As tax year 2011 starts heading toward the exit, the annual expectation arises that year-end tax planning can somehow help lower tax liability before it becomes fixed for the year, as well as helping to identify and maximize certain tax opportunities that may end with the New Year.
Some year-end strategies such as decisions over capital purchases may need to start being executed immediately because of delays between placing an order and its being placed in service. Others may need to be identified now simply to be ready for quick action at the eleventh hour, depending upon how circumstances develop. In either case, the process should begin with an awareness of many of the variables involved. Important to year-end tax planning is an identification of what tax opportunities may be sunsetting at the end of this year, which may be worth waiting for starting in 2012 or later, and in general what developments coming out of the Internal Revenue Service or the courts since last year bear upon the practitioner's standard toolkit of year-end techniques. This article attempts to provide such as an overview.
Although many taxpayers have become conditioned to expect a group of provisions known collectively as "the extenders" to regularly and routinely be given new life by Congress either immediately before (or sometimes immediately after) they are set to expire, the extension of provisions expiring at the end of 2011 may be a more difficult sell to a Congress concerned over deficit spending. Some, such as extension of an Alternative Minimum Tax exemption amount or equivalent and the additional R&D credit, appear likely to be extended. Others, such as the more generous small-business stock exclusion or Section 179 expensing, seem less likely to be given automatic renewal. Those that may be extended likely will be done late in 2011 or even retroactively in early 2012.
According to the staff of the Joint Committee on Taxation in JCX-2-11, there are over 50 provisions that will expire at the end of 2011. Among those provisions for businesses, 100 percent bonus depreciation and enhanced Section 179 expensing are two of the most valuable, and therefore our article gives them extra attention before tackling the other time-sensitive deadlines.
100 PERCENT BONUS DEPRECIATION
The bonus rate for qualifying assets acquired after Sept. 8, 2010, and placed in service before 2012, was increased by the 2010 Tax Relief Act from 50 percent to 100 percent. For assets placed in service in 2012, the bonus rate is scheduled to drop to 50 percent. No bonus depreciation is scheduled after 2012.
Bonus depreciation may only be claimed on qualifying property that satisfies "acquisition date" and "placed-in-service date" requirements. An asset is placed in service on the date that it is in a condition or state of readiness for a specifically assigned function in a trade or business on a regular, ongoing basis. The placed-in-service deadlines for the 50 percent and 100 percent rates are extended one year for property with a "longer production period."
Especially relevant to year-end planning, the rules for determining the acquisition date of an asset are different for the 50 percent and the 100 percent rate. For purposes of the 50 percent rate, an asset is considered acquired on the date that the taxpayer takes physical possession or control of the property (or under a written contract before Jan. 1, 2013). In contrast, 100 percent rate property is considered acquired when its cost is paid for by a cash-basis taxpayer or incurred by an accrual-basis taxpayer. An accrual-basis taxpayer generally incurs the cost of property when the property is "provided," which is usually when it is delivered. A taxpayer, however, is also permitted to treat property as "provided" when title to the property passes. In making the choice, the taxpayer should remember that the elected treatment constitutes a method of accounting that must be used consistently in the future and cannot be changed without IRS consent.
For tax years beginning in 2010 or 2011, the aggregate expensing limitation under Code Section 179 is set at an all-time-high $500,000. For 2012, the cap is lowered to $125,000 (adjusted for inflation), with a reduction to $25,000 (adjusted for inflation) scheduled for tax years beginning after 2012. The phase-out trigger amount of aggregate qualifying property placed in service in 2010 or 2011 is also at an all-time-high $2 million. This phase-out amount drops to $500,000 for tax years beginning in 2012 and $200,000 after 2012.
Whether purchased and placed into service in January 2011 or December 2011, the same full amount of expensing is allowed. Year-end purchasing strategies should also take advantage of maximizing the caps for 2011 and 2012, and look to expense assets that otherwise would have the longest recovery period.
Expensing certain Section 1250 property: For tax years beginning in 2010 and 2011, up to $250,000 of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property are also able to be expensed, subject to the overall Section 179 limitations. This is an exception to the rule that generally only tangible property subject to MACRS that is Section 1245 property may be expensed under Section 179. Unlike other Section 179 property, however, the amount of a carryforward of a Section 179 deduction that is attributable to qualified real property may not be carried forward to a tax year that begins after 2011.
OTHER BUSINESS PROVISIONS
In addition to bonus depreciation and enhanced expensing, the following additional tax benefits will expire at the end of 2011 if not extended by Congress:
The 20 percent credit for excess qualified research expenses under Code Sec. 41(h)(1)B);
The 100 percent exclusion under Code Sec. 1202 of gain for small-business stock acquired before 2012;
The Work Opportunity Tax Credit available to employers under Code Sec. 51;
The reduction in the S corporation recognition period for built-in gain under Code Sec. 1374(d)(7);
Contributions of conservation real property, food inventory, book inventory or computer equipment to certain charities or schools;
Basis adjustment under Code Sec. 1367(a) to stock of an S corporation making charitable contributions of property; and,
A variety of energy-related incentives.
EXPIRING PROVISIONS FOR INDIVIDUALS
Individuals looking to effectively implement a year-end strategy should be prepared to factor in the loss of a number of tax breaks starting January 2012 and accelerate expenses connected with them into 2011 when possible. Expiration of some tax breaks, such as the AMT exemption amount, would require additional planning to accelerate AMT preferences into 2011 if Congress fails to act. Here is a list of the more significant benefits set to expire at the end of 2011:
The 2010 Tax Relief Act's reduction of the employee share of the OASDI portion of Social Security taxes from 6.2 percent to 4.2 percent for wages, up to the $106,800 taxable wage base.
The AMT exemption amount for individuals (scheduled to decrease from $74,450 for joint filers/surviving spouses and $48,450 for others to $45,000 and $33,750, respectively, in 2012).
The personal credit offsets against regular tax and AMT under Code Sec. 26(a)(2).
The mortgage insurance premium deduction under Code Sec. 163(h)(3).
The state and local sales tax itemized deduction (in lieu of the state and local income tax itemized deduction) under Code Sec. 164(b)(5).
Monthly commuting fringe benefits for mass transit at the same $230 level as parking under Code Sec. 132(f).
The non-business energy credit under Code Sec. 25C for qualified energy efficiency improvements and residential energy property expenditures.
The adoption credit's non-refundable aspect and $1,000 additional amount under Code Sec. 36C and 137.
IRA distributions to charity of up to $100,000 without income consequences.
NEW RULINGS AND CASES
A handful of developments coming out of the IRS and the courts over the past year are relevant to particular year-end tax strategies. While no one of these developments could be viewed as a complete surprise, they are worth noting because of their direct application to the year's end.
Broker stock-basis reporting. The Emergency Economic Stabilization Act of 2008 enacted Code Sec. 6045(g), requiring brokers to report the adjusted basis and type of gain from sales of a covered security, including stock, debt and other financial instruments, is generally applicable to stock acquired on or after Jan. 1, 2011 (Jan. 1, 2012, for mutual funds and dividend reinvestment plans). The IRS continued to issue rules during 2011 that fine-tuned this reporting requirement. For taxpayers, this is a double-edged sword that can be disadvantageous to year-end selling strategies if the investor and the broker are not "on the same page" as to the amount of basis being factored in to a year-end sale. For purposes of computing gain or loss before executing year-end trade tax strategies, an investor should confirm the amount of basis that a broker will be reporting to the IRS for any shares that are sold in 2011.
TD 9542: Start-up and organizational costs. The language within final regulations permits a Code Sec. 195 deduction for start-up costs in the tax year "in which a taxpayer begins an active trade or business," in contrast to its language for Code Secs. 248 and 709 organizational expenses pegged to the tax year "in which a corporation [partnership] begins business." This distinction may cause a Code Sec. 195 deduction to take place in a tax year subsequent to that allowed Code Sec 248 or 709 deductions.
Revenue Procedure 2011-29/LB & I Directive 04-0511-012: Success-based fees. The IRS developed a safe harbor for success-based fees under which a taxpayer can elect to treat up to 70 percent of the fees a
s amounts that do not facilitate the transaction and, therefore, are immediately deductible, as long as the remaining 30 percent of the fees are capitalized.
CCA 201121001: Bond fees. The IRS chief counsel ruled that an accrual-basis limited liability partnership could not deduct the fee it owes for a bond guarantee until it actually pays the fee. Chief counsel stressed that accrual basis taxpayers must satisfy not only the all-events test: Economic performance is also required for deducting a liability. Here, paying the fee was the activity that had to be performed.
Rev. Proc. 2011-34: PAL elections. The IRS released a special procedure for real estate professionals to make a late election to aggregate rental real estate interests for applying the passive-activity loss rules under Code Sec. 469. The ability to make the election itself, however, also underscores how proactive attention to each real estate activity before year's end may help determine whether such an election is advisable. The election is binding for the year in which it is made and for all future years.
Constructive receipt cases. A standard year-end planning technique to defer income is to contractually restrict the receipt of the proceeds from a sale taking place at year's end. Three 2011 cases in which restricted stock was made part of the sale of a partnership indicate that the IRS will insist on real substance to the restrictions. In Gudmundsson (CA-2; Feb. 11, 2011), Fort (CA-11; April 19, 2011) and Hartman (Fed Cl.; May 13, 2011), the courts would not allow restricted shares held in escrow that contained certain nominal forfeiture provisions and other restrictions to successfully defer income.
CCA 201111006: Design costs. The IRS chief counsel ruled that a business must capitalize its design and development costs and allocate them to a long-term contract. The costs become deductible only when the taxpayer has to manufacture and deliver items pursuant to a purchase order. Chief counsel also noted that bidding and other pre-contract costs have to be capitalized, even though bidding is a non-long-term contract activity. Although it involves no manufacturing or construction, chief counsel concluded that bidding costs are clearly subject to capitalization.
Rev. Procs. 2011-17,-18: Holiday gift cards. The IRS issued two sets of guidance for merchants dealing with gift cards. One provided a safe harbor method of accounting for accrual-method merchants who issue gift cards to customers in exchange for returned merchandise. The other allowed taxpayers to defer recognizing in gross income advance payments received from the sale of gift cards that are redeemable for goods or services of the taxpayer or a third party.
WAITING FOR 2012
Although certain provisions are sunsetting at the end of 2011, should year-end planning also involve deferral or acceleration of either income or deductions specific to taking advantage of a tax benefit or incentive that does not begin until 2012? The jury is still out on the answer, if only because Congress has time before year's end to enact stimulus measures, tax cuts or tax increases that would provide effective dates in 2012.
Currently, no significant provision from past legislation carries a Jan. 1, 2012, effective date. However, the expectation that tax increases will take place in 2013 may indicate that a strategy that will later call for income to be accelerated into 2012 should at this time consider the cascading effect that deferring income into 2012 as a 2011 year-end strategy may have in efforts to balance overall tax liability between 2011 and 2012 to maximize use of the current graduated rate structure.
Year-end tax planning has always involved juggling a number of moving parts. Planning for year-end 2011 is no exception, complicated not only by an economy that demands consideration of loss techniques and other "downturn" strategies, but also by expiring provisions, upcoming changes in future years, and the continuing flow of guidance and case law that makes relying on the same generic bag of year-end tricks without customization unreliable.
More in an upcoming column.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
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