Some say they’re a way to save on business taxes. The U.S. Congress has termed them “loopholes” and is looking at ways to close them.

Here’s what’s being considered under what’s known as the American Jobs and Closing Tax Loopholes Act:

Carried interest
“Carried interest” occurs when a partner receives an interest in future profits in exchange for services. That income is taxed at capital gains rates. The  House and Senate want to change the way carried interest will be taxed:

House

• Part of the income that is recharacterized would be taxed at ordinary income rates, which, for tax years beginning before 2013, would be 50%.
• For tax years beginning after January 1, 2013, that rate increases to 75%.
• No industries would be exempt. This provision would be effective now, for tax years ending in 2010.

Senate

• This bill would tax the recharacterized income at 65% beginning after 2012.
• The rate would be reduced to 55% for gain or loss from the sale of assets held at least seven years.
• For 2011 and 2012, the applicable tax rate would be 50%.
• A carve-out would exempt the recharacterized income from the sale of certain interests in energy-related public partnerships.

With the top ordinary income rate currently at 35% and the top capital gain rate currently at 15%, the tax hike would be enormous as it is. Plus, after 2011 the two ordinary income rates are expected to rise to 39.6% and 20%, respectively. In addition, ordinary income would be subject to self-employment taxes.

S corporations
Both House and Senate bills address what some lawmakers see as evasion of employment tax by certain individuals. The Internal Revenue Service has stated that many taxpayers receive nominal salaries and take their earnings through distributions by S corps., limited partnerships, or other entities. The House and Senate bills would change that situation by imposing self-employment payroll taxes on 100% of S-corp. pass-through income when:

• The S corp. is engaged in a professional service business, with the key assets being the reputation and skill of no more than three employees, or
• The S corp. is a partner in a professional service business.

Foreign Tax Credit Reforms
The foreign tax credit was intended to prevent double taxation on foreign-source income. But corporations have found ways to use the credit to reduce the taxes they pay in the United States.

The House and Senate have adopted a matching rule that prevents the separation of creditable foreign taxes from the related foreign income. The bill contains various provisions which suspend the recognition of foreign tax credits until the associated foreign income is taxed in the U.S. Further:

• Stock acquisitions that are treated as asset purchases generally qualify for a stepped-up basis. For foreign companies, the step-up cannot be used for foreign taxes, but only for U.S. taxes, in order to prevent taxpayers from claiming foreign tax credits against foreign income that was never taxed in the U.S.
• The foreign tax credit is limited to the top U.S. tax rate of 35%. The Obama administration states that some taxpayers are inflating foreign source income by using treaties to shift the source of some assets to their foreign branches. House and Senate reforms set aside this income so that it is not used to claim foreign tax credits.

The bill, HR 4213, as of this date is still going through various procedural measures.

The White House and the Internal Revenue Service just released the details on eligibility for companies that want to get a tax credit under the new healthcare legislation.

To start with, generally, the smaller your business, the greater the tax credit. The max credit goes to companies that have 10 or fewer full timers and pay annual average wages of $25,000 or less. Once your company hits 25 FTEs receiving average annual wages of $50,000 per year, the credit phases out completely.

More details:

Dental and eyecare. Besides getting credit for the usual health coverage, employers can get the credit for supplemental dental and vision plans — or what’s known as limited-scope coverage. To get the credit, eligible small employers must pay at least 50% of the premium of such coverage.

Determining FTEs. You have some flexibility here, and that’s important because the value of the credit goes down as your number of FTEs goes up. The new guidance allows employers to choose from among three different methods of determining hours to minimize paperwork and still get the maximum credit. Employers can use (a) actual hours of service,  (b) an estimate of hours based on total days of service, or (c) an estimate based on total weeks of service.

State-based credits. Except in a few instances, the federal tax credit won’t be reduced if you get a state healthcare tax credit or subsidy — currently available in 20 states. You’ll get the full federal credit based on its entire contribution, as long as the federal credit doesn’t exceed the employer’s net contribution.

See IRS Notice 2010-44 for more details. The notice gives examples to help employers decide if they qualify for the credit. Generally, small businesses that pay at least half the cost of single coverage qualify. The maximum credit from 2010 to 2013 will be:

• 35% of premiums paid for eligible small business employers, and
• 25% of premiums paid by tax-exempt organization employers.

The study was conducted by USA Today and the Bureau of Economic Analysis, and compared tax rates today with those of the past. Here’s what came out:

• Federal, state and local taxes — including income, property, sales and other taxes — ate up 9.2% of all personal income in 2009, the lowest rate since 1950 and below the average of 12% for the past 50 years.
• On average, the federal tax rate has fallen 26% since the recession began in 2007.
• One-third of last year’s $862 billion economic stimulus went for tax cuts. Biggest reduction: The Making Work Pay tax credit reduced income taxes $800 for married couples earning up to $150,000.
• Changes in the tax code under Presidents Clinton and G.W. Bush — credits, lower rates, higher exemptions — cut income taxes for poor and middle-class families, meaning a drop in income now can trigger big tax breaks and sharply lower rates, sometimes zero.
• Consumers cut spending sharply in this downturn, thereby paying less in sales taxes.

The bad news

If the statistics are on target, that’s obviously good news. Here’s the bad news:

• The statistics cover what has happened. They don’t cover what’s going to happen as a result of increased government spending. Many experts say that higher taxes are inevitable.
• As noted, tax revenue has taken a hit in the last few recessionary years. People are spending less and making less, which usually pushes them into a lower tax bracket. After a meaningful recovery, the IRS bite should increase.

A review of the relevant details of the HIRE Act:

• Employers who hire unemployed workers this year (after Feb. 3, 2010, and before Jan. 1, 2011) may qualify for a 6.2% payroll tax incentive, in effect exempting them from the employer’s share of Social Security tax on wages paid to these workers after March 18.
• The reduction will have no effect on the employee’s future Social Security benefits. The employee’s 6.2% share of Social Security tax and the employer and employee’s shares of Medicare tax still apply to all wages.
• For each qualified employee retained for at least a year whose wages did not significantly decrease in the second half of the year, businesses may claim a new-hire retention tax credit of up to $1,000 per eligible worker.

You can get further details about the tax credit and the payroll tax exemption from a recently expanded list of answers to frequentlyasked questions about the new law.

To claim the payroll tax exemptions
New Form 941, Employer’s QUARTERLY Federal Tax Return, revised for use beginning with the second calendar quarter of 2010, will be filed by most employers claiming the payroll tax exemption for wages paid to qualified employees. The HIRE Act does not allow employers to claim the exemption for wages paid in the first quarter but provides for a credit in the second quarter. The instructions for the new Form 941 explain how this credit for wages paid from March 19 through March 31 can be claimed on the second quarter return.

Important notes:

• The HIRE Act requires that employers get a signed statement from each eligible new hire, certifying under penalties of perjury, that he or she was not employed for more than 40 hours during the 60 days before beginning employment with that employer. You can use new Form W-11, Hiring Incentives to Restore Employment (HIRE) Act Employee Affidavit, released last month, to meet this requirement.
• Though employers need this certification to claim both the payroll tax exemption and the new hire retention credit, they do not file these statements with the IRS. Instead, they must retain them along with other payroll and income tax records.
• New hires filling existing positions — and not just positions that have been added to your payroll — also qualify as long as they are replacing workers who left voluntarily or who were terminated for cause and otherwise are qualified employees.
• Family members and other relatives do not qualify for either of these tax benefits.
• Businesses, agricultural employers, tax-exempt organizations, tribal governments and public colleges and universities all qualify to claim the payroll tax exemption for eligible newly-hired employees. Household employers and federal, state and local government employers, other than public colleges and universities, are not eligible.

Sure, everyone’s talking about health reform and its down-the-road costs. There will be real and imposing administrative demands on your staff, too.

Here’s a five-year time line for major admin adjustments:

2010:

Your plan will have to:

• add employee dependents up to age 26
• drop preexisting condition exclusions on children
• lift lifetime limits on the value of coverage

Your payroll people will have to:

• Allow for a bigger income exclusion for qualified adoption assistance. The maximum adoption tax credit and income exclusion for employer-provided adoption assistance increases to $13,170 (indexed for inflation).
• Gather and provide data needed to qualify for employer subsidies and to receive a tax credit for employer-provided coverage for firms with no more than 25 employees and an average wage of less $50,000 per employee. From 2010 to 2013, the credit equals 35% of an employer’s contribution if the company pays at least 50% of the premium.

2011:

• The company will have to report the value of each employee’s employer-provided health coverage, along with other info, on Forms W-2.
• Get ready to change records if employees decide to set less money aside in a healthcare spending plans. Beginning next year, employees won’t be able to buy over-the-counter drugs tax-free through a flexible spending account health reimbursement account, or health savings account.

2012:

That’s the year Payroll will start increasing the paycheck deduction for the Medicare portion of the FICA tax increases — to 2.35% (up from 1.45%) — for individuals earning more than $200,000 annually ($250,00 for couples).

2013:

Payroll will have to adjust deductions to reflect new limits on pre-tax contributions to health accounts. Employees will be able to set aside up to $2,500 for health flexible spending accounts.

2014:

• This is the kick-in date for employers to begin offering a minimum level of health coverage — paying penalties for noncoverage. If you offer coverage that’s considered “unaffordable,” the company pays the lesser of $250 a month for each full-time worker receiving a government subsidy or $166.67 a month for each full-time worker
• If you don’t offer coverage, the penalty is $2,000 per full-time worker – even if just one employee receives a tax credit to buy insurance.

If you’re looking for a tax preparer, IRS cautions to look for red flags. Be wary if the prospective preparer:

• Promises to get you a bigger refund than another preparer. A blanket promise of a bigger refund is a dead giveaway that’s something’s not right.
• Uses a fee schedule that’s based on a percentage of the amount of a refund. Honest preparers won’t base fees on refunds.
• Promises to represent you in any dealing with the IRS, even though the preparer isn’t a tax attorney, a CPA or an otherwise enrolled agent. Tax preparers are authorized to represent you only in matters relating to forms they’ve actually prepared.
• Has no affiliation with recognized professional groups. Most legitimate tax preparers are members of professional organizations that provide continuing education and update on the tax laws, as well as having a code of ethics.

The IRS has also listed sample case studies involving prosecution of underhanded preparers and their clients.

The U.S. Chamber of Commerce and various unions have signed off on their opposition to the proposed 40% excise tax on so-called “Cadillac” health plans — those whose premiums exceed $8,500 for individuals and $23,000 for families.

Under the proposal, the tax would be levied on insurance companies that offer such plans and on employers who self-insure. The Congressional Budget Office says the tax would provide $149 billion in revenue by 2019. Further, proponents of the tax say it will help curb healthcare costs by forcing employees to be more aware of their medical spending and by discouraging insurance companies and employers from offering lavish plans.

Employers and unions firmly oppose the plan, for different reasons:

• Unions contend their workers have given up wage increases in return for better benefits. Labor leaders warn that the excise tax will force cuts in benefits or pass-along cost increases to workers. In an e-mail to members, the Teamsters said the tax would fall on one-third of Americans in a decade, and the average affected household would pay $7,600 more in taxes between 2013 and 2019. Further, as health-plan costs would almost certainly rise in the coming years, the tax would hit more and more people whose premiums would grow into the “Cadillac” category.
• Employer groups note that about 160 million people receive health coverage through employers that self-insure. The Chamber of Commerce argues that those employers will be hit with the cost burden, likely resulting in reduced worker benefits to avoid the tax or reduced wages to make up for the tax.

Both sides also argue the tax would be a killer in high-cost areas such as California or the Northeast, where health plans tend to be more expensive.

As previously reported, the Internal Revenue Service was gearing up for the audits to uncover unpaid business and payroll taxes. IRS is still planning the nationwide audit, but is pushing it back to February.

Here’s what auditors will be looking at:

• Three federal taxes collected, paid and/or remitted by employers — employee income taxes deducted by the employer, FICA and FUTA.
• Employment taxes related to four areas — worker classification, fringe benefits, reimbursed expenses and compensation of owner employees.

The audits have been triggered by an IRS study that shows a “tax gap” in the billions of dollars for unpaid business and payroll taxes.

The Internal Revenue Service is calling it “the National Research Program on employment tax compliance.” What it amounts to is a far-reaching audit program to dig up business-tax revenues.

Here are the two main areas that are going under the IRS spotlight:

• Improper worker classification. The agency is mainly concerned with workers classified as independent contractors because the classification affects the revenue state governments receive to pay for unemployment benefits.
• So-called nonconforming benefits. Those are benefits that could be considered wages subject to employment taxes. The typical targets: personal use of company vehicles, employee discounts, employer-provided housing and meals, accident and health benefits, educational assistance and stock-based compensation. Reimbursed expenses, in order to be tax-free and deductible, must generally be reasonable, have a business connection, include reasonable accounting for the expenses, and all excess reimbursement should be repaid within a reasonable time.

IRS has announced that it will be looking at mainly tax records for 2007 and 2008, but that doesn’t mean other years are exempt from examination. The announcement about the program was first made by the agency’s Anita Bartels at the Annual Congress of the American Payroll Association.

proposing a boost in the federal tax deduction for business meals from 50% to a whopping 80%.

U.S. Representative Neil Abercrombie (D-Hawaii) introduced the legislation, which would make changes in the tax code.

The new rate would apply to legitimate business deductions and have the additional benefit of helping restaurants and small businesses.

As you can imagine, that’s good news for restaurant and small business owners, who’ll likely see an increase in traffic if the new deduction gets passed. Restaurants are a big driver of the economy, responsible for about $1.5 trillion that circulates through the industry.

It’s estimated that a an increase in the tax deduction for business meals to 80% will boost business meal sales by $6 billion a year and create an $18 billion increase to the overall economy.

The industry currently employs an estimated 13 million people, or 9% of the U.S. workforce.

The federal tax deduction for business meals was reduced to 50% in 1993.

It wasn’t a new idea — technically, the taxes are already required. A 1989 law classifies personal use of a business phone as a taxable benefit, meaning employees are required to track their calls, text messages, and downloads, and pay taxes on the value of anything not work-related.

But the law was passed when cell phones were bulky, calls were expensive and service was limited. So hardly any employees got phones, and those who did made few personal calls.

Once cell phones became common, the IRS stopped enforcing the law. That stance looked as if it was going to change, though, when the agency unveiled a plan to collect the taxes.

To ease the administrative burden of tracking every call, the IRS came up with three other options:

1. Consider 75% of phone use to be work-related, and the other 25% to be personal, across the board. All employees would pay tax on the 25%, regardless of how they used the phone.
2. Let employees prove they have a personal cell phone they can use during work hours. Then they wouldn’t be taxed at all for the work-issued phone.
3. Have employers take a statistical sampling to determine employees’ average personal use.

The IRS announced it would take public comments on the proposals until Sept. 4. But it looks like they got enough already.

Even with the three options, the proposal generated an outcry of protest from IT and accounting staffers worried about dealing with call records, HR and benefits pros concerned about one of their perks diminishing in value, and people with work-issued cell phones who don’t want to pay more taxes.

In response, the agency reversed its position. In a statement, IRS chairman Doug Shulman asked Congress to make it clear there will be no tax consequence for employees who use work-related devices for personal reasons.

He said the purpose of the proposal was not to “crack down” on collecting the taxes, but rather to simplify the rules. However, Shulman said in the statement, “the passage of time, advances in technology, and the nature of communication in the modern workplace have rendered this law obsolete,” and keeping it on the books will “inevitably leave widespread confusion among employees and businesses.”

Bills that would repeal the old law have been introduced into both houses of Congress this year. We’ll keep you posted.