The 2010 Tax Relief Act – Taking Note of Beneficial (But Temporary) Provisions
By Eric J. Gould, Esq., Couzens, Lansky, Fealk, Ellis, Roeder & Lazar, P.C., Farmington Hills, MI
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 20101 (the “Act”), passed by the 111 th Congress in its closing days, extends numerous tax provisions for an additional two years2, introduces new tax provisions, and makes some significant changes to the federal estate, gift and generation-skipping transfer taxes. There are several elements of the Act worthy of note to those in the healthcare industry.
TEMPORARY EMPLOYEE PAYROLL CUT
For 2011, the Act provides a “tax holiday” of two percentage points of the employee portion of social security tax3. This reduces the tax from 6.2% to 4.2% on all wages earned up to $106,800. Self-employed individuals will pay only 10.4% instead of 12.4% of social security self-employment taxes on all of their self-employed income up to the same threshold. This tax reduction is only for the employee portion of social security taxes; employers will continue to be responsible for their 6.2% payment of social security tax on employee wages up to the threshold.
In light of the late adoption of the Act, the Internal Revenue Service (“IRS”) was delayed in issuing Publication 15 (Circular E), “Employer’s Tax Guide”, for use in 2011. Late in December, the IRS issued Notice 10364, “Early Release Copies of the 2011 Percentage Method Tables for Income Tax Withholding” to reflect changes made by the Act. Likely, employers using payroll services will, by the time of its publication, have implemented and adopted these revised withholding tables. In new Circular E, the IRS advises employers to implement the reduced employee social security tax rate as soon as possible, but no later than January 31, 2011. Once the adjustment has been made, employers are to make an offsetting adjustment in a subsequent pay period to correct any over-withholding under the prior tables. That adjustment should be made as soon as possible, but not later than March 31, 2011.
TEMPORARY INVESTMENT INCENTIVE
To encourage investments in new business equipment, the Act temporarily alters the current law for recovering the cost of capital expenditures under a depreciation schedule. For any asset acquired after September 8, 2010 which has been placed into service before January 1, 2012, businesses are entitled to receive immediate and full depreciation of the asset5. This will provide companies with larger deductions for 2011. Moreover, if expenses exceed income, then losses can be carried back to the prior two years to create a tax refund, and any such unused loss may be carried forward to offset future income.6 A taxpayer may also elect to forego the loss carry backs and merely carry the losses forward.7
This provision is not subject to dollar limitations or restrictions as to the type of depreciable property purchased, nor the size of the deduction taken. This is in contrast to Internal Revenue Code Section 1798, which provides taxpayers with an election to immediately expense a portion of the cost of qualifying property placed into service during the year (which is $500,000 in 2011). The $500,000 limitation is reduced by the amount by which the cost of property placed into service exceeds $2,000,000. Also under this election, a taxpayer may not create a loss. The Act provides all companies with an opportunity to make capital acquisitions and receive full and immediate expensing of the cost, which benefit is more advantageous than electing to expense under Section 179. Consequently, large capital acquisitions should be closely evaluated. Many healthcare entities will find this provision attractive, especially if they have been evaluating the replacement or acquisition of equipment in 2011.
Consideration also should be given to forming a new business entity to acquire the assets and subsequently lease the property since doing so would provide a significant loss to the company during its first year. If the entity is formed as an S corporation9, LLC, or partnership, potentially significant losses can be passed through to the owners. Of course, a physician maintaining a financial relationship with an entity that that leases equipment to the physician’s medical practice is subject to the Stark law and the regulations thereunder10. There is a statutory exception for equipment leases. The lease must: be in writing, signed by the parties, specify the equipment, have a stated term of at least one year, and set payments in advance at a commercially reasonable fair market value which does not take into account the volume or value of referrals or other business generated. The equipment lease must not exceed what is legitimately reasonable and necessary for the lessee’s exclusive use of the equipment.
An alternative for owners of existing companies is to loan money to the entity to finance the purchase. This allows the business to fully depreciate the assets purchased and placed into service in 2011 with the note, and payments will be made by the borrowing entity with a deduction for the interest paid under the note. (Of course, the note holders will have interest income, taxed at the higher ordinary income tax rates.) The notes could be secured by the purchased assets. Before incurring this debt or offering security in the assets, it is essential to review the terms of any existing financing and other contractual arrangements to avoid violating any covenants or other contractual commitments in the agreements.
An additional benefit can be obtained under the Act as to computer technology and equipment. The Act extends an enhanced charitable deduction for contributing computer equipment and software to an elementary or secondary school or public library11. The amount of the deduction equals the corporation’s basis in the donated property, plus one-half of the amount of ordinary income that would have been realized if the property had been sold. To qualify, a corporation must make the contribution within three years of the property’s acquisition or the substantial completion of its construction or assembly. Another condition is that either the donor or the recipient must be the original user of such property. The Act also extends for two years a provision that allows S corporation shareholders to take into account their pro rata share of such charitable deductions, even if those deductions exceed their adjusted basis in their stock.12 As a result, 2011 provides a unique opportunity to upgrade and replace computer systems, fully deduct the cost of the new computer equipment, and obtain a charitable contribution for the replaced equipment.
TEMPORARY INCREASE OF GIFT TAX EXEMPTION
Under EGTRRA the credit for gift tax was limited to gifts of $1 Million of assets, even though the estate tax exemption amount increased over time to $3.5 Million. The Act “re-couples” the exclusion amount, permitting the transfer of $5 Million of assets either by gift during lifetime or bequests at death.13 This larger exclusion creates a greater opportunity to transfer property for numerous purposes. Those with appreciating assets can transfer the assets and remove the future appreciation from their taxable estate. Medical professionals should take note of this expanded opportunity to transfer assets without gift tax and protect a greater amount of assets from claims of creditors.
A few items of caution: First, all asset protection planning should be done with great care to not constitute a transfer to defraud creditors. This means that no transfers should be made when there are known claims or potential claims against the individual; the transferor should retain sufficient assets in his or her name to meet current obligations; and the transfer should not violate the terms of any existing loans, guarantees, or other contractual obligations. Second, planning should be done with the understanding that the $5 Million exemption under the Act is temporary. The exemption amount sunsets on December 31, 201214, and without further action, will revert to $1Million thereafter.15Third, there is no “standard” plan or strategy to merely present, adopt, and implement. Tax planning and asset protection planning are highly dependent on an individual’s goals, objectives, needs and preferences, among other considerations that go into such planning. And, not all goals and objectives are reasonable or achievable. Proper planning, review, analysis, and client understanding of the advantages, disadvantages, and limitations of such planning are critical.
TEMPORARY EXCLUSION OF FUNDS FROM CERTAIN SCHOLARSHIPS
The Act provides extended relief for award recipients from the National Health Service Corps Scholarship Program and the F. Hebert Armed Forces Health Profession Scholarship and Financial Assistance Program. Both programs provide education awards to participants on the condition that they provide certain services.16 Under Internal Revenue Code Section 117,17 scholarships are excluded from gross income, unless they represent payment for services required as a condition for receipt of the scholarship or tuition reduction. These awards were excluded from income through December 31, 2010, even though they represent payment for teaching, research and other services. The Act extends the expiration of this exclusion to December 31, 201218.
A constant throughout the Act is its short duration. In fact, the word “temporary” is used in each title of the Act, except for the final title regarding budgetary provisions. The Act offers individuals and businesses new tax benefits, as well as continued enjoyment of other favorable tax provisions. Members of the healthcare industry will find some interesting and very favorable opportunities which are available for a limited time.
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