisions take effect over a number of years (2018).

Excludable Medical Reimbursements for Older Children

Effective on Mar. 30, 2010, the general exclusion for reimbursements for medical care expenses under an employer-provided accident or health plans is extended to any child of an employee who hasn't attained age 27 as of the end of the tax year.

Big Break for Self-Employed Health Insurance Deduction

Generally, a self-employed individual (or a partner or a more-than-2%-shareholder of an S corporation) can deduct as an above-the-line expense 100% of the amount paid during the tax year for medical insurance on behalf of himself, his spouse and his dependents subject to certain requirements, commonly referred to as the self-employed health insurance deduction.  Effective on March 30, 2010, this above-the-line deduction can include medical insurance on behalf of the self-employed individual’s child under the age of 27 as of the end of the year.

Tax Credits for Small Employers Offering Health Coverage

For tax years 2010 through 2013, qualified small employers, generally those with no more than 25 full-time employees with an average annual full-time equivalent wage of no more than $50,000, will be eligible for a tax credit of up to 35% of the cost of non-elective contributions to purchase health insurance for its employees.  The maximum credit is available to employers with no more than 10 full-time equivalent employees with an annual full-time equivalent wage from the employer of less than $25,000.

2014 and Later - In 2014 and later, eligible small employers who purchase coverage through the Insurance Exchange would be eligible for a tax credit for two years of up to 50% of their contribution.

Adoption Credit Limit Raised, Made Refundable and Extended

One of the non-health care related items included in the new law is an increase in the dollar limitation for the adoption credit to $13,170 (adjusted for inflation after 2010) and an extension of the credit through 2011. The credit also is changed from being nonrefundable to a refundable credit.

Tanning Services Excise Tax

For indoor tanning services performed on or after July 1, 2010, a new 10% excise tax is imposed on the amount paid for any indoor tanning service, whether paid for by insurance or otherwise. The tax is imposed on tanning service recipients, although the service provider is liable for the collection and payment of the tax; thus, service providers are liable if they fail to collect the tax.

Over-the-Counter Medication Restriction for Employer-Provided Plans

Beginning in 2011, over-the-counter medications, except for doctor prescribed over-the-counter medication and insulin will no longer qualify for reimbursement.  This restriction applies to health reimbursement accounts (HRAs), health flexible savings accounts (FSAs), health savings accounts (HSAs), and Archer medical savings accounts (MSAs).

Small Employer Simple Cafeteria Plans

For years beginning after Dec. 31, 2010, small employers (average of 100 or fewer employees on business days during either of the two preceding years) may provide employees with a “simple cafeteria plan.”  Under such a plan, the employer is provided with a safe harbor from the nondiscrimination requirements for cafeteria plans as well as from the nondiscrimination requirements for specified qualified benefits offered under a cafeteria plan–

• including group term life insurance,
• benefits under a self-insured medical expense reimbursement plan, and
• benefits under a dependent care assistance program.

Increased Tax on Nonqualifying HSA or Archer MSA Distributions

Beginning in 2011, the additional tax for HSA withdrawals for other than qualified medical expenses before age 65 are increased from 10% to 20%, and the additional tax for Archer MSA withdrawals for other than qualified medical expenses is increased from 15% to 20%. Distributions after age 65 are not subject to the penalty.

Expansion of Information Return Reporting

Currently a business paying more than $600 per year to a noncorporate service provider who isn’t an employee is required to file an information return (Form 1099-MISC). The new law expands the return filing requirement to include both corporate and noncorporate providers of property and services, beginning with tax years beginning in 2011.

Employer Flexible Health Spending Plan Contributions Limited

Beginning in 2013, the maximum that can be contributed to an employer’s health flexible spending accounts (FSAs) would be limited to $2,500 per year.  The amount will be indexed for inflation after 2013.

Medical Itemized Deductions Limited – Beginning in 2013, the itemized deduction for medical expenses will be limited in the following manner:

• AGI Threshold - The AGI threshold for claiming medical expenses on a taxpayer’s Schedule A is increased from 7.5% to 10%, which is the same as the current alternative minimum tax (AMT) rate.  Individuals (and their spouses) age 65 and older will continue to use the 7.5% rate through 2016.
  
  
• Deduction for Employer Part D would be Eliminated - The deduction for the subsidy for employers who maintain prescription drug plans for their Medicare Part D eligible retirees is eliminated.

Taxpayers Earning Over $200,000

Beginning in 2013, higher-income taxpayers will be subject to the following additional taxes:

• Additional Hospital Insurance Tax - The Hospital Insurance (HI) tax rate (currently at 1.45%) would be increased by 0.9 percentage points on an individual taxpayer earning over $200,000 ($250,000 for married couples filing jointly).
  
  
• Surtax on Unearned Income – A 3.8% surtax, called the Unearned Income Medicare Contribution, would be placed on the net investment income of a taxpayer earning over $200,000 ($250,000 for a joint return).  Net investment income includes interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business).  “Net” investment income is investment income reduced by allowable investment expenses. Distributions from qualified retirement plans and IRAs will not be subject to the surtax.

Penalty For Not Being Insured

Beginning in 2014, taxpayers will be penalized for failing to maintain the minimum essential coverage.  The penalty will be phased in beginning in 2014 and the fully-implemented penalty in 2016 will be the greater of:

• 2.5% of household income over the threshold amount of income required for income tax filing, or
  
  
• $695 (indexed for inflation after 2016) per uninsured adult in the household ($348 if under age 18).

Maximum Penalty – The total household penalty cannot exceed 300% of the per-adult penalty ($2,085) or national annual premium for the “bronze level” health plan offered through the Insurance Exchange that year for the household size.  Penalties are based upon the months that the required insurance is not in force.

Penalty Phase-In – The maximum penalty will not be imposed until 2016.  The phase-in rates are:   
                                             
                                                             2014           2015
Per-adult annual penalty                  $95            $325
% of income penalty                           1%               2%
Family maximum                              $285           $975 

Taxpayers Exempt from the Penalty – Individuals are exempt from the penalty if either their employer’s sponsored coverage or the lowest cost “bronze” coverage exceeds 8% of household income.  Also exempt are individuals residing outside of the U.S., those exempted for religious purposes, and those whose income is below the threshold for having to file a return.

Low-Income Health Exchange Participation Credits

Beginning in 2014, tax credits will be available for low-income individuals and families with incomes up to 400% of the federal poverty level that are not available for Medicaid, employer-sponsored insurance, or other acceptable coverage.  To qualify for the credits, these individuals and families would have to obtain coverage in the newly-established insurance exchange.  Based upon the current poverty levels, the credit would phase-out at $42,420 for individuals and $88,200 for a family of four.  Additionally, a cost-sharing subsidy will be provided for low-income individuals to help pay for their coverage.

Large Employer Responsibilities

Beginning in 2014, large employers, generally those with 50 or more full-time employees in the prior calendar year, that:

• Do not offer coverage for all its full-time employees,
  
  
• Offer minimum essential coverage that is unaffordable, or
  
  
• Offer minimum essential coverage where the plan's share of the total allowed cost of benefits is less than 60%,

Would be required to pay a penalty if any of its full-time employees were certified to the employer as having purchased health insurance through a state exchange and qualified for either tax credits or a cost-sharing subsidy discussed previously.

Penalty – The excise tax penalty for any month would be $167 times the number of full-time employees in excess of 30.

Free Choice Vouchers

Beginning in 2014, employers who offer minimum essential coverage through an eligible employer-sponsored plan and pay a portion of that coverage will be required to offer an equivalent value voucher, allowing a qualified employee the option of purchasing coverage through the Insurance Exchange.  An employee qualified to make this choice is an individual with a required contribution to the employer plan that exceeds 8%, but does not exceed 9.5% of the household income and has income that does not exceed 400% of the poverty line for the family.

Excise Tax on High-Cost Employer-Sponsored Health Coverage

Beginning in tax year 2018, there will be a 40% non-deductible excise tax on insurance companies and plan administrators for any health coverage plan where the premiums exceed the following amounts:

Single Coverage:                                                                                             $10,200
Single Coverage, high-risk employment or retired age 55 and older:  $11,850
Family Coverage:                                                                                             $27,500
Family Coverage, high-risk employment or retired age 55 and older:  $30,950

The tax would apply to self-insured plans and plans sold in the group market, but not to plans sold in the individual market (except for coverage eligible for the deduction for self-employed individuals).  Stand-alone dental and vision plans would be disregarded in applying the tax.  The dollar amount thresholds may be later adjusted for inflation.

As a result of changes made by the recently enacted Affordable Care Act, health coverage provided for an employee's children under 27 years of age is now generally tax-free to the employee, effective March 30, 2010.  Generally, under pre-Act law, to be a qualifying child of a taxpayer for this purpose the child must have been the taxpayer’s dependent under age 19 (or under age 24 in the case of a full-time student).

Child – Broad Definition for this Purpose Other than age, the “child” definition has no other restriction.  Thus, there is no income or marital restrictions.

These changes immediately allow employers with cafeteria plans – plans that allow employees to choose from a menu of tax-free benefit options and cash or taxable benefits – to permit employees to begin making pre-tax contributions to pay for this expanded benefit.

Employees who have children who will not have reached age 27 by the end of the year are eligible for the new tax benefit from March 30, 2010, forward, if the children are already covered under the employer’s plan or are added to the employer’s plan at any time. For this purpose, a child includes a son, daughter, stepchild, adopted child or eligible foster child.

Employees may immediately make pre-tax salary reduction contributions to provide coverage for children under age 27, even if the cafeteria plan has not yet been amended to cover these individuals. Plan sponsors then have until the end of 2010 to amend their cafeteria plan language to incorporate this change.

In addition to changing the tax rules as described above, the Affordable Care Act also requires plans that provide dependent coverage of children to continue to make the coverage available for an adult child until the child turns age 26. The extended coverage must be provided not later than plan years beginning on or after Sept. 23, 2010.

Contact your employer for further information regarding the employer’s plan related to this very beneficial change.

For years beginning after Dec. 31, 2010, small employers (average of 100 or fewer employees on business days during either of the two preceding years) may provide employees with a “simple cafeteria plan.” (Code Sec. 125(j)) Under such a plan, the employer is provided with a safe harbor from the nondiscrimination requirements for cafeteria plans as well as from the nondiscrimination requirements for specified qualified benefits offered under a cafeteria plan–

o including group term life insurance,
o benefits under a self-insured medical expense reimbursement plan, and
o benefits under a dependent care assistance program.

Note: Once the Simple Cafeteria plans have been established, the employer is deemed as having met the small employer requirement until such time as the average number of employees exceeds 200 on business days during any year preceding any such subsequent year.

Simple Cafeteria Plan – For purposes of the provision, a simple cafeteria plan is a plan that:

(1) is established and maintained by an eligible employer,

(2) meets prescribed contribution requirements, and

(3) meets prescribed eligibility and participation requirements.

Contribution Requirements – To create a simple cafeteria plan, the employer will have to make contributions to provide qualified benefits under the plan on behalf of each qualified employee (without regard to whether a qualified employee makes any salary reduction contribution) in an amount equal to:

(1) a uniform percentage (not less than 2%) of the employee's compensation for the plan year, or

(2) an amount which is not less than the lesser of
(a) 6% of the employee's compensation for the plan year, or
(b) twice the amount of the salary reduction contributions of each qualified employee.

The requirements of (2) above are not met if, under the plan, the rate of contributions with respect to any salary reduction contribution of a highly compensated or key employee at any rate of contribution is greater than that with respect to an employee who is not a highly compensated or key employee.

Qualified Employee – Does not include highly compensated or key employees.

Highly-Compensated Employee - is any employee who:

(1) was a five percent owner at any time during the year or the preceding year or,

(2) for the preceding year, received compensation from the employer in excess of the inflation adjusted compensation amount of $80,000 ($110,000 for 2010), and, if the employer elects, was in the top-paid group of employees for the preceding year.  The employer can make the election annually, without the consent of IRS. An employee is in the top-paid group of employees for any year if such employee is in the group consisting of the top 20 percent of the employees when ranked on the basis of compensation paid during such year (Code Sec. 414(q)(1)(B)(ii)).

Key Employee - In general, the term “key employee” (Sec 416(i)) means an employee who, at any time during the plan year, is an officer of the employer having an annual compensation greater than $130,000 or a 5-percent owner of the employer, or a 1-percent owner of the employer having an annual compensation from the employer of more than $150,000.

Minimum Eligibility & Participation Requirements - The minimum eligibility and participation requirements will be met with respect to any year if, under the plan,

(a) all employees who have at least 1,000 hours of service for the preceding plan year are eligible to participate, and

(b) each employee eligible to participate in the plan may, subject to terms and conditions applicable to all participants, elect any benefit available under the plan.

However, an employer will be able to elect to exclude under the plan employees:

(1) who have not attained the age of 21 before the close of a plan year (plan may provide for a younger age),

(2) who have less than one year of service with the employer as of any day during the plan year (plan may provide for a shorter period of service),

(3) who are covered under an agreement which the Secretary of Labor finds to be a collective bargaining agreement, if there is evidence that the benefits covered under the cafeteria plan were the subject of good faith bargaining between employee representatives and the employer, or

(4) who are described in Code Sec. 410(b)(3)(C) (relating to nonresident aliens working outside the U.S.)

2010 is the final year for the advanced lean-burn technology motor vehicle tax credit. Advanced lean-burn technology vehicles are passenger cars or light trucks with an internal combustion engine designed to operate primarily using more air than is necessary for complete combustion of the fuel.  The vehicles also must incorporate direct fuel injection technology and achieve at least 125 percent of the 2002 model year city fuel economy rating.

Available credit amounts may vary and include a base credit amount based on fuel economy compared to the 2002 model year city fuel economy rating and an additional amount based on the vehicle’s lifetime fuel savings.  For a taxpayer to claim the credit, the original use of the vehicle must begin with the taxpayer, and the vehicle must be acquired for use or lease by the taxpayer and not for resale.

There is a limitation on the number of qualified hybrid and advanced lean-burn technology vehicles eligible for credit.  The phase-out period begins when a manufacturer sells 60,000 qualified hybrid and advanced lean-burn technology vehicles. Note that Volkswagen America has reached the limit and therefore it’s credit in 2010 is reduced. See note under table below.

Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th hybrid passenger automobile or light truck or advanced lean-burn technology motor vehicle. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit.  For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit.  No credit is allowed after the fifth quarter.

The qualifying vehicles and their credit amounts are:




Volkswagen Group America (includes Audi vehicles) reached the 60,000 vehicle limit in the 1st quarter of 2010.  Thus, the allowable credit is reduced by 50% for vehicles purchased for the balance of 2010.  The lean burn credit expires at the end of 2010, thus no credit available after 2010.

Every year, many of the various tax limitations, deductions, allowances, etc., are inflation adjusted. The following are the more commonly-encountered values that apply to 2010, along with the prior year's amounts. Click here for the table.

Please note - the inflation adjustments for exemptions, standard deductions, pension contributions and AGI phase outs were virtually unchanged from 2009 and many of the amounts remain the same.

These are not the only items that are inflation adjusted. If you have questions regarding other limitations not listed here, please call this office.

Tax Credit for Residential Energy Improvements – Energy property improvements to a principal residence located in the United States and placed in service during before the end of 2010 qualify for the residential energy improvement credit.  2010 is your last chance to “go green” and get Uncle Sam to cover part of the cost in the form of a tax credit.

The credit is 30% of the cost of:

• Qualified advanced main air circulating fan;
• Qualified natural gas, propane, or oil furnace;
• Qualified natural gas, propane, or oil hot water boiler;
• Qualified energy efficient heat pumps;
• Qualified energy efficient water heaters;
• Qualified energy efficient central air conditioners;
• Qualifying insulation;
• Qualified exterior windows including skylights;
• Qualified exterior doors;
• Qualified metal roofs coated with heat-reduction pigments; and
• Qualified asphalt roofing with appropriate cooling granules.

This credit is limited to $1,500 for 2009 and 2010 (combined, not each year).  If you claimed pre-2009 credits under this provision, they are not counted toward the new $1,500 limit.  No credit is allowed for amounts paid or incurred for onsite preparation, assembly or original installation of the component.  The improvement’s original use must commence with the taxpayer, and the improvement must reasonably be expected to remain in use for at least five years. 
 
Residential Energy Efficient Property Credit (REEP Credit) – This credit is available for years 2009 through 2016.  The installation must be on the taxpayer’s main or second home located in the U.S.  A 30% credit with no maximums (except as noted) applies to the following items:

• Qualified solar water heaters 
• Residential solar electric systems    
• Fuel cell equipment – with a maximum credit of $500 for each half-kilowatt of capacity
• Qualified wind energy equipment
• Qualified geothermal energy equipment

Labor costs for onsite installation and for piping and wiring connections are qualifying costs for these credits.  However, the credits do not apply to equipment used to heat swimming pools or hot tubs. 

Definition of “Qualified” – These credits are only allowed for “energy efficient components” and the term “qualified” means the components must meet certain energy efficient standards.  That doesn’t mean you need to have an engineering degree to determine which components qualify.  For each qualified component the manufacturer is required to supply a certification that the components comply with the energy efficient standards.

The IRS has indicated that a taxpayer may rely on a manufacturer’s certification that the component is eligible for the credit, provided that the IRS hasn’t withdrawn the certification.  The taxpayer is not required to attach the certification statement to the return on which the credit is claimed but must retain it with the taxpayer’s records. 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).

Exception for exterior windows and skylights: An exterior window or skylight that bears an “Energy Star” label and is installed in the region identified on the label may be treated as an eligible component even without a manufacturer’s certification statement.

Credit Limitations – Although these credits can be used to offset both the regular tax and AMT, they are nonrefundable personal credits that can only reduce a taxpayer’s tax to zero, and any remaining balance is not refundable.  If the amount of the credit for the residential energy efficient property credit (REEP - i.e., the credit for residential solar and fuel cell equipment and wind/geothermal energy equipment) exceeds the taxpayer’s tax after subtracting other nonrefundable personal credits, the excess can be carried to the next tax year and is added to that year’s allowable credit.

Caution - You are strongly urged to contact this office before entering into any contractual arrangements to install any of these energy items to first verify what your tax benefit might be.

Beginning in 2010, legislation:

(1) Eliminates the $100,000 modified AGI limit on conversions of traditional IRAs to Roth IRAs, and

(2) Permits married taxpayers filing a separate return to convert amounts in a traditional IRA into a Roth IRA. Under prior law, married taxpayers who filed separate returns were restricted from making conversions.

In addition, for conversions made in 2010, the taxpayer can choose to elect to:

a. Include the income in the 2010 return, or
b. Include one-half of the conversion income in 2011 and one-half in 2012.

Note: 2010 is the last year for the current “low” tax rates unless Congress extends them in future legislation. Thus, using the option to include the income in 2011 and 2012 may not be a good option for taxpayers that may be subject to the increased tax rates after 2010.

• Strategy – Generally, rollovers are thought of as transfers from a qualified plan to an IRA or from one IRA to another IRA. However, beginning in 2002, the law has allowed an IRA to be rolled (or transferred) to other qualified plans including 401(k) plans, 403(a) and 403(b) annuities and 457 governmental retirement plans (assuming the plan will accept the IRA funds). In addition, the law only allows the taxable portion of the IRA to be moved to qualified plans. For taxpayers who have mixed IRAs (including both deductible and nondeductible contributions), this provides a means to segregating the taxable and nontaxable amounts and then later converting the nontaxable portion without paying any conversion tax (except on any interim earnings). Thus, the taxable portion can be rolled into a qualified plan, leaving the nontaxable portion in the IRA where it can be converted to the Roth IRA.

The amount of tax imposed on a Roth conversion will depend on a number of issues including the taxpayer’s marginal tax bracket, intended conversion amount and whether or not the conversion is made in one or multiple years. Also a factor is whether the taxpayer made deductible IRA contributions in earlier years in addition to the nondeductible contributions intended for rollover to the Roth. All of the taxpayer’s regular, SEP and SIMPLE IRAs have to be combined when determining the amount that is taxable upon conversion, so there could be unintended taxable consequences. Minimizing the conversion tax requires careful planning and strict adherence to the conversion rules.

For vehicles bought after February 17, 2009 and before January 1, 2012, the Recovery Act creates a new 10% nonrefundable personal credit for low-speed vehicles, motorcycles, and three-wheeled vehicles that meet the criteria of a qualified plug-in electric drive motor vehicle.  The maximum credit for these vehicles is $2,500.  If the vehicle is also used in business, the business portion of the credit is treated as a general business credit.  Four-wheel vehicles purchased after January 1, 2009 also qualify for this credit based on a law passed in 2008.  There are additional qualifications, so please call for further details.