Tax writers in Congress are set to begin debating and writing tax reform legislation. On September 27, the White House and GOP leaders in Congress released a framework for tax reform. The framework sets out broad principles for tax reform, leaving the details to the two tax-writing committees: the House Ways and Means Committee and the Senate Finance Committee. How quickly lawmakers will write and pass tax legislation is unclear. What is clear is that tax reform is definitely one of the top issues on Congress’ Fall agenda.

Tax writers in Congress are set to begin debating and writing tax reform legislation. On September 27, the White House and GOP leaders in Congress released a framework for tax reform. The framework sets out broad principles for tax reform, leaving the details to the two tax-writing committees: the House Ways and Means Committee and the Senate Finance Committee. How quickly lawmakers will write and pass tax legislation is unclear. What is clear is that tax reform is definitely one of the top issues on Congress’ Fall agenda.

Individuals

The GOP framework proposes consolidating the current seven individual tax rates into three: 12, 25 and 35 percent. However, the framework leaves open the possibility of an additional top rate “to the highest-income taxpayers to ensure that the reformed tax code is at least as progressive as the existing tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers.”

For individuals, the GOP framework also proposes to:

• Eliminate the alternative minimum tax
• Roughly double the standard deduction
• Repeal the federal estate tax
• Preserve the home mortgage interest deduction and the deduction for charitable contributions
• Eliminate most other itemized deductions
• Repeal the personal exemption for dependents
• Retain tax benefits that encourage work, higher education and retirement security

Family incentives

Family incentives have traditionally garnered bipartisan support in Congress and the GOP framework includes several. The child tax credit, for example, currently phases out when incomes reach certain levels. The GOP framework calls for increasing the income levels for the credit to unspecified amounts.   Another proposal would create a new non-refundable $500 credit for non-child dependents. The details would be left to the tax-writing committees.

Businesses

One pillar of the GOP framework is a corporate tax rate cut. The framework calls for a 20 percent corporate tax rate, down from the current 35 percent rate. Businesses that operate as passthroughs, such as S corporations, would have a maximum tax rate of 25 percent, subject to unspecified limitations to prevent abuses.

Other business proposals include:

• Enhanced expensing
• Limiting the deduction for net interest expenses by C corporations
• Eliminating the Code Sec. 199 deduction
• Preserving the research and development credit and tax preferences for low-income housing
• Reforming certain international taxation rules

Drafting legislation

After the GOP framework was released, the chairs of the tax writing committees said their committees would begin drafting legislation. The Ways and Means Committee is made up of 24 Republicans and 16 Democrats. Republicans also have a majority on the Senate Finance Committee but only by two votes (14 to 12). This narrow vote margin is likely to influence any tax bill out of the Senate Finance Committee. Our office will keep you posted of developments.

Extenders

A number of popular but temporary tax incentives have expired. Unless extended, these “extenders” will not be available to taxpayers when they file their 2017 returns in 2018. They include:

• Tax exclusion for canceled mortgage debt
• Mortgage insurance premium deductibility
• Higher education tuition deduction
• Special expensing rules for film, television, and theatrical productions
• Seven-year recovery period for motorsports entertainment complexes

Other tax bills

Several tax-related bills may be taken up by either the House or Senate, including:

• RESPECT Act, passed by the House and waiting for a vote in the Senate, would limit the IRS’s ability to seize assets related to structured transactions
• FY 2018 IRS budget bill, passed by the House and waiting for a vote in Senate, which would fund the IRS for FY 2018

Please contact our office if you have any questions about tax reform, the extenders or other tax bills.

As millions of Americans recover from Hurricanes Harvey, Irma and Maria, Congress is debating disaster tax relief. The relief would enhance the casualty loss rules, relax some retirement savings rules, and make other temporary changes to the tax laws, all intended to help victims of these recent disasters. At press time, a package of temporary disaster tax relief measures is pending in the House. The timeline for Senate action, however, is unclear.

As millions of Americans recover from Hurricanes Harvey, Irma and Maria, Congress is debating disaster tax relief. The relief would enhance the casualty loss rules, relax some retirement savings rules, and make other temporary changes to the tax laws, all intended to help victims of these recent disasters. At press time, a package of temporary disaster tax relief measures is pending in the House. The timeline for Senate action, however, is unclear.

Tax relief

In past years, after disasters similar to Hurricanes Harvey, Irma and Maria, Congress passed disaster tax relief measures. After Hurricane Katrina, far-reaching disaster tax relief was passed by Congress, which benefited businesses and individuals. In 2008, lawmakers passed a national disaster tax relief law. However, that law was temporary. After Hurricane Sandy several years ago, disaster tax relief was introduced in Congress but ultimately was not passed. Now, Congress is revisiting disaster tax relief.

Targeted tax relief

The House bill is the Disaster Tax Relief Act of 2017. The bill provides targeted tax relief to victims of Hurricanes Harvey, Irma and Maria. Unlike national disaster tax relief, discussed below, the measures in the House bill are temporary.

Included in the House bill is language to:

• Enhance the deduction for personal casualty losses
• Allow penalty-free access to retirement funds
• Encourage charitable giving
• Provide a tax credit to qualified employers
• Allow taxpayers to use prior year income for EITC and child tax credit

At press time, a similar disaster tax relief bill has not been introduced in the Senate. Reports have surfaced that the Senate Finance Committee may unveil some proposals in the near future. These proposals could mirror some or all of the ones in the House bill.

National disaster tax relief bill

In September, Rep. Bill Pascrell, D-New Jersey, and Rep. Tom Reed, R-New York, introduced the National Disaster Tax Relief Act of 2017. Their bill aims to create disaster tax relief not just for victims of Hurricanes Harvey, Irma and Maria, but victims of all disasters. The lawmakers modeled their 2017 bill on previous national disaster tax relief acts, including the legislation passed in 2008.

Like the House-passed temporary disaster tax relief bill, the National Disaster Tax Relief Act would relax the casualty loss rules. The National Disaster Tax Relief Act would also provide a temporary five-year net operating loss (NOL) carryback for qualified natural disaster losses; allow an affected business taxpayer to deduct certain qualified disaster cleanup expenses; and increase temporarily the limits that an affected business taxpayer could expense for qualifying Code Sec. 179 property.

Please contact our office if you have any questions about disaster tax relief.

IRS Exam staffing in fiscal year (FY) 2016, the latest tax year with statistics available, reached a 20-year low. As a result, the Treasury Inspector General for Tax Administration (TIGTA) has reported that the IRS undertook fewer audits.

IRS Exam staffing in fiscal year (FY) 2016, the latest tax year with statistics available, reached a 20-year low. As a result, the Treasury Inspector General for Tax Administration (TIGTA) has reported that the IRS undertook fewer audits.

Staffing

"Examination is a vitally important aspect of maintaining a voluntary tax compliance system because 85 percent of the Gross Tax Gap is comprised of underreported tax on timely filed returns," TIGTA reported. Although hiring increased in FY 2016, it did not make up for recent attrition and retirements, TIGTA found. Examination staffing in FY 2016 reached a 20-year low with 8,847 employees, a decrease of four percent from FY 2015 (9,189 employees) and 23 percent lower than FY 2012 (11,432 employees).

Overall, the number of IRS full-time employees has declined by some 14 percent since FY 2012. The decline in the number of employees is likely to continue, TIGTA predicted. Approximately 22 percent of full-time permanent employees in the IRS are eligible to retire, and the IRS expects this number to increase to 34 percent by 2019, TIGTA found. "Should this loss of staffing be realized, the gap created by the loss of knowledge and experience has the potential to materially affect the administration and enforcement of tax laws," TIGTA reported.

Audit coverage

Individuals. TIGTA reported that the IRS examined one of every 143 individual income tax returns in FY 2016. This reflected a 16 percent decline compared to FY 2015 and 30 percent fewer examinations than the five-year high reported in FY 2012. The IRS examined one in 17 returns in FY 2016 with more than $1 million in income, which, according to TIGTA, is a decline of 29 percent compared to FY 2015.

Corporations and S corps. TIGTA found that fewer corporate tax returns were examined during FY 2016 than any year since FY 2004. The number of S corp examinations fell 15 percent from FY 2015 to FY 2016 (one in every 295 S corp returns in FY 2016 compared to one in every 248 S corp returns in FY 2015).

Partnerships. Partnership examinations also declined, TIGTA found. The number of partnership returns examined decreased 24 percent from FY 2015 to 14,645 in FY 2016. "Due to a focus on partnership examinations in FY 2015, one of every 196 returns filed were examined; however, this number decreased to one of every 263 returns being examined in FY 2016," TIGTA reported.

TIGTA Ref. No. 2017-30-072

IRS Chief Counsel, in generic legal advice (AM-2017-003), recently described when a qualified employer may take into account the payroll tax credit for increasing research activities. The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) created the payroll credit aimed at start-ups with little or no income tax liabilities. This tax break allows taxpayers to get the cash benefit of the payroll tax credit sooner as they reduce their payroll tax liability as payroll payments are made, instead of having to wait until the end of the quarter to receive the credit.

IRS Chief Counsel, in generic legal advice (AM-2017-003), recently described when a qualified employer may take into account the payroll tax credit for increasing research activities. The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) created the payroll credit aimed at start-ups with little or no income tax liabilities. This tax break allows taxpayers to get the cash benefit of the payroll tax credit sooner as they reduce their payroll tax liability as payroll payments are made, instead of having to wait until the end of the quarter to receive the credit.

Background

A qualified business during a tax year may elect to apply a portion of its research credit against the 6.2 percent payroll tax imposed on the employer’s wage payments to employees. This payroll credit for research expenditures is limited to the lesser of: (a) the research credit for the tax year; (b) $250,000; or (c) the amount of the business credit for the tax year, including the research credit that may be carried forward to the tax year immediately after the election year.

Schedule B. Chief Counsel explained that if an employer is a semiweekly schedule depositor, it must complete Schedule B (Form 941), Report of Tax Liability for Semiweekly Schedule Depositors, and attach it to Form 941. Schedule B is also referred to as Record of Federal Tax Liability (ROFTL) for semiweekly schedule depositors. The IRS uses this information to determine if the employer made its federal employment tax deposits on time. Current Instructions for Schedule B describe the payroll tax credit.

Payroll credit

Employers, Chief Counsel explained, know the maximum amount of payroll tax credit potentially available for a quarter at the beginning of the quarter. This is because the return reflecting the payroll tax credit election on Form 6765, Credit for Increasing Research Activities, must have been filed before the quarter begins in which the employer can claim credit. However, the amount of the credit that is allowed for the quarter is limited to the employer Social Security tax on wages paid to the employer's employees during the quarter.

Therefore, as the employer makes payments of wages from the beginning of the quarter for which the payroll tax credit is taken, the employer can take the payroll tax credit into account for purposes of the Schedule B and for purposes of deposit liability on the Form 941 or other employment tax return, provided the employer later files Form 8974, "Qualified Small Business Payroll Tax Credit for Increasing Research Activities," Chief Counsel explained.

Further, the payroll tax credit should be taken against deposit liabilities and reflected on Schedule B as the employer incurs liability for employer Social Security tax on wages paid in the quarter to which it applies, beginning with the first payment of wages in the quarter. "It would be counter to the purpose of the payroll tax credit to allow it as a credit only when the employer files its Form 941 for the quarter claiming the credit and not as the employer is paying wages during the quarter subject to employer Social Security tax," Chief Counsel stated.

Deadline opportunity: The IRS also recently announced that it would allow start-up companies to make the payroll tax credit election on an amended return for the 2016 tax year, but as long as the amended return is filed by December 31, 2017.

Yes, however, there are special timing rules for foreign adoptions. These rules differ from the timing rules for domestic adoptions and impact when you may claim qualified adoption expenses.

Yes, however, there are special timing rules for foreign adoptions. These rules differ from the timing rules for domestic adoptions and impact when you may claim qualified adoption expenses.

The Tax Code provides a nonrefundable credit for qualified adoption expenses. The credit is subject to income limitations, which means that some taxpayers may not qualify for it. Generally, the credit covers adoption expenses such as fees, court costs, traveling expenses, and other expenses directly related to the adoption.

The Tax Code also distinguishes between domestic and foreign adoptions. This distinction is important due to timing rules. The IRS has explained that a domestic adoption is the adoption of a U.S. child, an eligible child who is a citizen or resident of the U.S. or its possessions before the adoption effort begins. Qualified adoption expenses paid before the year the adoption becomes final are allowable as a credit for the tax year following the year of payment, even if the adoption is never finalized and even if an eligible child was never identified.

A foreign adoption is the adoption of an eligible child who is not yet a citizen or resident of the U.S. or its possessions before the adoption effort begins. Qualified adoption expenses paid before and during the year are allowable as a credit for the year when the adoption becomes final.

Let’s look at an example. Julia pays qualified adoption expenses of $2,000 in 2015, $3,000 in 2016 and $4,000 in 2017 related to the adoption of Marisa, who is not a U.S. citizen or resident. The adoption becomes final on September 5, 2017. Because the adoption is foreign and not domestics, Julia may claim all $9,000 in expenses on her 2017 federal income tax return.

After an adoption becomes final, qualified adoption expenses paid during or after the year of finality are allowable as a credit for the year of payment, whether the adoption is foreign or domestic. In our example, Julia pays an additional $1,000 in qualified adoption expenses in 2018. Julia may claim the $1,000 in expenses on her 2018 return.

The adoption credit is just one personal tax preference that could be modified if Congress passes a tax reform bill. Under current law, as described above, there is a distinction between domestic and foreign adoptions. Please contact our office if you have any questions about the adoption credit and how it may help offset the expenses of an adoption, whether domestic or foreign.

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important federal tax reporting and filing data for individuals, businesses and other taxpayers for the month of October 2017.

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important federal tax reporting and filing data for individuals, businesses and other taxpayers for the month of October 2017.

October 4

Employers. Semi-weekly depositors must deposit employment taxes for Sept 27–Sept 29.

October 6

Employers. Semi-weekly depositors must deposit employment taxes for Sept 30, Oct 1–Oct 3.

October 10

Employees who work for tips. Employees who received $20 or more in tips during September must report them to their employer using Form 4070.

October 12

Employers. Semi-weekly depositors must deposit employment taxes for Oct 4–Oct 6.

October 13

Employers. Semi-weekly depositors must deposit employment taxes for Oct 7–Oct 10.

October 16

Individuals. Individuals with automatic 6-month extensions file Form 1040, 1040A, or 1040EZ, and pay any tax, interest, and penalties due.

Corporations. Corporations who had timely requested an automatic six-month extension file calendar year income tax return (Form 1120) and pay any tax, interest and penalties due.

Employers. For those to whom the monthly deposit rule applies, deposit employment taxes and nonpayroll withholding for payments in September.

October 18

Employers. Semi-weekly depositors must deposit employment taxes for Oct 11–Oct 13.

October 20

Employers. Semi-weekly depositors must deposit employment taxes for Oct 14–Oct 17.

October 25

Employers. Semi-weekly depositors must deposit employment taxes for Oct 18–Oct 20.

October 27

Employers. Semi-weekly depositors must deposit employment taxes for Oct 21–Oct 24.

October 31

Employers. File Form 941 for third quarter of 2017 and deposit or pay any undeposited tax. Pay tax liability in full with timely filed return if less than $2,500. If the tax for the quarter was deposited timely, properly, and in full, deadline to file Form 941 is November 13.

Employers. Deposit federal unemployment tax owed through September if more than $500.

Certain Small Employers. Deposit any undeposited tax if tax liability is $2,500 or more for 2017 but less than $2,500 for the third quarter.

November 1

Employers. Semi-weekly depositors must deposit employment taxes for Oct 25–Oct 27.

November 3

Employers. Semi-weekly depositors must deposit employment taxes for Oct 28–Oct 31.

Every year, Americans donate billions of dollars to charity. Many donations are in cash. Others take the form of clothing and household items. With all this money involved, it's inevitable that some abuses occur. The new Pension Protection Act cracks down on abuses by requiring that all donations of clothing and household items be in "good used condition or better."

Good used or better condition

The new law does not define good or better condition. For guidance, you can look to the standards that many charities already have in place. Many charities will not accept your donations of clothing or household items unless they are in good or better condition.

Clothing cannot be torn, soiled or stained. It must be clean and wearable. Many charities will reject a shirt with a torn collar or a jacket with a large tear in a sleeve. As one charity spokesperson summed it up, "Don't donate anything you wouldn't want to wear yourself." 

Household items include furniture, furnishings, electronics, appliances, and linens, and similar items.  Food, paintings, antiques, art, jewelry and collectibles are not household items. Household items must be in working condition. For example, a DVD player that does not work is not in good used or better condition. You can still donate it (if the charity will accept it) but you cannot claim a tax deduction. Household items, particularly furnishings and linens, must be clean and useable. 

The new law authorizes the IRS to deny a deduction for the contribution of a clothing or household item that has minimal monetary value. At the top of this list you can expect to find socks and undergarments, which have had inflated values for years.

Fair market value

You generally can deduct the fair market value of your donation. Unless your donation is new - for example, a blouse that has never been worn - its fair market value is not what you paid for it. Just like when you drive a new car off the dealer's lot, a new item loses value once you wear or use it.  Therefore, its value is less than what you paid for it.  

If you're not sure about an item's value, a reputable charity can help you determine its fair market value. Our office can also help you value your donations of used clothing and household items.

Get a receipt

Generally, you must obtain a receipt for your gift. If obtaining a receipt is impracticable, for example, you drop off clothing at a self-service donation center, you must maintain reliable written information about the contribution, such as the type and value of the property.

Charitable contributions of property of $250 or more must be substantiated by obtaining a contemporaneous written acknowledgement from the charity including an estimate of the value of the items. If your deduction for noncash contributions is greater than $500, you must attach Form 8283 to your tax return. Special rules apply if you are claiming a deduction of more than $5,000.

Exception

In some cases, the new rules about good used or better condition do not apply. The restrictions do not apply if a deduction of more than $500 is claimed for the single clothing or household item and the taxpayer includes an appraisal with his or her return.

If you have any questions about the new charitable contribution rules for donations of clothing and household items, give our office a call. The new rules apply to contributions made after August 17, 2006.

Uncle Sam takes a tax bite out of almost every asset sold and collectibles are no exception. Indeed, collectibles are currently subject to one of the highest rates of federal taxation on investment property. Capital gain from the sale of a collectible is taxed at 28 percent.

What is a collectible?

What is a "collectible?" Of course, collectibles include stamps and coins, fine wines, glassware, and other commonly collected items.

It's important to keep in mind that less obvious items are often "collectibles." For example, a collection of political campaign buttons and badges can be a collectible. If an item is an antique, it is probably a collectible.  

Higher tax rate

Traditionally, collectibles have been taxed at a high capital gains rate because of public policy arguments. Supporters of high capital gains tax rates for collectibles justify their position by the lack of broader benefits, such as innovation, new products and higher productivity, that society receives from collectibles. On the other hand, society benefits from the preservation of works of art, antiques and many other collectibles.

Currently, the capital gains tax rate for collectibles is 28 percent. This is significantly higher than the capital gains tax rate for stocks, securities and many other investments, which enjoy a 15 percent capital gains tax rate (five percent for taxpayers in the 10 or 15 percent tax brackets).

Understanding basis

Before you calculate gain, you have to have an understanding of basis. If you purchased the item, then your calculations start with the cost of acquisition. These costs include not only what you actually paid for the collectible but also auction and broker's fees.

Inherited collectibles are treated differently. Your basis is the collectible's fair market value at the time of inheritance. Most commonly, fair market value is determined by an appraisal but there are other methods. Another way to show fair market value is by looking at current sales of comparable collectibles.

Your collectible may have been a gift from another person. In this case, your basis is the same as that of the person who made the gift.

Many collectibles require special care. You may have spent money to maintain the collectible or restore it.  These costs are also part of your basis in the collectible.

After you have calculated your basis in the collectible, you subtract your basis from the amount you sold the item for. This is your capital gain.

Example. Beverly inherits a 19th century rocking chair from her grandmother. Shortly before she died, Beverly's grandmother had the chair appraised. Its value was determined to be $2,000. Beverly spends $500 to restore the chair. Two years later, Beverly sells the chair online. Beverly earns $3,900 from the sale. Beverly's basis in the chair is ($2,500) ($2,000, which was the chair's fair market value when she inherited it, plus the $500 she spent to restore it). Beverly's capital gain is $1,400 ($3,900 minus $2,500). As a collectible, it is taxed at 28 percent rather than 15 percent, a difference of $182 in tax.

"Gold bug" advice

The price of gold has almost doubled in the past several years. Investing in gold presents two issues. First, there is the issue of valuing gold coins. When coins have numismatic worth exceeding their face denomination, the amount realized is the numismatic value of the coins, not the face value. Second, if you want to invest in the price of gold rather than in the collectible nature of a gold coin, you should consider investing in gold strictly as a precious metal, through a mutual fund, gold stocks, or other negotiable certificate. That interest, and the gain realized by selling it, is entitled to full capital gain treatment.

Understanding the tax treatment of collectibles is complicated. Our office can help you determine if your item is a collectible, what your basis is and, if you have sold it or are thinking of selling it, what your capital gain would be. Don't hesitate to give our office a call.

The actual date a business asset is placed in service is important because it affects when depreciation may be claimed for tax purposes. Depreciation begins in the tax year that an asset is placed in service. The placed-in-service date is especially important in the case of end-of-tax year acquisitions.

If an asset is placed in service on December 31 by a calendar-year taxpayer, depreciation is claimed on that asset for that tax year. If the same asset is placed in service one day later on January 1, depreciation deductions cannot be taken before that new year. The placed-in-service date also determines whether certain mid-quarter and half-year "conventions" will apply, which can mean greater depreciation deductions if purchase and use are timed just before the quarter or mid-year cut off date.

An asset is placed in service on the date that it is in a condition or state of readiness for a specifically assigned function in a trade or business or the production of income, which is not necessarily the date of acquisition. An asset that is being used in a trade or business is clearly placed in service. However, an asset not put to use is most likely not placed in service, unless everything in the taxpayer's power has been done to put the asset to use. An example of this is a canal barge that was deemed placed in service in the year it was acquired despite not being used until the following tax year because the canals were frozen.

Another related rule is that an asset will not be considered placed in service until the business actually begins operations. For example air conditioners installed in a grocery store before the store's opening were not considered placed in service until the store was actually open for business. In many instances this is not a bad thing, since a startup business usually has a limited amount of income during its first year to offset with depreciation deductions. Depreciation deductions in that case generally are more valuable later in the business's development.

No, parking tickets are not deductible. Internal Revenue Code Sec. 162 (a) provides that no deduction is allowed for fines or penalties paid to a government (U.S. or foreign, federal or local). While many delivery businesses consider parking tickets as a cost of doing business and more akin to an occasional "rental" payment for a place to park, a parking ticket is a fine and, as such, it is not deductible. By definition, parking tickets are civil penalties imposed by state or local law. The Tax Court decided that parking tickets are not business deductions way back in 1975 in a case dealing with a taxpayer that was trying to deduct as a business expense some parking tickets, among other things. The court allowed the other deductions but did not allow the parking tickets, citing Code Sec. 162.

The AMT is difficult to apply and the exact computation is very complex. If you owed AMT last year and no unusual deduction or windfall had come your way that year, you're sufficiently at risk this year to apply a detailed set of computations to any AMT assessment. Ballpark estimates just won't work.

If you did not owe AMT last year, you still may be at risk. The IRS estimates that half million more individuals will be subject to the AMT in 2006 because of rising deductions and exemptions. If Congress doesn't extend the same AMT exclusion amount given in 2005, an estimated 3 million more taxpayers will pay AMT.

For a system that was intended originally to target only the very rich, the AMT now hits many middle to upper-middle class taxpayers as well. Obviously something has to be done, and will be, eventually, through proposed tax reform measures. In the meantime, expect AMT to be around for at least another year.

Basic calculations. Whether you will be liable for the AMT depends on your combination of income, adjustments and preferences. After all the computations, if your AMT liability exceeds your income tax liability, you will be liable for the AMT. Here are the basic steps to take to determine in evaluating whether you will owe the AMT:

• Step #1: Calculate your regular taxable income. If your regular tax were to be determined by reference to an amount other than taxable income, that amount would need to be determined and used in the next steps.
  
• Step #2: Calculate your alternative minimum taxable income (AMTI) by increasing or reducing your regular taxable income (or other relevant amount) by applying the AMT adjustments or preferences. These include business depreciation adjustments and preferences, loss, timing and personal itemized deductions adjustments, and tax-exempt or excluded income preferences. This is the step with potentially many sub-computations in determining increases and reductions in tax liability.
  
• Step #3:  If your AMTI exceeds the applicable AMT exemption amount, pay AMT on the excess.

While no single factor will automatically trigger the AMT, the cumulative result of several targeted tax benefits considered in Step #2, above, can be fatal. Common items that can cause an "ordinary" taxpayer to be subject to AMT are:

• All personal exemptions (especially of concern to large families);
• Itemized deductions for state and local income taxes and real estate taxes;
• Itemized deductions on home equity loan interest (except on loans used for improvements);
• Miscellaneous Itemized Deductions;
• Accelerated depreciation;
• Income from incentive stock options; and
• Changes in some passive activity loss deductions.

Starting for tax year 2005, businesses have been able to take a new deduction based on income from manufacturing and certain services. Congress defined manufacturing broadly, so many businesses -just not those with brick and mortar manufacturing plants-- will be able to claim the deduction. The deduction is 3 percent of net income from domestic production for 2005 and 2006. This percentage rises to 6 percent and then 9 percent in subsequent years.

Domestic production includes the manufacture of tangible personal property and computer software in the U.S. It also includes construction activities and services from engineering and architecture. Income from these activities must be calculated on an item-by-item basis and cannot be determined by division, product line or transaction. Direct and indirect costs are subtracted to determine "qualified production income." Land does not qualify as domestic production property.

The 3 percent rate is applied to the lower of net income from domestic production and overall net income. That amount is then capped at 50 percent of wages paid out by the employer for all its business activities.

Example. In 2005, Company X has $300,000 of income from domestic production activities. The company's overall net income was $500,000.  The 3 percent rate is applied to $300,000, yielding a potential deduction of $9,000.

Company X paid its employees $50,000 in wages and reported this amount on Forms W-2 for 2005.  Since the deduction is limited to 50 percent of wages paid and reported, Company X's deduction for 2005 is capped at $25,000 (50 percent of $50,000 in wages).  X is entitled to a $9,000 deduction.

W-2 wage limitation

In some cases, the W-2 wage limit can easily trip up taxpayers. A successful sole proprietor who earns income but has no employees would not have any W-2 wages and, therefore, could not take the deduction.  Self-employment income is not treated as wages. Neither are payments made to independent contractors. A small business that is incorporated but has no employees would have the same problem. Because payments to partners are not W-2 wages, a partnership with two partners and no employees also would be unable to take the deduction. Sole proprietors and other small businesses may want to consider putting a family member on the payroll, so that they have W-2 wages to satisfy this requirement.

An incorporated business, such as an S corporation, could put an owner on the payroll and apply the W-2 limit to reasonable wages paid to the owner. Employees include officers of the corporation and common law employees, as defined in the Tax Code.  The more labor-intensive the manufacturing process, the more likely that a deduction will not be reduced by the W-2 wage limitation. The more automated the manufacturing process, the more likely it is that the manufacturer will find itself restricted by the wage limitation and not be able to take the full manufacturing deduction.

Code Sec. 199 defines W-2 wages as the sum of the total W-2 wages reported on Forms W-2, "Wage and Tax Statement," for the calendar year ending during the employer's taxable year. W-2 wages are defined as wages and deferred salary that is included on Form W-2.  Deferred salary includes elective deferrals for a 401(k) plan or tax-sheltered annuity; contributions to a plan of a state and local government or tax-exempt entity; and designated Roth IRA contributions. IRS guidance provides three methods for calculating W-2 wages.

Our office can help you determine your eligibility for the manufacturing deduction and the amount of the deduction. Give us a call today.