Transcript Tax & Legal Update

Peter Scott
Worldwide ERC
Tax Counsel
Advancing > Lives > Forward
Topics:
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Federal Tax Changes
New Medicare Taxes for 2013
IRS Audits of Homesale Programs
Relocation Short Sales
Tax Primer: One year rule
Federal Tax Changes
• “American tax laws are constantly changing as our
elected representatives seek new ways to ensure
that whatever tax advice we receive is incorrect.”
Dave Barry
Federal Tax Changes
• Most Americans dodged a bullet on January 1
– Tax cuts from 2001 and 2003 were set to expire
– A number of other provisions of value to mobility
industry would also have expired
• “American Taxpayer Relief Act”
Federal Tax Changes
• New law Jan 1:
– Reduced tax rates made permanent, except for
taxpayers with taxable income of $400,000
($450,000 married filing jointly)
• 10%, 15%, 25%, 28%, 33%, 35%
• Brackets are adjusted for inflation after 2013
Federal Tax Changes
• Top rate returns to 39.6% for taxable income above
“high income” thresholds
– $400,000/$450,000 also indexed for inflation
– Note these taxpayers only paying top rate on
income above the thresholds
Federal Tax Changes
• Capital Gains
– Had Congress not acted, reduced capital gain tax rate would have
disappeared
– Capital gains will still be taxed at 15%, except 20% rate returns for
those in high income brackets above
• Dividends
– Would have returned to tax at regular income tax rates
– 15% rate made permanent
– 20% for high income
Federal Tax Changes
• Personal exemptions, itemized deductions
– Old law phaseouts would have returned had Congress not acted
– New law limits phaseouts, but makes permanent
• Phaseouts now begin at $250K of adjusted gross income ($300K married
filing jointly)
– Old phaseouts started at $178K
– However, still will raise taxes for fair number of taxpayers (note AGI is
larger than taxable income)
• This is where Dave Barry comes in!
Federal Tax Changes
• Effects on Mobility
– Gross-up calculations largely unaffected; would have changed
considerably if all rates rose
– Saves companies lots of money
– Supplemental withholding rate also stays at 25%
– Withholding tables provided by IRS, to be used ASAP but no later than
February 15
– Reinstatement of personal exemption and itemized deduction
phaseouts may prompt a few more gross-up challenges
– No more uncertainty about rates
Federal Tax Changes
• A casualty: No more reduced FICA tax
– Employee portion returns to 6.2% from 4.2%
– Employers told to implement increased
withholding by February 15, adjust for underwitholding by March 31
• Wage Base $113,500 for 2013
Federal Tax Changes
• Alternative Minimum Tax (AMT)
– Taxpayer must pay the higher of standard tax or alternative
minimum tax
– Alternative minimum tax is intended to ensure that taxpayers pay
at least minimum tax, but not adjusted for inflation
– Original exemption amounts, if allowed to come into play today,
would result in some 30-40 million middle class taxpayers paying
AMT. Big gross-up problem
– AMT doesn’t allow personal exemptions, standard deductions,
deductions for state income taxes or for interest on second
homes or home equity lines
– AMT higher exemption amounts expired on December 31, 2011,
but the problem has now been permanently fixed
Federal Tax Changes
• Big Deal: AMT permanently fixed
– Exemption levels rise, are indexed for inflation
– No more annual fixes
– Saves some 30 million taxpayers from owing
several thousand more
– Reduces gross-ups
Federal Tax Changes
• Other good news
– Exclusion for up to $2 million forgiven mortgage debt on
principal residence extended through 2013
– Private mortgage insurance deduction reinstated for 2012
and 2013
– Same for deduction for state and local sales taxes
Federal Tax Changes
• Many other credits/breaks extended
– Child tax credit
– Student loan interest deduction
– Child and dependent care credit
– Adoption credit
• These may be welcome to transferees, but can complicate
gross-up when taxable relocation puts transferee above levels
when credits phase out
Tax Reform
• “A tax loophole is something that benefits the other
guy. If it benefits you, it is tax reform.” Russell B.
Long
• “I was working on a flat tax proposal, and I
accidentally proved there’s no God.” Homer Simpson
• “This idea that you start with a clean slate and end
up with a beautiful, logical tax system just isn’t
democracy.” John L. Knapp
Tax Reform
• Possibly could happen as part of “grand bargain” to address the deficit
• Most popular notion is to reduce/eliminate tax breaks that cost money,
reduce/flatten rates somewhat
• Tax breaks we care a lot about might be included
– Mortgage interest deduction
– State/local income tax deduction
– Foreign income exclusion
– Home sale capital gain exclusion
– Moving expense deduction
• Not likely this year, but Boy Scout motto applies
New Medicare Taxes
• Two new taxes on high income individuals begin January 1,
2013
– .9% increase, to 2.35%, in employee share of Medicare
– Applies to those whose wages exceed $200,000 ($250,000 married
filing jointly)
– Employer not required to withhold unless the wages of the spouse
working for the employer exceed $200k, even if joint wages exceed
$250k
– Will require adjustment of withholding for high income employees,
and consideration of gross-up if taxable relocation puts employee over
$200k and if company grosses up for Medicare
New Medicare Taxes
• Second new tax is a 3.8% tax on unearned income (for example, interest,
dividends, annuities, rents, capital gains)
• Applies to those whose Adjusted Gross Income exceeds $200,000
($250,000 married filing jointly). Note different standard for threshold
• Applies to the lesser of unearned income or the amount AGI exceeds the
threshold
– Example: UI is $15,000, AGI is $210,000. Tax applies to $10,000.
• No withholding required, but companies will have to consider gross up if
taxable relocation puts employee over the AGI threshold. This is not a
Medicare tax, but an additional INCOME tax to help fund Medicare
New Medicare Taxes
• UI tax could apply to gain from home sale
• However, applies after the home sale capital gain exclusion
($250,000, or $500,000 married filing jointly), and after basis
is subtracted. That is, applies to net capital gain after the
exclusion
– Example: Sale price $800,000, basis $600,000, capital gain exclusion
$250,000, amount subject to 3.8% tax is zero
– Very few relocating employees have reportable capital gain beyond
the home sale exclusion
• Reports circulating on internet that this is a tax on real estate
sales are erroneous
• However, would apply to gain from sales of second homes if
seller income is high enough
New Medicare Taxes
• May cause estimated tax issues for those affected
• Some may owe both the 0.9% Medicare tax and the
3.8% UI tax, although applied to different parts of the
income base
• Gross-up issues will require reference to actual tax
returns
IRS Audits of Homesale Programs
• “The Opera reminds me of my tax
audit. It was in a language I didn’t
understand, and it ended in tragedy.”
Jeff McNelly’s “Shoe”
IRS Audits-Homesale Program
• IRS agents still sometimes contend BVO with no appraisal,
guaranteed buyout, not within Rev. Rul. 2005-74
• Good case they are wrong, but ERC continues to recommend
addition of delayed AV process
• Position of IRS lawyers who wrote Rev. Rul. 2005-74 unclear
– Have expressed some skepticism that BVO works, but no
definite position
• No indication yet that issue has resurfaced as part of the IRS’s
ongoing special employment tax audits, but caution advised
IRS Audits-Homesale Programs
• Delayed AV Process-Example
– Employee markets with BVO for 90 days
– If no offer, company does appraisals or BMA’s, determines an
appraised value
– Offers employee appraised value, or some realistic percentage
of it (e.g., 90%), but
• Employee must continue to market for 60 days before accepting
• Must market at no more than realistic percentage of appraised value
(e.g., 102%)
• IRS invariably accepts this process as a qualifying AV
IRS Audits-Homesale Programs
• Generally, audits less frequent than in past, but still a
number every year
• Audits focus not only on basic BVO, but procedures
used (also in AV)
• Poor audit results are almost always the result of
questionable risk reduction procedures used by
company
Procedure Problems
• In both AV and BVO, companies often have waited to
enter contract with transferee until inspections are
complete, all contingencies are removed from outside
contract
• Transferee is usually involved in negotiating inspection
results
• Sometimes, company intentionally waits to sign contract
with transferee until very shortly before outside closing,
resulting in a “holding period” of no more than 1-3 days
Procedure Problems
• IRS consistently maintains that this practice falls within
“situation 3” of Rev. Rul. 2005-74 and that the program
fails. Company has simply not assumed significant
ownership risk for any significant period of time
– Recent audit: IRS disqualified all transactions in which contract
with outside buyer signed first
– Cost company millions, will also cost more millions for the next
few years until company can clean up its practice
Procedure Problems
Companies should NOT engage in practices that artificially
create short holding periods. They should also NOT wait
for inspections to be completed before contracting with
employee. Better practice is to do own inspections up
front, do not rely on buyer inspections to set price for
purchase from employee
Audit Results
• “We try to cooperate fully with the IRS, because, as citizens,
we feel a strong patriotic duty not to go to jail.” Dave Barry
• Tax Lawyer’s Golden Rule: If somebody has to go to jail, make
sure it’s the client
Audit Results
• In audits, IRS invariably asks for complete list of
purchase and sale dates
• IRS invariably concludes that all purchases/sales within
a few days of each other fail
– Some success for taxpayer when it can be shown that nothing
other than transferee vacate date causes some to be close
together
– However, if procedures force short periods, IRS always sticks to
disallowance
• Settlements usually involve company conceding all
transactions where purchase/sale within some agreed
number of days of one another
Audit Results
• Other issues:
– Reverse contracts
• Can be explained if occasional delays on one side or the other the
cause
• IRS always questions if delay intentional
– Regular delays in payments of equity until outside sale
closes
– Repayment agreement including home sale expenses
Audit Results
• IRS sometimes notes company is not treating houses
as capital assets for income tax deduction purposes,
takes that to mean it is contending it doesn’t actually
own them
– But company does agree it owns houses
– They are not capital assets because section 1221 excludes
from that category property held for sale in the ordinary
course of a trade or business
• Interestingly, incidence of income tax audits raising
capital loss issue has greatly declined
Relocation Short Sales
• Old Country Song: “How can I miss you if you
won’t go away”?
• Another: “I’m so miserable without you, its
just like you’re still here”
• Short sales can involve both of these
principles
Relocation Short Sales
• It is possible to take these homes into a
relocation home sale program (some
companies will do so, others won’t), but
some issues must be addressed
Relocation Short Sales
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In a relocation short sale, still must have two separate, independent sales
for tax purposes
In a homesale program, companies must be extremely careful that the
amount of negotiation and finalization of the outside sale between
transferee and buyer does not violate the “two transaction” requirement for
favorable tax treatment
– Lender ordinarily willing to base acceptance of short sale on offer from
employer, provided it can be satisfied amount is FMV
– In an AV or GBO, there will be appraisals
– In a BVO, need contract with outside buyer to establish value.
Relocation Short Sales
• But company must protect itself in event lender
approval to reduce debt is not obtained
– If company buys house without reduced debt, will
become liable for entire debt
– Excess debt over FMV of house will be wage income
to employee, subject to withholding, FICA
– Same result as if employer had paid negative equity
on employee’s behalf
Relocation Short Sales
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How to protect company:
– DO NOT include clause in sale contract with outside buyer making that
contract contingent on employee obtaining debt reduction
– DO include clause in purchase contract with employee making that
transaction dependent upon employee obtaining debt reduction
• This is no different than standard clause in such contracts requiring
that employee pay negative equity
– DO include clause in Addendum with buyer making entire contract
contingent upon company ability to obtain ownership of the home
• This is a standard clause in all relocation sales
Relocation Short Sales
• Other factors:
– Lenders should actually prefer relocation short sales over not only
foreclosures, but over other short sales
• Unlike other short sales, company is paying sale costs, they don’t come
out of proceeds and reduce lender share
• Sometimes lenders don’t understand this, have to be reminded
– Some lenders continue to have issues with corporate purchasers, or
with fact there will be a “flip” within a short period
– Lenders sometimes include various representations in affidavits that
purchaser must sign that are problematic because company doesn’t
know all the facts relating to outside buyer
Tax Primer: One-year rule
• Moving expense regs say move has to be “proximate in time”
with beginning of work at new location
– One year is presumed to be proximate
– But if taxpayer can show that “circumstances existed which
prevented” the move within one year, moving expenses
still deductible
• Example: children finishing school (IRS has allowed 30
months)
Tax Primer: One-year rule
• What else might “prevent” the move?
– Spouse employment
– Parent or dependent care
• How about inability to sell the old home?
– No authority, but good case
• If transferee has made good faith and unsuccessful efforts to sell,
or
• Cannot afford to sell because “underwater” on debt
– Won’t work if transferee just wants to wait for market to
improve
Tax Primer: One-year rule
• Important principle:
– One-year rule has NOTHING TO DO with the tax treatment
of home sale programs
• Employee goes to new job in 2009, doesn’t want to sell old home
yet
• Employer puts home through qualifying Amended Value program
in 2012
• Home sale costs are not taxable to employee
• However, costs of moving HHG in 2012 will be taxable unless
transferee can show that “circumstances existed which prevented”
a move within one year
The End (whew!)
• Old saying: “Knowledge is knowing the tomato is a fruit.
Wisdom is not putting it in a fruit salad.” However,
• Murphy’s First Minor Law:
– Anything you try to make absolutely clear will confuse
everybody
• Therefore:
QUESTIONS!!! (And Answers)
• Rules:
– Has to be one I can answer (but not necessarily on the
subjects we covered)
– Questioner cannot be on permanent “banned” list (you
know who you are)
– No “stump the tax nerd”
– No questions such as “how much do you weigh”
• Contact information:
– [email protected]
– 910-579-5332