2011 YEAR-END TAX ISSUE - · PDF filereclassify independent contract workers as ... of...

2011 YEAR-END TAX ISSUEExperience a clear perspective to help you make accounting, tax and other important decisions with confidence.

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INSIDE YOU’LL FIND

Tax Update for 2011 & 2012

DOL Regulations on Fee Transparency for 401(k)-Type Retirement Plans

Estate & Gift Tax Update & Opportunities

Tax Legislation Outlook

Economic Nexus: Its Origin & Application in Today’s

Tax Environment

Reporting Requirement for Merchant Card & Third-Party

Network Payments

Recent Transfer Pricing Developments

Foreign Investment Reporting Changes for Individual Taxpayers

Developments in International Tax

by Jim Still [email protected]

While Congress has not passed any major

tax legislation so far this year, several tax policy changes will affect taxpayers for 2011 and 2012.

Gift Card Accounting Gift cards have become very popular among retailers and service providers in recent years, and deferring income from gift card sales has drawn the attention of the IRS. Generally, taxpayers may elect to defer revenue from gift cards redeem-able for their own goods or services until the revenue is recognized in their finan-cial statements up until the second year following the year payment is received. The IRS previously took the position that a taxpayer could not defer the recogni-tion of gift card revenue if the card was redeemable for goods and services of a third party or related party. The IRS recently reversed this position effective for tax years ending on or after December 31, 2010. Common arrangements covered by this new guidance include:

• Gift cards of an affiliated group sold by a gift card subsidiary

Tax Update for 2011 & 2012• Franchisor or franchisee’s sale of gift

cards redeemable at other members or franchises

• Retailers’ sale of gift cards redeemable at their own stores or those operated by related or unrelated parties

Issuing gift cards in exchange for returned goods is a common practice for retailers. The IRS issued guidance on a safe harbor accounting method for issuing gift cards as refunds effective for tax years ending on or after December 31, 2010. Under the safe harbor method, taxpayers will be allowed to treat gift cards issued in exchange for goods as a payment of a cash refund and the sale of a gift card both of which equal the amount of the gift card issued. Taxpayers can defer income from the deemed sale of the gift card until it is recognized for financial statement purposes. However, the income must be recognized no later than the second year following the year the gift card refund is issued. Taxpayers can file an automatic accounting method change to adopt the safe harbor accounting method.

Voluntary Classification Settlement Program Determining if a worker is an employee or independent contractor has

long been a point of contention between the IRS and taxpayers. Determining the proper classification of a worker can be difficult. To provide some relief to taxpayers, the IRS has implemented a new Voluntary Worker Classification Settlement Program. The program allows eligible taxpayers to reclassify independent contract workers as employees on a prospective basis for federal employment tax purposes and obtain partial relief for past payroll tax obligations. To be eligible, taxpayers must consistently have treated the workers as nonemployees and filed all required Forms 1099 for the workers for the previous three years. They also must not be currently under audit by the IRS, Department of Labor or state agency audit for a worker classification issue. Taxpayers participating in the program must prospectively treat the class of workers as employees for future tax years and pay 10 percent of the employment tax liability that would have been due for the prior year using a reduced employment tax rate. The employer will not be subject to interest or penalties on the calculated amount. For the first three years under the program, the taxpayer will be subject to a six-year statute of limitation period for payroll taxes. Form 8952, Application for Voluntary Classification Settlement Program, is required to apply for the program and acceptance is subject to IRS approval.

Employer-Provided Cell Phones Under new IRS guidance on the tax treatment of employer-provided cell phones, the business-use portion of a cell phone provided to an employee for substan-tial business reasons is excluded from an employee’s taxable income as a working condition fringe benefit. Also, the substan-tiation requirements an employee would have to meet for the employer to receive a business deduction are deemed satisfied. Additionally, personal use of employer-provided cell phones issued for noncompen-satory business reasons is excluded from an employee’s taxable income as a de minimis

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Tax Update for 2011 & 2012 fringe benefit, eliminating the detailed docu-mentation required to substantiate business and personal use in prior years. Examples of noncompensatory reasons include an employer’s need to contact employees at all times for work-related emergencies or an employer’s requirement that the employee be available to speak with clients while away from the office or outside of normal business hours. The guidance is effective for tax years ending after December 31, 2009.

Repeal of Enhanced Form 1099 Information Reporting The Patient Protection and Affordable Care Act added Form 1099 information reporting requirements for payments made for goods or other property beginning in 2012, as well as making payments made to corporations subject to 1099 informa-tion reporting. The Small Business Jobs Act of 2010 provided that, subject to limited exceptions, a person receiving rental income from real estate would be treated as engaged in the trade or business of renting property for 1099 reporting purposes. Rental income recipients making payments of $600 or more to a service provider would have been required to issue a 1099 reporting such payments. In 2011, the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act repealed the enhanced 1099 reporting provisions. The reversion to prior information-reporting rules should reduce taxpayer burden, especially for small businesses facing added cost of compliance with the previous law. The former rules generally require reporting by payors engaged in a trade or business for payments for services totaling at least $600 in a year. Payments to corporations are exempt from the reporting require-ment, subject to certain exceptions such as payments for attorney’s fees.

Trust Advisory Fees In 2008, the Supreme Court ruled investment advisory fees paid by a trust were subject to the 2 percent itemized deduction floor. In response to the decision, the IRS issued proposed regulations addressing tax treatment of trust advisory fees. Under the

2011 Rates 2012 Rates

Status Rate Bracket Rate Bracket

Single 10% $0 - 8,500 10% $0 - 8,700 15% 8,501 - 34,500 15% 8,701 - 35,350 25% 34,501 - 83,600 25% 35,351 - 85,650 28% 83,601 - 174,400 28% 85,651 - 178,650 33% 174,401 - 379,150 33% 178,651 - 388,350 35% Over 379,150 35% Over 388,350

Head of 10% $0 - 12,150 10% $0 - 12,400Household 15% 12,151 - 46,250 15% 12,401 - 47,350 25% 46,251 - 119,400 25% 47,351 - 122,300 28% 119,401 - 193,350 28% 122,301 - 198,050 33% 193,351 - 379,150 33% 198,051 - 388,350 35% Over 379,150 35% Over 388,350 Married Filing 10% $0 - 17,000 10% $0 - 17,400Jointly & 15% 17,001 - 69,000 15% 17,401 - 70,700Surviving 25% 69,001 - 139,350 25% 70,701 - 142,700Spouse 28% 139,351 - 212,300 28% 142,701 - 217,450 33% 212,301 - 379,150 33% 217,451 - 388,350 35% Over 379,150 35% Over 388,350

Married Filing 10% $0 - 8,500 10% $0 - 8,700Separately 15% 8,501 - 34,500 15% 8,701 - 35,350 25% 34,501 - 69,675 25% 35,351 - 71,350 28% 69,676 - 106,150 28% 71,351 - 108,725 33% 106,151 - 189,575 33% 108,726 - 194,175 35% Over 189,575 35% Over 194,175

Trusts 15% $0 - 2,300 15% $0 - 2,400 25% 2,301 - 5,450 25% 2,401 - 5,600 28% 5,451 - 8,300 28% 5,601 - 8,500 33% 8,301 - 11,350 33% 8,501 - 11,650 35% Over 11,350 35% Over 11,650

Individual Tax Rate & Schedule

proposed regulations, costs incurred by a trust that would have been subject to the 2 percent floor if incurred by an indi-vidual also will be subject to the 2 percent floor. Specifically, the regulations address ownership costs, investment advisory fees and bundled fees. A reasonable allocation method should be used to allocate costs for bundled fees between expenses that are subject to the 2 percent itemized deduc-tion floor and those that are not. However, until the proposed regulations become final, taxpayers may continue to treat the entire amount of bundled fees as not subject to the 2 percent floor.

Federal Unemployment Tax Act (FUTA) Surtax Effective July 1, 2011, the 0.2 percent FUTA surtax expired. As a result, the FUTA tax rate on or after July 1, 2011, before considering state unemployment tax credits is 6 percent. Since FUTA rates have changed, employers need to separately track FUTA taxable wages paid before and after July 1, 2011. The IRS is currently working to revise Form 940, Employer’s Annual Federal Unemployment Tax Return, to accommodate the different rates; the form should be available before the January 31, 2012, due date.

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2011 2012

Child’s Earnings Limit to be Exempt

from Kiddie Tax $1,900 $1,900

Kiddie Tax

Bonus Depreciation Guidance The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 made 100 percent bonus depreciation available for the cost of qualified property placed in service after September 8, 2010, and before January 1, 2012 (January 1, 2013, for certain longer-lived property). Fifty percent bonus depreciation is available for qualified property placed in service after December 31, 2011, and before January 1, 2013 (January 1, 2014, for certain longer-lived property). In 2011, the IRS issued additional guidance on bonus depreciation for self-constructed property, qualified restaurant property and qualified retail improvement property, as well as how to opt out of 100 percent bonus depreciation.

For bonus depreciation purposes, self-constructed property is generally considered acquired when the taxpayer begins constructing, manufacturing or producing the property. Therefore, any self-constructed property in which the construction, manufacture or production begins before September 9, 2010, will not be eligible for 100 percent bonus deprecia-tion. A limited exception is available for components of self-constructed property. Taxpayers can take 100 percent bonus depreciation on qualifying components of a project. The project must otherwise qualify for 50 percent bonus depreciation, and the materials and supplies for the project must be acquired pursuant to a contract entered into after December 31, 2007. For purposes of this rule, a “component” refers to any part used in the manufacture, construction or production of the larger self-constructed property, which may or may not be the same as the asset for depre-ciation purposes or the unit of property for tax purposes. For example, assume a taxpayer entered into a contract to acquire mate-rials to construct a $20 million power plant during 2008. Construction on the plant started in 2008, and as of September 8, 2010, construction was under way on $15 million of plant components. Construction on the remaining $5 million

of components began after September 8, 2010, and the entire plant was placed into service in 2011. The taxpayer is eligible to take 100 percent bonus depreciation on the $5 million of components on which construction began after September 8, 2010. The remaining $15 million of components is eligible for 50 percent bonus deprecia-tion. Taxpayers must file an election on their timely filed return indicating which components are eligible for 100 percent bonus depreciation. Qualified restaurant property and qualified retail improvement property gener-ally does not qualify for bonus depreciation. Under IRS guidance, if a unit of property meets the definition of both qualified leasehold improvement property and either qualified restaurant property or qualified retail improvement property, the property will be eligible for bonus depreciation. IRS guidance also allows a taxpayer to elect 50 percent bonus depreciation instead of 100 percent bonus depreciation for property placed in service after September 8, 2010, for all qualified property included in the same asset class. The IRS is allowing this election since taxpayers may have trouble determining the exact date the property was acquired and placed in service. The election must be filed with the taxpayer’s timely filed return and state the asset class of property for which the election is made.

Tax Update for 2011 and 2012

2011 2012

Annual Gift Tax Exclusion $13,000 $13,000

Gift Exclusions

Basic Standard Deductions 2011 2012

Married - Joint or Surviving Spouse $11,600 $11,900

Head of Household $8,500 $8,700

Single $5,800 $5,950

Married - Separate $5,800 $5,950

Dependent of Another $950 $950

Married - Joint & Over 65 or Blind $12,750 $13,050

Single & Over 65 or Blind $7,250 $7,400

Personal Exemption 2011 2012

Personal Exemption $3,700 $3,800

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Important Reminder: Bonus deprecia-tion deductions for passenger automobiles are generally limited under the luxury auto rules. However, the depreciation on trucks, vans, SUVs and certain crossover vehicles may not be limited if certain weight limit requirements are met. Bonus depreciation on trucks and vans with a gross vehicle weight of more than 6,000 pounds will generally not be limited. For SUVs and certain crossover vehicles, the vehicle must have an unloaded gross vehicle weight of 6,000 pounds or less. In order for bonus depreciation to apply, the business use of a vehicle must exceed 50 percent of total use.

Success-Based Transaction Fees Generally, amounts paid to facilitate a business transaction such as a merger, acquisition, restructuring or recapital-ization must be capitalized, while non-facilitative costs potentially could be deducted. An amount is paid to facilitate a transaction if it is incurred to investigate or pursue the transaction. The treatment of success-based fees, which are contingent upon the closing of a transaction, has been a controversial subject between the IRS and taxpayers. To alleviate the contro-versy, the IRS has provided a safe harbor accounting method. Under the safe harbor method, a taxpayer must:

1. Treat 70 percent of the success-based fees as an amount that does not facili-tate the transaction, i.e., potentially current deduction

2. Capitalize the remaining 30 percent as an amount that does facilitate the transaction

To elect the safe harbor method, a taxpayer should attach a statement to its original federal income tax return for the taxable year the success-based fee is paid or incurred, stating the safe harbor election, identifying the transaction and stating the success-based fee amounts that are

deducted and capitalized. The safe harbor allocation is effective for success-based fees paid or incurred in taxable years ending on or after April 8, 2011.

Employer-Provided Health Coverage Reporting Under the Health Care Reform Act, employers must disclose the cost of employer-provided health care to an employee on their W-2. In 2010, the

IRS announced the reporting would not be required for the 2011 tax year, allowing taxpayers more time to update their payroll reporting systems to meet the requirements. The IRS made the reporting optional in 2012 for employers with less than 250 employees in 2011.

If you have questions about tax policy changes, contact your BKD advisor. s

For tax years beginning January 1, 2011, medical expenses qualify for tax-free reimbursement as follows:

2011 2012

Over-the-Counter Medicines - without prescription Not Qualify Not Qualify

Over-the-Counter Medicines - with prescription Qualify Qualify

Prescribed Drugs or Insulin Qualify Qualify

Medical Equipment (such as crutches) Qualify Qualify

Medical Supplies (such as bandages) Qualify Qualify

Medical Diagnostic Services (such as blood sugar tests) Qualify Qualify

Eye Glasses & Contact Lenses Qualify Qualify

Co-pays & Deductibles Qualify Qualify

Reimbursable Medical Expenses

2011 2011 2012 2012 Self Only Family Self Only Family Coverage Coverage Coverage Coverage

Deductible Contributions $3,050 $6,150 $3,100 $6,250

High-Deductible Health Plan - Minimum Deductible $1,200 $2,400 $1,200 $2,400

Maximum Out-of-Pocket Expenses $5,950 $11,900 $6,050 $12,100

Out-of-pocket expenses generally do not include the cost of insurance premiums. Catch-up contributions for an individual and their spouse who have reached age 55 before the close of the tax year may make additional contributions in 2011 and 2012 up to $1,000. A one-time transfer from an individual retirement account, health flexible spending or a health reimburse-ment arrangement can be made to an HSA.

Health Savings Accounts

by Vicki Graft [email protected]

I n the past several years, the Department of Labor (DOL) has

released three initiatives to improve fee disclosures to plan sponsors and participants in individual account retire-ment plans. DOL deemed these initiatives necessary to allow plan sponsors to make informed decisions pertaining to the fees associated with the specific services being provided and, for the participants, to facili-tate an apples-to-apples comparison among the plan investment options offered. The first two initiatives focused on fee transparency to the plan sponsor—the revised Schedule C, effective with the 2009 Form 5500 filings, and the required service provider fee disclosures, effective April 1, 2012. The third initiative provides regula-tions on participant-level fee disclosures. The new regulation, which becomes effective for plan years beginning on or after November 1, 2011 (January 1, 2012, for calendar year plans), will significantly affect the content and the timing of providing information to participants with the right to

DOL Regulations on Fee Transparencydirect their retirement account investments. It will apply to all plans that are subject to the Employee Retirement Income Security Act (ERISA) and “individual account” plans where participants are given the right to direct the investment of their accounts (such as 401(k) and 403(b) plans.) It will not apply to non-ERISA 403(b) arrange-ments, IRAs, SEP or SIMPLE plans. The required disclosures must be provided to all eligible participants, regard-less of whether they are currently enrolled—including former employees with account balances. Although the regulation imposes the participant-level disclosure obligation on the plan administrator, generally the plan sponsor or employer, much of the work will be passed on to the record keeper (investment provider) or the third-party administrator. The regulations require disclosure in four areas:

General Operational Information – In addition to plan identification informa-tion, this category covers general informa-tion regarding participant ability to give investment instructions, how to make those instructions, any restrictions or limitations

on investments, how voting rights are exer-cised, a listing of all the investment options available under the plan, identification of the designated investment managers and a description of any available self-directed brokerage accounts. This disclosure must be provided prior to or on the date that the participant first becomes eligible to initially direct his investment and then annually thereafter.

Plan Administrative Expenses – The plan administrator must provide an explanation of any fees or expenses for administrative services (record keeping, accounting and legal) not included in the investment-related fees and charged to the participants’ accounts. There must also be an explana-tion of how these fees are allocated to each account, i.e., pro rata or per capita. The timing of the notice is the same as the general operational information above. Additionally, participants must be provided a statement at least quarterly detailing the actual fees deducted from their account in the preceding quarter. Most record keepers will be able to provide this quarterly infor-mation; however, you should confirm this with your specific provider. For plans using revenue sharing from plan investments to offset administrative expenses, the participants must be provided a statement stating that, in addition to the expenses reported on the statement, some of the plan’s administrative expenses for the preceding quarter were paid from the annual operating expenses of one or more of the plan’s designated investment alternatives, i.e., through revenue sharing arrangements, Rule 12b-1 fees or sub-transfer agent fees. The specific fee-sharing amounts for each investment needn’t be disclosed.

Individual Participant Expenses – Expenses directly related to services performed specifically on behalf of the participant, i.e., loan origination,


Individuals 50 and over can make elective catch-up contributions to their retirement accounts. The catch-up amounts are in addition to the existing contribution limits, making the maximum allowed elective deferral retirement contributions:

2011 2012

401(k), 403(b), 457 & SAR-SEP Plans - Younger than Age 50 $16,500 $17,000

401(k), 403(b), 457 & SAR-SEP Plans - Age 50 & Older $22,000 $22,500

Traditional & Roth IRAs - Younger than Age 50 $5,000 $5,000

Traditional & Roth IRAs - Age 50 & Older $6,000 $6,000

SIMPLE Plans - Younger than 50 $11,500 $11,500

SIMPLE Plans - Age 50 & Older $14,000 $14,000

Elective deferrals are amounts an employee instructs the employer to take out of regular pay and put into a pension account. Employers with profit-sharing plans are required to contribute funds to employee’s pension accounts. The total sum of an employee’s combined pension contributions can’t exceed $49,000 for 2011 or $50,000 of 2012. An employer’s tax deduction for contributions can’t exceed 25 percent of all employees’ annual compensation, taking into account individual compensation.

The annual benefit limitation for defined benefit plans is a limit of $195,000 for 2011 and 200,000 for 2012.

Retirement Plan Contribution Limits

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for 401(k)-Type Retirement Plansdistribution or QDRO fees or investment advice services, must be disclosed in the same manner as the plan administrative expenses.

Investment-Related Information – The required disclosure for this category is lengthy and will require significant information for the participants. This information ideally will be provided by the plan’s investment provider, but you should confirm this with your provider. As with the other categories, the initial notice must be provided prior to or on the first day a participant can direct his account and annually thereafter. Required information includes:

• Name and category of the fund

• Website where additional information can be found on each fund

• The annual rate of return and term of the investment for fixed investments

• Performance data, including one-year, five-year and 10-year returns and a comparison to benchmarks for invest-ments with variable rates of return

• Description of fees charged directly to participants such as sales loads or redemptions

• Description of any limitations on the ability to purchase, transfer or withdraw from an investment option

• The funds expense ratio expressed as a percentage

• An example illustrating total annual operating expenses of the investment options expressed as a dollar amount for a $1,000 investment

DOL has provided a model guide for disclosing investment-related information. A participant or beneficiary could bring a civil action against the plan admin-istrator for breach of ERISA fiduciary duties for any losses the participant or beneficiary incurs from failure of the plan

administrator to provide the required fee and investment disclosures. Record keepers, investment compa-nies and other plan vendors will be able to provide many of the required disclo-sures, but plan administrators must be prepared to add any missing information. Furthermore, plan administrators should develop procedures to provide the required information to eligible participants who are not currently enrolled or have existing balances with the plan’s investment provider.

Note: The following deadlines apply in 2012 for calendar-year plans:

May 31, 2012 – Deadline for first annual disclosures to participants

August 14, 2012 – Deadline for first quarterly expense disclosures to participants

For more information on these requirements, contact your BKD advisor. s


by Grant Glackman [email protected]

Some of the most significant and taxpayer-friendly

tax law changes over the past year were in estate and gift taxes. After years of uncertainty, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, enacted on December 17, 2010, appears to have provided a two-year period of certainty that will end December 31, 2012. The changes provide for unprecedented opportunities during this two-year time span.

Gift Tax The most sweeping changes occurred in gift taxes. The gift tax exemption was reunified with the estate tax exemption at $5 million effective January 1, 2011, and with an inflation adjustment for years after 2011; the 2012 exemption is $5.12 million. This is an increase of $4 million over the previous level. Through 2012, all individuals can give away the additional $4 million—$8 million for married couples—while those who have not previously made taxable gifts can give the entire $5 million. The maximum tax rate through 2012 was set at 35 percent, the lowest rate since 1975. Those who don’t take advantage of this window of opportunity before 2013 may find unused amounts subject to gift or estate tax at higher rates in the future. Without congressional intervention, the exemption will return to $1 million with a top rate of 55 percent in 2013. Although heavily debated, no changes were made to the gift tax laws that would curtail many of the estate-planning tech-niques used in the past to minimize estate taxes. As these techniques will likely be an ongoing topic of discussion in the budget debates, there can be no assurances that they will be available into the future. The following are just a few of the items that

Estate & Gift Tax Update & Oppwill continue to be discussed during 2011 and 2012 with clients who are considering family transactions:

Large Taxable Gifts – Those with sub-stantial estates should consider taking advantage of some or all of the new $5 million lifetime exemption. To further enhance the gift, a discount vehicle should be considered.

Lifetime Credit Shelter Trust – For married couples, one way to take advan-tage of the new exemption is to establish a qualified trust for the spouse’s benefit. These trusts have the added benefit of the principal remaining accessible as long as both spouses are living and remain married. Properly structured, trusts can be estab-lished for each spouse to take advantage of the full $5 million exemption.

Family Limited Partnerships – Although heavily debated, current law continues to allow the use of these vehicles, which can produce substantial discounts in the value of family assets. Coupled with already low asset values, this technique can be extremely helpful when handled properly.

Grantor Retained Annuity Trust (GRAT) – With the low interest rate envi-ronment, the GRAT will continue to be an excellent vehicle to shift wealth tax-free to future generations in 2011 and 2012. The short-term GRAT (two to five years) utilized by many will be a continued topic of discussion in Congress for periods after 2012, so utilization now may be prudent.

Qualified Personal Residence Trust (QPRT) – The higher exemption, combined with a depressed real estate market, can make a QPRT an ideal way to transfer a residence or vacation home to the next generation at a substantial discount.

Low-Interest-Rate Transactions – Many planning techniques are much more effec-tive when interest rates are low. Among

those are outright sales in return for a note, sales to defective trusts, gifts to a GRAT or gifts to a charitable lead trust.

General Estate Plan Cleanup – With the added exemption available, this is a great time to forgive lingering loans to children or equalize gifts between children.

Annual Exclusion Gifts – For 2011 and 2012, tax-free gifts of up to $13,000 can be made to any number of recipients.

Estate Tax The estate tax exemption was also increased for 2011 and 2012 to the $5 million level (with inflation adjustment after 2011) with a top rate of 35 percent. Without congressional action by the end of 2012, the exemption will once again drop to $1 million with a top rate of 55 percent. While most experts don’t expect this will happen, there is no assurance that the $5 million exemption level will be maintained. President Obama’s budget proposals have consistently called for a $3.5 million exemption and higher rates. Perhaps the most intriguing aspect of the estate tax law changes is the introduction of the concept of portability of any unused exemption at death to a surviving spouse. An election to take advantage of the portability provi-sions must be made on a timely filed federal estate tax return at the first death. While this election can salvage some poor planning, it should not be used as a substitute for traditional estate planning for larger estates, and it is only effective for deaths occurring before 2013. Due to budget restraints, many states continue to decouple from the federal estate and gift tax system and impose their own tax regime. You should review the current status of the estate and gift tax system in your state of residence.

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Estate & Gift Tax Update & OppGeneration-Skipping Tax (GST) Since the estate tax laws are struc-tured to tax net worth at each generation, limitations have been placed on the amount an individual can transfer beyond the first generation. If transfer amounts exceed these levels, an additional tax can be levied over

and above the normal gift and estate tax. For 2011 and 2012, the GST exemption also has been set at $5 million (with infla-tion adjustment after 2011), with a top rate of 35 percent. With uncertainty for years after 2012, it is imperative that clients review their

estate and gift tax situations. Failure to do so could result in substantial financial cost to your family. Due to the complex nature of estate planning and the fact that all situa-tions differ, you should consult your BKD advisor to discuss appropriate strategies. s

ortunities

New simplified per diem travel rates became effective October 1, 2011. Employers can give employees these per diem allowances instead of reimbursing actual business travel expenses. Use of the per diem rates greatly simplifies record-keeping requirements needed to substantiate deductions for business travel.

Travel Rates

A payor must treat M&IE allowances as a food and beverage expense subject to the 50 percent deduction limit. However, the deductible percent-age is 80 percent for food and beverage expenses of certain individuals, e.g., air transport workers, interstate truckers and bus drivers, during or incident to a period of duty subject to the Department of Transportation hours-of-service limits.

Beginning Beginning October 2010 October 2011

Lodging, Meals & Incidentals - “High-Cost Localities” $233 per day $242 per day

Lodging, Meals & Incidentals - Other Localities $160 per day $163 per day

Meals & Incidentals Only - “High-Cost Localities” $65 per day $65 per day

Meals & Incidentals Only - Other Localities $52 per day $52 per day

Transportation Industry: Meals & Incidentals - Continental U.S. $59 per day $59 per day

Transportation Industry: Meals & Incidentals - Outside Continental U.S. $65 per day $65 per day

2011

Jan. - June July - Dec.

Business 51¢ per mile 55.5¢ per mile

Charitable 14¢ per mile 14¢ per mile

Medical & Moving 19¢ per mile 23.5¢ per mile

Standard Mileage Rates 2011 2012 2011 2012

Rates Rates Wage Base Wage Base

Social Security - Employee 4.20% 6.20% $106,800 $110,100

Social Security - Employer 6.20% 6.20% $106,800 $110,100

Medicare - Employee 1.45% 1.45% Unlimited Unlimited

Medicare - Employer 1.45% 1.45% Unlimited Unlimited

FICA Tax Schedule


by Jesse Palmer [email protected]

While 2011 has been relatively

quiet in terms of major tax legislation, we may be experiencing the calm before the storm. Many legislators are calling for increased taxes on the wealthi-est taxpayers and the repeal of perceived tax loopholes to help reduce the federal deficit. Others argue that raising taxes in a weak economy when unemployment remains above 9 percent will hinder growth and cause the economy to slip into another recession. The potential solution to reduce either the deficit or unemployment could negatively affect the other problem. Raising taxes on the wealthy—often perceived as the country’s job creators—could slow eco-nomic growth. Reducing tax rates or offer-ing tax credits targeted at job growth would increase the federal deficit unless offset with spending cuts. Given the low approval ratings of Congress and the looming 2012 elections, few politicians are willing to make decisions that could anger their constituents. This article will explore some of the tax discussions related to the Joint Select Com-mittee on Deficit Reduction and President Obama’s job creation package, as well as recent major tax reform proposals.

Deficit Reduction Committee After weeks of disagreements, Con-gress finally passed the Budget Control Act of 2011. The act, signed into law on August 2, raised the federal debt limit but offset the increase with $900 billion in discretionary spending reductions over 10 years and an-other $1.5 trillion deficit reduction over 10 years through a combination of budget cuts and revenue enhancements. The act created a 12-member bipartisan joint committee to come up with the $1.5 trillion deficit reduction package, which would be voted on by Congress.

Tax Legislation Outlook• Limiting value of itemized and certain

above-the-line deductions to 28 percent for taxpayers with income of more than $250,000

• Returning the estate tax to its 2009 parameters for decedents dying after December 31, 2012—a top estate tax rate of 45 percent and a $3.5 million exemption

• Repealing last-in, first-out and the lower-of-cost-or-market inventory accounting methods

Jobs Act Proposal In an effort to stimulate the economy and promote job growth, President Obama proposed a $447 billion jobs package for Congress to consider. Referred to as the American Jobs Act of 2011, this proposal contained several tax incentives to encour-age hiring and was paid for with additional taxes on higher income taxpayers. Provi-sions in the proposed act include:

• Reducing the employee share of Social Security’s Old Age, Survivors and Disability Insurance (OASDI) tax to 3.1 percent for 2012; the employee’s current share is 4.2 percent but is set to revert back to 6.2 percent after December 31, 2011, and similar relief would apply to self-employed taxpayers

• Reducing the employer portion of OASDI tax from 6.2 to 3.1 percent on the first $5 million of wages paid during 2012 and providing a payroll tax credit on OASDI taxes for busi-nesses experiencing payroll growth in 2012 on up to $50 million of wages paid above the 2011 amount

• Expanding the Work Opportunity Tax Credit to include long-term unemployed individuals—those unemployed for more than six months—and unemployed veterans; the credit for hiring unemployed veterans varies depending on length of

Since the committee comprises six Republicans and six Democrats, finding a consensus on the $1.5 trillion of cuts has been a struggle. Democratic committee members insist on raising revenues while Republicans oppose any tax increases, although this position has eased recently. Due to the hard-line stance taken by both parties, the committee formally announced on November 21, that a bipartisan agree-ment would not be reached by the Novem-ber 23 mandated deadline. Under the act, the committee’s failure results in triggering automatic spending cuts—i.e., sequesters—which will take effect in 2013. The cuts would eliminate $1.2 trillion of spending over 10 years. However, several members of Congress have already started pushing to make changes to the automatic spending cuts, most notably the $600 billion in cuts to defense spending. Whether the sequesters as originally enacted survive through 2012 remains to be seen.

White House Deficit Plan On September 19, 2011, the White House released a deficit reduction plan for the committee’s consideration, including $1.5 trillion of proposed tax increases. The majority of the revenue would come from increased taxes for higher-income taxpayers starting in 2013. It also included the “Buffett Rule,” a reference to statements by Warren Buffett, famed billionaire inves-tor and CEO of Berkshire Hathaway, about how he paid a lower tax rate than his secretary. Under the Buffett Rule, no household making more than $1 million annually will pay a smaller share of its income in taxes than what middle-class families pay. Details on implementing this rule were not included in the plan. Other revenue measures in the plan included:

• Allowing the Bush tax cuts to expire at the end of 2012 for taxpayers with income over $250,000, raising the top two rates to 36 and 39.6 percent

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unemployment and whether the veteran has service-connected disabilities

• Extending 100 percent bonus deprecia-tion through 2012

The proposal would pay for the tax incentives by limiting the tax benefit of itemized deductions and certain other ex-penditures to 28 percent for higher income taxpayers, taxing “carried interest” at ordi-nary rates, repealing various tax incentives for the oil and gas industry and a longer depreciation recovery period for corporate jets. While the chances of Congress passing the president’s proposed jobs act in its en-tirety is slim, portions of the proposal could be included in various legislation. In fact, the credit for hiring unemployed veterans was recently included as an amendment to a bill that would repeal the 3 percent withholding rule for certain government payment for goods and services set to go into effect in 2013. Congress passed this bill and the president signed the legislation in mid-November.

Tax Reform Legislation It has been more than 25 years since the last major tax reform act. Since the Tax Reform Act of 1986, the Internal Revenue Code has grown significantly in volume and complexity, as Congress often uses the tax law to stimulate the economy, benefit certain industries and encourage certain behaviors. Many argue the current tax code is inequita-ble and impedes economic growth. Propo-nents of tax reform argue U.S. businesses are at a disadvantage to foreign competitors due to the high U.S. corporate tax rate compared to other developed nations. Given the current federal deficit issues, struggling economy and the presidential election in 2012, talks of major tax reform are at the forefront. Many reform ideas pro-mote revenue neutrality by broadening the tax base through elimination of most current tax deductions and credits and reduction of the tax rate. This would include eliminat-

ing several popular tax deductions such as the deduction for mortgage interest and charitable contributions. The ideas coming from presidential candidates range from a flat tax to replacing the income tax with a national sales tax. House Ways and Means Committee Chairman Dave Camp, R-Mich, recently unveiled a corporate tax reform plan that would reduce the top corporate tax rate from 35 percent to 25 percent. The pro-posed plan states it would be revenue-neu-tral. However, details were not provided on what corporate deductions and credits would be eliminated to pay for the plan. Furthermore, a recent report from the Joint

Committee on Taxation raised concerns that even if all corporate tax incentives were eliminated, the top corporate tax rate could only drop to 28 percent to remain revenue neutral. Most commentators believe major tax reform will likely be delayed until at least 2013. The direction of tax reform will depend largely on the outcome of the elections. Proactive tax planning in the next year will be important to help prepare you for the uncertainty ahead. For more information on the latest tax legislation and assistance in assessing an appropriate strategy based on your situation, please contact your BKD advisor. s


by Mary Reiser, [email protected], Bob Johnson, [email protected] &Bryan Neuendorf, [email protected]

One of the most important issues in state income taxation is which activities constitute taxable

nexus with a particular state. The guiding principles for determining nexus have been the Due Process Clause and the Commerce Clause of the U.S. Constitution. The Due Process Clause calls for some “minimal con-nection” between the state and the activity being taxed, while the Commerce Clause demands a nexus standard that does not burden interstate commerce. Historically, these clauses had been treated as somewhat synonymous. However, the distinction and interpretation given these clauses in Quill Corp. v. North Dakota changed the landscape of their application to the concept of state income tax nexus. As a result, state income tax nexus remains an obscure concept often defined by the will of the taxing jurisdic-tions. In response to this obscurity and the economic uncertainty underpinning state governments, many states have expanded their definition of income tax nexus to include “economic nexus.” In Quill Corp. v. North Dakota, the U.S. Supreme Court evaluated whether a mail-order vendor had use tax nexus with North Dakota based solely upon its sales and marketing activity in the state. The decision made a distinction between the Due Process Clause and the Commerce Clause not made in prior cases. The court distinguished that Due Process nexus would be created by a taxpayer’s purposeful direction of its activity towards the market of the taxing state. However, the Commerce Clause required a substantial nexus with the state that would not impose an undue burden on interstate commerce. The court ruled a taxpayer must have a physical presence to meet the substantial nexus standard set by the Commerce Clause for use tax purposes. The court was quick to point out the physical presence test applied only to sales

Economic Nexus: Its Origin & Application inand use tax, the specific tax evaluated in the case: “We have not, in our review of other types of taxes, articulated the same physical presence requirement that Bellas Hess established for sales and use taxes.” Furthermore, the court stated current case law might support a less concrete nexus standard. Its decision to use the physical presence standard stemmed largely from the taxpayer’s reliance on the bright-line rule established in another case, Bellas Hess. The court’s omission of any pertinent direction for state income tax purposes left income tax nexus open for interpretation.

a state should be subject to its jurisdiction to impose an income tax even though not physically present.” As a result, the court established a precedent for economic nexus that was quickly pursued in a slew of court cases avowing state income tax nexus to intangible holding companies. One recent and far-reaching case on the issue of state income tax nexus is KFC Corp. v. Iowa Dept. of Rev. Similar to prior intangible holding company cases, KFC licensed its intellectual property to franchisees in Iowa. Although prior case law addressed nexus issues with respect to intangible property used in a state, the KFC case presented one defining differ-ence: The franchisees were unrelated third parties; previous cases had generally involved licensing agreements between affiliated companies. This distinction ultimately made no difference, as the Iowa Supreme Court ruled the intellectual property had “a sufficient connection to Iowa to amount to the functional equiva-lent of ‘physical presence’ under Quill.” As in the intangible holding company cases before it, the court found economic nexus and resolved that actual physical presence would be an unsuitable restraint for income tax purposes. The Iowa court spoke directly to the fundamental purpose of the Commerce Clause: to prevent an undue burden on interstate commerce. Following the logic of Quill, the court surmised the tax burden of an economic nexus threshold for sales and use tax purposes would outweigh the burden for income tax purposes. Both courts estimated “more than 6,000 jurisdic-tions” for sales and use tax purposes would be much greater than the number of income tax jurisdictions. This 2010 case may have set an even broader precedent for purposes of determining state income tax nexus. These precedents have led to the indefinite concept of nexus confronting taxpayers. As state governments struggle economically, they are looking for opportu-

Taxpayers need to be aware economic nexus means they might have income tax exposure in states where they have no physical presence.

Geoffrey, Inc. v. South Carolina Tax Commission tested the waters of substantial nexus. In Geoffrey, the South Carolina Tax Commission attributed nexus to Geoffrey, Inc., an intangible holding company incorporated in Delaware. Geoffrey held the trademarks underlying the Toys“R”Us retail stores throughout the United States. It licensed the trademarks to the related company owning the stores for a royalty fee. Even though Geoffrey had no physical presence in South Carolina, the Commission asserted the company had nexus due to its intangible property in the state: its franchise. As such, it sought to tax royalty payments to Geoffrey from its South Carolina store licenses. The court decided in favor of South Carolina based upon the Quill interpre-tation of the Due Process Clause: the company’s purposeful direction of its activity toward the state’s economic market. However, the court failed to address the substantial nexus issues introduced under the Commerce Clause in the light of income tax nexus. It ruled “any corpora-tion that regularly exploits the markets of

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nities to increase tax revenues from out-of-state businesses. However, state tax laws establishing compliance procedures are still rooted in the manufacturing environment of the mid-20th century, often built on the physical presence of manufacturing facili-ties. Even state apportionment measures are structured around the property and payroll this industry once anchored throughout the United States. Meanwhile, the current economy is much more service-based. Taxpayers now have income sourced from many states where they have no physical presence via tangible assets and employ-ees. Technological advances also have made business activity more remote since many state tax laws were instituted. As such, more and more states are looking to economic nexus provisions and other structural changes to tighten the perceived gap between the income generated from their state and state tax laws. Until courts or federal legislators set boundaries for these changes, state taxing authorities likely will continue to encroach upon taxpayers’ rights in their states. The most prevalent approaches for adopting economic nexus provisions are the institution of bright-line tests and non-income based taxes. Bright-line tests have allowed states to develop concrete factors for asserting income tax nexus. These tests have been structured such that nexus is created if a taxpayer’s activities attain a minimum amount or percentage of either sales, property or payroll in the state. The tests are always anchored by a minimum level of sales or gross receipts in the state. These sales provisions allow state taxing authorities to catch most taxpayers utilizing the state’s economic market, even if not physically present in the state. The only protection a taxpayer may have from these tests is Public Law 86-272. This law protects taxpayers from state taxing jurisdictions if the taxpayer’s only activity in the state is the solicitation of tangible personal property for which the actual sale

is approved outside the state. Any activity in excess or other than soliciting tangible personal property likely will subject the taxpayer to the state’s taxing jurisdiction. Service-based organizations largely have no recourse with regard to these bright-line tests. Some of the most recent states to introduce bright-line tests are California, Colorado and Connecticut. Each of these states has adopted a $500,000 sales thresh-old in addition to other minimum property and payroll provisions in their bright-line tests. Taxpayers should consult their tax advisors to determine whether their sales, property or payroll in these or other states might subject them to a state’s income tax. Aside from bright-line tests, some states have moved away from the traditional income tax system toward a gross receipts or non-income-based tax. Non-income-based taxes amount to a tax on the privilege to engage in or transact business in a state. These systems are built on the taxpay-ers’ gross receipts with an allowance, in some cases, for certain limited deductions. Unlike bright-line tests built into income tax systems, taxpayers cannot rely on Public Law 86-272 with respect to non-income-based taxes, as it only offers protection from income-based taxes. Non-income-based taxes still may require some minimum connection with a state such as solicitation or marketing activity directed toward the state. However, these connections are fairly easily to make, and states are often very aggressive in their pursuit to establish these connections. Other states simply have a bright-line test similar to states such as California, Colorado and Connecticut. Three of the most well established non-income-based taxes are the Ohio Commercial Activity Tax (CAT), the Texas Margin Tax and the Washington Business and Occupation Tax. Ohio’s CAT is based on a bright-line test. Any taxpayer with $500,000 of Ohio gross receipts will auto-matically be subject to the tax. However, a taxpayer could also be assessed based upon

the property and payroll factors in its bright-line test. Perhaps the most complex of the three taxes is the Texas Margin Tax. The margin tax requires some minimal activity in the state, such as solicitation. However, it is not limited by any threshold of sales or gross receipts. The tax is based on the lower of three possible tax calcula-tions: 70 percent of revenues, revenues less cost of goods sold or revenues less a deduction for compensation. Despite the allowance of certain deductions—even cost of goods sold—the margin tax is not con-sidered an income-based tax. Washington has a bright-line test similar to Ohio. Any taxpayer with $250,000 in Washington gross receipts will be subject to this tax. A taxpayer also may be assessed based on the property or payroll dictated in its bright-line test. Taxpayers should contact their tax advisors to determine if activity in any of these states or other states might subject them to non-income-based taxes. Despite the physical presence standard referenced in the Quill case, the U.S. Supreme Court has indicated this standard applies strictly to the context of sales and use taxes; there is no federally established bright-line test for defining income tax nexus. Until a bright-line test is established, states likely will continue to broaden their interpretation of nexus, and it appears the court system will allow this move toward economic nexus. Taxpayers need to be aware economic nexus means they might have income tax exposure in states where they have no physical presence. Please consult your BKD advisor concerning your activities in each state to determine if you have economic nexus. s

Economic Nexus: Its Origin & Application in Today’s Tax EnvironmentOne of the most important issues in state income taxation is which activities constitute taxable nexus with a particular state.


by Jim Still [email protected]

T he Housing Assistance Tax Act of 2008 added a

new information report-ing requirement for merchant card and third-party network payments made by payment settlement entities. This require-ment is effective for transactions occurring after December 31, 2010. As a result, the IRS issued Form 1099-K, Merchant Card and Third-Party Network Payments, for reporting these transactions.

Who Is Subject to 1099-K Reporting? Payment settlement entities subject to 1099-K reporting include:

• Banks or other organizations with a contractual obligation to make payment to participating payees to settle payment card transactions

• Third-party settlement organizations such as eBay or PayPal, which are con-tractually obligated to make payments to participating payees of third-party payment transactions

What Transactions Are Included on 1099-K?• Payment card transactions, includ-

ing debit card, credit card, gift cards, stored-value/prepaid cards and any other type of card in which any account number or other indicia associated with the card is accepted as payment

• Third-party network transactions, including any transactions settled through a third-party network. However, an organization operat-ing a network that merely processes electronic payments (such as wire transfers, electronic checks and direct deposit payments) between buyers and sellers, but does not have a

Reporting Requirement for Merchant Cardcontractual agreement with sellers to use that network, is not required to report under this provision. Similarly, an agreement to transfer funds between two demand deposit accounts will not, by itself, be a third-party network transaction.

What Transactions Are Excluded From 1099-K Reporting?• Withdrawalsandcashadvancesbya

payment cardholder at an automated teller machine or cash advances or loans against the cardholder’s account

• Conveniencechecksissuedincon-nection with a payment card account; these are not reportable payment trans-actions since these checks are processed through the banking system in the same manner as a traditional check

• Transactionsinwhichthepayeeandthe issuer are related

• Deminimisthird-partynetworktrans-actions are excluded when the aggregate amount does not exceed $20,000 and the number of transactions is less than 200; the de minimis exception applies per payee. For example, if a vendor uses eBay to sell products and the total amount of sales is less than $20,000 and the total number of transactions is less than 200, no 1099-K reporting would be required. The de minimis exception does not apply to payment card transactions.

What Is Included on Form 1099-K? Form 1099-K must include the following information:

• Thename,addressandtaxpayeriden-tification number of each participating payee to whom one or more qualifying payments are made

• Thegrossdollaramountofcreditcard,debit card and similar transactions as well as third-party network transactions

made to a payee during the calendar year; the gross dollar amount is shown as a total annual amount as well as on a monthly basis—Note: The reporting of both annual and monthly amounts is necessary in order to reconcile differ-ences between information returns and tax returns of fiscal year filers; the gross amount is determined without regard to adjustments for credits, cash equiva-lents, discount amounts, fees, refunded amounts or any other amounts, while the dollar amount of each transaction is

by David [email protected]

T he IRS has con-tinued its efforts to enhance its

international tax capa-bilities, with specific efforts to bolster its transfer pricing enforcement capabil-ity. The IRS intends to more effectively identify, examine and resolve transfer pricing cases through the recent reor-ganization of the Large and Mid-Sized Business (LMSB) division, the hiring of additional technical transfer pricing personnel and the addition of a transfer pricing director. With the expected increase in transfer pricing-focused audits, taxpayers increasingly will benefit from sensible transfer pricing documentation to justify their intercompany pricing. In October 2010, the IRS reorga-nized the LMSB division into the Large Business and International (LB&I) division, signifying renewed attempts to integrate and coordinate its international tax compliance efforts. The IRS’ inter-national subdivision will add nearly 900 employees to the 600 employees in place

Recent Transfer

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Reporting Requirement for Merchant Carddetermined on the date of the transaction

How is Form 1099-K Filed? Form 1099-K must be provided to the payee by January 31 of the year fol-lowing the year for which the return was made. The first payee statements must be furnished by January 31, 2012. The payee statement may be furnished electroni-cally with consent of the recipient; if so, the email address required to make such return may be shown in lieu of the phone number. Form 1099-K is due to the IRS

by February 28 (March 31 if filed elec-tronically) of the year following the trans-actions. The first forms will be due for calendar year 2011 and must be submitted to the IRS by February 28, 2012 (March 31, 2012 if filed electronically). Since March 31 falls on a Saturday, the due date for filing electronically is April 2, 2012. Due to the increased burden this filing requirement will create for certain entities, the IRS has provided penalty relief for incorrect or incomplete filings of Form 1099-K if the reporting entity

makes a good-faith effort to accurately file the return and accompanying payee statement. This penalty relief applies only to calendar year 2011 payments reported in 2012. The IRS also has delayed the backup withholding requirement to payments made after December 31, 2012, for cases where the payee fails to furnish a correct taxpayer identification number to the payer. For more information on this new filing requirement, contact your BKD advisor. s

& Third-Party Network Payments

at the end of 2010. New personnel will include examiners, transfer pricing econo-mists and technical staff. New Transfer Pricing Director Samuel Maruca has been tasked with developing and managing the international subdivision’s transfer pricing strategy, training initiatives and operating policies, as well as the soon-to-be combined Advance Pricing Agreement and Competent Authority programs. To better coordinate the efforts of the transfer pricing national office and the field, the LB&I division intends to create a transfer pricing advisory group organized geographically, comprising 40 to 60 personnel. According to Michael Danilack, the IRS Deputy Commissioner (International), there will be an enhanced focus on intercompany transactions of foreign-controlled U.S. corporations and U.S. branches of foreign corporations. With Japan reducing its statutory tax rate, the U.S. will soon have the highest statu-tory tax rate in the world, and the IRS will be dedicating resources to challenge intercompany transactions that avoid U.S. tax by inappropriately shifting income back to the taxpayer’s home country.

Taxpayers without proper contempo-raneous transfer pricing documentation—especially U.S. subsidiaries of foreign companies—should have proper docu-mentation in place to avoid potentially

costly adjustments to taxable income, which could lead to double-taxation, penalties and interest. For more on transfer pricing develop-ments, contact your BKD advisor. s

Pricing Developments


by Gregory [email protected]

T he IRS continues to focus on inter-national report-

ing by individuals and businesses. In 2010, the IRS realigned the Large and Mid-Size Business division into the Large Business and International Division, which will examine certain high-wealth individuals. The IRS has led several initiatives to reveal undisclosed offshore assets and accounts. In response to a potential federal criminal investigation regarding its offshore private banking services, Credit Suisse, AG, Switzerland’s second-largest bank, is making arrangements to turn over client names to the IRS. Switzerland is now negotiating settlements with the U.S. that would cover its entire banking industry of about 355 banks. The U.S. taxpayer remains at risk, with individual data and identity information being disclosed to U.S. authorities. The IRS

recently closed its second Voluntary Disclosure Program. The first program ran March 26, 2009, through October 15, 2009, and allowed taxpayers with undisclosed offshore assets and financial accounts to come forward under a set penalty framework to avoid criminal prosecution. The program resulted in 15,000 voluntary disclosures, with more than 3,000 additional taxpayers coming forward after the program closed. IRS Commissioner Douglas H. Shulman said, “For taxpayers who continue to hide their head in the sand, the situation will only become more dire …”

The IRS’ second Voluntary Disclosure Program ran February 8, 2011, through September 9, 2011. Facing an increased penalty structure and longer coverage period (2003 to 2010) compared to the 2009 program, taxpayers were still allowed to avoid criminal prosecution and pay potentially reduced penalties. More than 12,000 voluntary disclosures were made under the second program. “The new disclosure initiative is the last, best

chance for people to get back into the system,” Shulman said. The IRS has become stricter regard-ing the filing requirements on interna-tional disclosure forms. The Foreign Account Tax Compliance Act (FATCA), passed in 2010, is designed to ferret out previously undisclosed foreign financial accounts and income. The penalties are disproportionately high, and it is becoming more difficult to successfully assert “reasonable cause” to waive the related penalties. Beginning with the 2011 tax returns, several important FATCA changes addressing foreign reporting will take effect. More specifically, taxpayers may need to file Forms 8621, Information Return by a Shareholder of a Passive Foreign Investment Company (PFIC) or Qualified Electing Fund and 8938, Statement of Specified Foreign Financial Assets, with their 1040.

Form 8621 Currently, Form 8621 is filed when there is a recognized gain on direct or

Foreign Investment Reporting Changes for

17

indirect disposition of PFIC stock, the taxpayer receives direct or indirect distri-butions from PFIC or a taxpayer makes an election reportable in Part I of Form 8621. U.S. interest holders in U.S. partnerships or S corporations must file only if the pass-through entity fails to file Form 8621 or the U.S. person is required to recognize income under Section 1291 in Part IV of Form 8621. Amassing the filing requirements for Form 8621, new Section 1298(f ) replaces current disclosure law and requires U.S. persons owning shares in a PFIC to file an annual information return disclosing their PFIC ownership. Regardless of whether PFICs issue PFIC statements to their U.S. investors, taxpayers are being held more account-able for their share of foreign financial assets. To illustrate, U.S. taxpayers should typically treat foreign mutual funds and foreign exchange-traded funds (ETF) as PFICs, even though the taxpayer is unlikely to receive anything from the mutual fund or broker regarding fund status as a PFIC. For mutual funds and ETFs not providing annual PFIC infor-mation statements, the taxpayer may benefit from a mark-to-market election on Form 8621. A mutual fund or ETF’s foreign status is not determined by its principal investment in non-U.S. securi-ties; instead, it is based on which jurisdic-tion the fund itself was legally organized.

Form 8938 For individuals with an interest in any specified foreign financial assets during a taxable year in which the aggre-gate value of all such assets is greater than $50,000 as of the last day of the year or greater than $100,000 at any time during the year ($100,000 and $200,000 for married filing jointly), Section 6038D requires attachment of Form 8938 to their income tax return. Specified foreign financial assets include ownership of:

• Any financial account maintained by a foreign financial institution, including investment vehicles such as foreign mutual funds, foreign hedge funds and foreign private equity funds

• Any of the following not held in an account maintained by a financial institution:

o Any stock or security issued by a foreign person

o Any financial interest or contract held for investment that has foreign issuer or counterparty

o Any interest in a foreign entity, e.g., a corporation, partnership or trust

Because the IRS is requesting more documentation and transparency, it is important to break down the areas of interest and potential reporting require-ments. Even if a taxpayer does not sub-stantially understate foreign account and asset reporting, amended Section 6501(e) still gives the IRS six years to investigate and audit the taxpayer. This disclosure extends the three-year statute of limita-tions to six years if the taxpayer omitted more than $5,000 of income attribut-able to one or more assets required to be reported under Section 6038D. Section 6038D applies to assets held during tax years beginning after March 18, 2010. The individual taxpayer generally will attach the form to their returns for the 2011 tax year.

Penalties Generally, all U.S. persons—includ-ing individuals, corporations and partner-ships—are required to annually file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), if they have a financial interest in or signature authority over foreign financial accounts, including bank accounts, securities or other types of financial accounts if the aggregate value of these financial accounts exceeds $10,000

at any time during the calendar year. The report is due on June 30 following each year. Please note the filing of Form 8938 does not satisfy FBAR filing requirements. The new Section 6038D contains broader reporting requirements compared to the FBAR, which can subject an individual to Section 6038D reporting requirements when similarly not faced with any FBAR filing obligations. For example, Section 6038D requires individuals with invest-ments in foreign entities, such as foreign hedge funds and private equity funds, to report these investments, while new FBAR regulations effective March 28, 2011, exempt these types of assets from FBAR reporting. Failure to disclose under Section 6038D can result in a minimum penalty of $10,000, increasing by $10,000 for each 30-day period following notifica-tion from the Treasury Department, up to $50,000. There is a 90-day grace period following notification from Treasury before additional $10,000 penalties accrue. The penalty may be waived if the taxpayer is able to demonstrate reasonable cause due to failure to file. Other than the new Form 8938 and requirement to file Form 8621 when owning a PFIC, other foreign information reporting forms remain the same. Forms you need to be aware of include:

• Form 926 – Return by a U.S. Transferor of Property to a Foreign Corporation

• Form 3520 – Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts

• Form 5471 – Information Return of U.S. Persons With Respect To Certain Foreign Corporations

• Form 8865 – Return of U.S. Persons With Respect to Certain Foreign Partnerships s

Individual Taxpayers


by Mike Burgess, [email protected]& Chris Clifton, [email protected]

The IRS Large Business and International (LB&I) Division, which serves corporations, S corpo-

rations and partnerships with assets greater than $10 million, has labeled a number of international tax areas Tier I issues. Tier I issues include transactions considered by the IRS to be high risk—posing the highest compliance risk across multiple industries, having significant monetary value, involv-ing substantial compliance risk or being of high visibility. These Tier I issues are of strategic importance to the LB&I Division and represent the division’s highest compli-ance priorities. In the context of interna-tional tax, the LB&I Division has identified the following issues as Tier I, thus indicat-ing an emphasis on these issues for the foreseeable future:

• Reporting and Withholding on U.S. Source Income

• Transfer of Intangibles/Offshore Cost Sharing

• Foreign Earnings Repatriation

• Foreign Tax Credit Generators

Reporting & Withholding on U.S. Source Income U.S. persons who make payments of certain U.S. source income types to nonresidents generally are required to withhold tax at a rate of 30 percent of the gross payment amount. This rate may be reduced or eliminated if the payment is made to a qualified resident of a country with which the U.S. has a double tax treaty. These payments to nonresidents generally are required to be reported on Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. The IRS may examine the processes and documentation of a withholding agent—a person making a payment of income subject to withholding—in order

to ensure compliance with the withhold-ing requirements and proper calculation of required withholding amounts. As part of this investigation, the IRS may request confirmation that foreign payees have been properly documented using the proper W-8 certificate as well as other documentation supporting the calculations and determina-tions related to withholding.

Transfer of Intangibles/ Offshore Cost Sharing Taxpayers sometimes transfer intangible property to offshore jurisdictions to reduce their global effective tax rate. U.S. corpora-tions have entered into buy-in and cost-sharing arrangements with a related party, whereby the related party acquires the rights to existing intangible property through the buy-in agreement and agrees to share in the cost of developing additional intangible property through the cost-sharing agree-ment. Both parties have the right to exploit the intangible property in defined territories. The IRS contends these offshore transfers often are concluded for inadequate consider-ation and has devoted extensive resources to examining these issues. The IRS’ primary concern is the adequacy of any buy-in payments under Internal Revenue Code (IRC) Section 482 transfer pricing principles; examination may cover any number of issues related to valua-tion of the intangible property. Such issues may include investigation of the defini-tion, scope and useful life of the intangible property transferred or examination of the form, method and timing of payments under the agreement. When examining buy-in and cost-sharing payments, the IRS generally will thoroughly review the tax-payer’s transfer pricing documentation.

Foreign Tax Credit Generators Foreign tax credit generator transac-tions cross many industries but are most commonly found by the IRS in financial services. These are highly structured transac-tions through which taxpayers attempt to

generate foreign taxes. The IRS contends such transactions are abusive because they are not consistent with the law’s intent. Two types of transactions identified by the IRS to date are asset-parking trans-actions and lender/borrower transactions. Asset-parking transactions involve moving assets that generate a passive income stream such as interest or dividends into a structure that subjects the income to a foreign tax. Lender/borrower transactions purportedly result in the duplication of tax benefits by using structured transactions to take advantage of inconsistencies between U.S. and foreign tax laws related to financ-ing transactions. Because of the nature of the issue, it is difficult for the IRS to identify these issues on a tax return, including Schedule M-3, Net Income (Loss) Reconciliation, or Form 1118, Foreign Tax Credit – Corporations. Any return for which foreign tax credits are claimed for passive types of income may therefore be subject to additional IRS scrutiny in an effort to identify these perceived abusive transactions.

Foreign Earnings Repatriation IRC Section 965, enacted as part of the American Jobs Creation Act of 2004, is a temporary provision allowing U.S. companies to repatriate earnings from their foreign subsidiaries at a reduced tax rate if certain conditions and restrictions are satisfied. These companies were allowed an 85 percent dividends-received deduction for eligible dividends. This issue cur-rently is of extremely limited application, applying only to returns being audited that include Section 965 dividends. Any such return may be subject to enhanced IRS scrutiny.

What Lies Ahead On September 19, 2011, the Obama administration submitted a proposal to the Joint Select Committee on Deficit Reduction including international tax pro-

Developments in International Tax

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posals similar to proposals in the Obama administration’s previous budgets:

• Defer deductions of interest expense related to deferred foreign income

• Determine the indirect foreign tax credit on a pooled basis

• Tax current excess returns associated with transfers of intangibles offshore

• Clarify the definition of intangible property for purposes of IRC Sections 367(d) and 482, to prevent inappropriate shifting of income outside the U.S.

• Limit earnings stripping by expatriated entities

• Modify foreign tax credit rules for dual-capacity taxpayers

• Create a separate foreign tax limitation category for foreign oil and gas income

The Treasury and IRS 2011-2012 Priority Guidance Plan includes several international projects for the upcoming year, including guidance and regulations on the following topics:

• Subpart F and other anti-deferral issues including final contract manufacturing regulations

• Inbound transactions including guidance under the new FATCA withholding rules of IRC Sections 1471-1474 enacted in 2010; the BKD 2010 Year-End Tax Advisor summarizes these new rules

• Outbound transactions, including final regulations on outbound asset reorgani-zations and regulations on transfers of intangible property to foreign corporations

• Foreign tax credit issues, including regulations under the three new statutory provisions enacted in 2010 concerning covered asset acquisitions, foreign tax credit splitters and the anti-hopscotch rule under IRC Section 956; see the 2010 Advisor for detailed analysis of these new provisions

• Transfer pricing issues such as final regula-tions on cost-sharing arrangements and regulations on global dealing operations

• Sourcing of income and interest expense allocations

Developments in International Tax• Other international related items, includ-

ing final regulations on currency gains and losses on foreign branch remittances

While the Obama administration, Treasury Department and IRS focus on perceived areas of abuse and noncompli-ance in the international tax area, Congress recently has turned its attention to broader discussions on international tax reform. In 2011, congressional committees held numerous hearings on international tax reform focusing on competitiveness in the current global economy and how to make the U.S. more attractive for investing capital and creating jobs. Many believe a comprehensive review of the fundamental core principles shaping the U.S. interna-tional tax system over the past 50 years—including taxation on worldwide income, general deferral on foreign subsidiary earnings and foreign tax credits—is long overdue, as a number of developed coun-tries have lowered their corporate income tax rates and moved from a worldwide system of taxation with foreign tax credits to a territorial tax system or participation regime in which dividends from foreign affiliates are wholly or partly tax-exempt. Repatriation cost is a major focus surrounding these congressional discus-sions, as many U.S. multinational cor-porations sit on large amounts of capital held overseas by foreign subsidiaries and are unwilling or unable to repatriate these funds to the U.S. due to high repatriation cost and the financial statement impact from the deferred tax liability on foreign subsidiary earnings not permanently rein-vested overseas. Some U.S. multinational corporations have found it more practical to keep foreign earnings offshore and focus on growing overseas operations rather than repatriating their foreign earnings to use in growing their U.S. operations. Congress is looking to reverse this trend by develop-ing tax policies that encourage or motivate multinational corporations to bring capital back into the U.S. economy. At the same

time, there also is focus on establishing tax policies that serve to keep operations, jobs and intellectual property (IP) in the U.S. and do not encourage U.S. companies to move their operations and IP offshore. Many ideas on how to accomplish these goals have been discussed, some of which represent significant changes to the current U.S. international tax system, including further limiting or completely eliminating deferral on foreign subsidiary earnings, simplifying the foreign tax credit limitation calculations, providing a tempo-rary repatriation tax holiday, reducing U.S. corporate income tax rates and shifting from a worldwide taxation system to more of a territorial tax approach. On October 26, 2011, House Ways and Means Committee Chair Dave Camp (R-Mich.) proposed major international tax rule modification that would lower the top U.S. corporate income tax rate to 25 percent and would feature a 95 percent deduction for domestic C corporations on the foreign source portion of dividends received from controlled foreign corpo-rations (CFCs). The proposal would treat foreign branches as CFCs, and U.S. corporate shareholders owning at least 10 percent of other foreign corporations could elect to treat such foreign corpora-tions as CFCs to qualify for the 95 percent exemption. The Subpart F anti-deferral rules largely would be retained to ensure the participation exemption applies only to income from the conduct of an active foreign business. The foreign tax credit system also would be preserved for taxes not connected to dividends eligible for the 95 percent exemption. Whether the Camp proposal—or any other major changes to the U.S. interna-tional tax system—have any real chance of becoming law remains to be seen. But the continued focus on international tax reform may indicate significant changes to the U.S. international tax regime on the horizon. s

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Depreciation of Autos & Certain Trucks, Vans & SUVs

Qualifying for Not Qualifying for Potential First-Year Bonus First-Year Bonus Additional Depreciation Depreciation DeductionsAutos

First-Year Depreciation $11,060 $3,060 $8,000

Second-Year Depreciation $4,900 $4,900 $0

Third-Year Depreciation $2,950 $2,950 $0

Fourth-Year Depreciation & Each Succeeding Tax Year $1,775 $1,775 $0

Qualifying for Not Qualifying for Potential First-Year Bonus First-Year Bonus Additional Depreciation Depreciation DeductionsTrucks, Vans & SUVs*

First-Year Depreciation $11,260 $3,260 $8,000

Second-Year Depreciation $5,200 $5,200 $0

Third-Year Depreciation $3,150 $3,150 $0

Fourth-Year Depreciation & Each Succeeding Tax Year $1,875 $1,875 $0

*Generally applies to trucks and vans with a gross (loaded) vehicle weight of no more than 6,000 lbs. For SUVs, the table generally applies to vehicles with a gross unloaded vehicle weight of no more than 6,000 lbs.

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