2011 reporting for 2010 conversions to Roth accounts explained

Taxpayers who convert a traditional IRA to a Roth IRA must include the amount transferred in their gross income and pay tax accordingly. For the 2010 tax year, the IRS created special rules enabling taxpayers to convert their traditional IRAs to Roth IRAs with minimal tax liability. Generally, these taxpayers were required to report half of the transferred income on their 2011 return and half on their 2012 return (unless the taxpayer elected to report the income in 2010). Now that the 2012 filing season is upon us, taxpayers who elected to take advantage of this benefit must remember to report the first half of their converted IRA funds on their returns.

Background

2010 was the first year that taxpayers could transfer funds from a traditional individual retirement account (IRA) to a Roth IRA without restriction. To encourage taxpayers to take advantage of this opportunity, Congress provided a special benefit for taxpayers who created Roth accounts in 2010 and made a taxable transfer to the account. Instead of having to report all the income in 2010, taxpayers could defer reporting the income until 2011 and 2012, a welcome benefit for taxpayers who transferred large amounts to their Roth accounts in 2010.

Scope

Amounts transferred into a Roth account from another retirement account are taxable, although they are not subject to the 10 percent tax on early withdrawals. Taxes apply to:

• Eligible rollovers from a retirement plan to a Roth IRA;
• Amounts transferred from a non-Roth IRA to a Roth IRA (a conversion); and
• An in-plan rollover of benefits in a retirement plan to a Roth account maintained by the same plan.

The IRS instructed that taxpayers engaging in one of these transactions must report half of the taxable amount from the transfer on their 2011 tax return and half of the taxable amount in 2012, unless the taxpayer:

• Elected to include the taxable amount in income in 2010 (this election cannot be revoked after the due date for the 2010 tax return);
• Recharacterized the transfer to a Roth IRA as a traditional IRA (the deadline for recharacterizing a 2010 transfer was October 17, 2011; also, an in-plan Roth rollover cannot be recharacterized); or
• Received a taxable distribution in 2010 or 2011 from the Roth IRA (in which case, the taxpayer would not report half of the income but would report a different amount on the 2011 return).

On their 2010 tax return, Form 8606, Nondeductible IRAs, taxpayers would have reported the transfer and either made the election to report it in 2010 or identified the 50 percent amounts reportable in 2011 and 2012.

2011 Reporting

Assuming they did not receive a distribution in 2011, taxpayers who made a transfer to a Roth account in 2010 must include it on their 2011 Form 1040 under Line 15a IRA distributions.

If the taxpayer received a taxable distribution (of the converted amount) in 2010 from the Roth IRA, then in 2011 the taxpayer would report the smaller of:

• The 50-percent amount reported in 2010; or
• The remaining taxable amount from the 2010 transfer.

Example.  Mary transferred $30,000 from a traditional IRA to a Roth IRA in 2010. Later in 2010, Mary received a $20,000 distribution. Mary must include the $20,000 in income for 2010. The 50-percent amount that would have been reportable in 2011 is $15,000 (half of the $30,000 transfer). However, only $10,000 of the transfer remains to be taxed. Since this is smaller than $15,000, Mary reports the remaining $10,000 in 2011, and does not report anything from the transfer in 2012.

If, instead, the taxpayer received a taxable distribution of the converted amount in 2011, then the taxpayer has to fill out Part III or Part IV of the 2011 Form 8606 to determine how much of the transferred amount to report in 2011 and 2012.

Please feel free to call this office for a more targeted explanation of how these reporting rules work in your situation.

IRS audits of higher income taxpayers increase

The IRS audited one in eight individuals with incomes over $1 million in fiscal year (FY) 2011. While the overall audit coverage rate for individuals remained steady at just over one percent, the audit coverage rate for higher-income individuals experienced growth in FY 2011. This trend, however, could be slowed by IRS budget cuts. Congress appropriated $305 million less for the IRS in FY 2012 compared to FY 2011.

Higher income Individuals

The audit coverage rate for individuals with incomes under $200,000 was 1.04 percent in FY 2010 and fell to 1.02 percent in FY 2011. However, the audit coverage rate for individuals with incomes $200,000 and higher increased from 3.10 percent in FY 2010 to 3.93 percent in FY 2011.

Significant gains in audit coverage came in audits of individuals with incomes $1 million or more. The audit coverage rate for those millionaires increased from 8.36 percent in FY 2010 to 12.48 percent in FY 2011.

Field audits of individuals with incomes $200,000 and higher increased from 58,521 in FY 2010 to 78,392 in FY 2011. Field audits of individuals with incomes $1 million and higher increased from 16,509 in FY 2010 to 20,475 in FY 2011.

Businesses

Examinations of business returns in FY 2011 decreased compared to FY 2010. Overall, the IRS examined 9,869,358 business returns (all types of businesses) in FY 2011. That number was 9,941,289 in FY 2010.

Corporations.  Corporations with assets $10 million and higher had the highest audit coverage rate at 17.64 percent in FY 2011 (16.58 percent in FY 2010). Within the large corporation category, the audit coverage rate was highest for corporations with assets $250 million or higher, at 27.6 percent for FY 2011. The audit coverage rate for small corporations (corporations with assets under $10 million) was 1.02 percent in FY 2011 compared to 0.94 percent in FY 2010.

Partnerships/S Corps.  The audit coverage rate for partnerships in FY 2011 was 0.40 percent, compared to 0.36 percent in FY 2010. The audit coverage rate also increased for S corps (0.42 percent in FY 2011 compared to 0.37 percent in FY 2010).

Please feel free to call this office for a more targeted explanation of how these developments may impact your operations.

How Do I… Receive my tax refund that the IRS used to offset my spouse’s debt?

FAQ: What tax breaks come with raising a child?

 Taxpayers with children should be aware of the numerous tax breaks for which they may qualify. Among them are: the dependency exemption, child tax credit, child care credit, and adoption credit. As they get older, education tax credits for higher education may be available; as is a new tax code requirement for employer-sponsored health care to cover young adults up to age 26. Employers of parents with young children may also qualify for the child care assistance credit.

Dependency Exemption

In addition to the personal exemption an individual taxpayer may take for him or herself to reduce taxable income (Line 42 on Form 1040), that taxpayer may also take an exemption for each qualifying dependent who has lived with the taxpayer for more than half of the tax year. A dependent may be a natural child, step-child, step-sibling, half-sibling, adopted child, eligible foster child, or grandchild, and generally must be under age 19, a full-time student under age 24, or have special needs. The amount of the exemption is the same as the taxpayer’s personal exemption, $3,700 for the 2011 tax year and $3,800 for the 2012 tax year.

Child Tax Credit

Parents of children who are under age 17 at the end of the tax year may qualify for a refundable $1,000 tax credit. The credit is a dollar-for-dollar reduction of tax liability, and may be listed on Line 51 of Form 1040. For every $1,000 of adjusted gross income above the threshold limit ($110,000 for married joint filers; $75,000 for single filers), the amount of the credit decreases by $50.

Child and Dependent Care Credit

If a taxpayer must pay for childcare for a child under age 13 in order to pursue or maintain gainful employment, he or she may claim up to $3,000 of his or her eligible expenses for dependent care. If one parent stays home full-time, however, no child care costs are eligible for the credit.

Adoption Credit

Taxpayers who have incurred qualified adoption expenses in 2011 may claim either a $13,360 credit against tax owed or a $13,360 income exclusion if the taxpayer has received payments or reimbursements from his or her employer for adoption expenses. For 2012, the amount of the credit will decrease to $12,650, and in 2013 to $5,000.

Higher Education Credits

There are two education-related credits available for 2012: the American Opportunity credit and the lifetime learning credit. The American Opportunity credit amount is the sum of 100 percent of the first $2,000 of qualified tuition and related expenses plus 25 percent of the next $2,000 of qualified tuition and related expenses, for a total maximum credit of $2,500 per eligible student per year. The credit is available for the first four years of a student’s post-secondary education. The credit amount phases out ratably for taxpayers with modified AGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers). The lifetime learning credit is equal to 20 percent of the amount of qualified tuition expenses paid on the first $10,000 of tuition per family. The phaseout for 2012 ranges from $52,000 to $62,000 ($104,000 to $124,000 for joint filers). Parents also find tax relief in saving for college though Coverdell accounts, section 529 plans and specified U.S.. savings bonds.

Extended Health Care Coverage

Effective since September 23, 2010, the new health care law requires plans to provide coverage for children until they attain age 26. Further, effective on or after March 30, 2010, children under the age of 27 are considered dependents of a taxpayer for purposes of the general exclusion from income for reimbursements for medical care expenses of an employee, spouse, and dependents under an employer-provided accident or health plan. Therefore, a plan must provide coverage to a child who is still a dependent up to age 26; but can do so up to age 27 without income tax consequences. A child includes a son, daughter, stepson, or stepdaughter of the taxpayer; a foster child placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction; and a legally adopted child of the taxpayer or a child who has been lawfully placed with the taxpayer for legal adoption.

Child Care Assistance Credit (for businesses)

Employers may take up to $150,000 of the eligible costs of providing employees with child care assistance as tax credit. These costs may include a portion of the costs of acquiring, constructing, improving, and operating a child care facility.

If you have any questions about these provisions and how they may benefit you, please contact our office.

February 2012 tax compliance calendar

 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 tax reporting and filing data for individuals, businesses and other taxpayers for the month of February 2012.

February 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 25-27.

February 3

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 28-31.

February 8

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 1-3.

February 10

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

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 4-7.

February 15

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 8-10.

Monthly depositors. Monthly depositors must deposit employment taxes for payments in January.

February 17

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 11-14.

February 23

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 15-17.

February 24

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 18-21.

February 29

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 22-24.

March 2

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 25-28.

March 7

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 29-March 2.

FAQ… When do I need to file IRS Form 8938, Statement of Specified Foreign Financial Assets?

 The Foreign Account Tax Compliance Act (FATCA), enacted in 2010, requires certain U.S. taxpayers to report their interests in specified foreign financial assets. The reporting requirement may apply if the assets have an aggregate value exceeding certain thresholds. The IRS has released Form 8938, Statement of Specified Foreign Financial Assets, for this reporting requirement under FATCA.

Reporting

For now, only specified individuals are required to file Form 8938, but specified U.S. entities will eventually also have to file the form. Taxpayers who do not file a federal income tax return for the year do not have to File Form 8938, even if the value of their foreign assets exceeds the normal reporting threshold.

Individuals who have to file Form 8938 include U.S. citizens, resident aliens for any part of the year, and nonresident aliens living in Puerto Rico or American Samoa.

Reporting applies to specified foreign financial assets. Specified foreign financial assets include:

• A financial account maintained by a foreign financial institution;
• Other foreign financial assets, such as stock or securities issued by a non-U.S. person, or an interest in a foreign entity.

The aggregate value of the individual’s specified foreign financial assets must exceed specified reporting thresholds, as follows:

• Unmarried U.S. taxpayers, and married U.S. taxpayers filing a separate return - more than $50,000 on the last day of the year, or more than $75,000 at any time during the year;
• U.S. married taxpayers filing a joint return - more than $100,000 on the last day of the year, or more than $150,000 at any time during the year; or
• Taxpayers living abroad: if filing a joint return, more than $400,000 on the last day of the year, or more than $600,000 during the year; other taxpayers, more than $200,000 on the last day of the year, or more than $300,000 at any time during the year.

Taxpayers who report assets on other forms, such as Form 3520, do not have to report the asset on Form 8938, but must use Form 8938 to identify other forms on which they report.

Filing

Reporting applies for tax years beginning after March 18, 2010, the date that FATCA was enacted. Most taxpayers, such as those who report their taxes for the calendar year, must start filing Form 8938 with their 2011 income tax return.

If you have any questions about Form 8938, please contact our office.

Payroll tax cut extended two-months; other temporary incentives expire

 As 2012 gets underway, Congress has extended the employee-side payroll tax cut but a laundry list of tax incentives have expired and their renewal is in doubt. The fate of these incentives, along with the Bush-era tax cuts, will dominate debate in Washington D.C. in 2012. At the same time, tax planning in a time of uncertainty appears to have become the new normal.

Payroll tax cut

The Temporary Payroll Tax Cut Continuation Act of 2011, approved by Congress on December 23 and signed by President Obama the same day, extends the 2011 payroll tax holiday through the end of February 2012. The employee-share of OASDI taxes is 4.2 percent for the period January 1, 2012 through February 29, 2012 (10.4 percent for self-employment income). The new law also includes a recapture provision for certain individuals. However, the House Ways and Means Committee reported that the recapture provision will only apply if the payroll tax reduction is not extended for the remainder of 2012. Lawmakers are expected to extend the employee-side payroll tax cut through the end of 2012, although not before difficult negotiations.

One speed bump to extending the payroll tax cut through the end of 2012 is its cost. The two-month extension is paid for by increasing certain fees charged to mortgage lenders. A full-year extension will require additional offsets (unless Congress decides not to offset an extension). Lawmakers are reportedly discussing additional revenue raisers, such as unspecified changes to the S corporation rules and the closing of a loophole for corporate jets. Other revenue raisers reportedly under consideration are repeal of certain oil and gas preferences and repeal of the last-in, first-out (LIFO) method of accounting. A variety of spending cuts are also on the table.

Extenders

After December 31, 2011, many popular but temporary tax breaks expire. The incentives, which are known as “extenders,” impact individuals and businesses. Some of the more popular individual extenders are the state and local sales tax deduction, the higher education tuition deduction, and the teachers’ classroom expense deduction. For businesses, the research tax credit is one of the most important extenders. 

One immediate change that many taxpayers will notice is a drop in transit benefits. In 2011, commuters benefitted from more generous transit benefits. The 2011 monthly limit on the tax benefit for transit and vanpools of $230 per month reverts to $125 per month in 2012. However, the monthly limit for qualified parking provided by an employer to its employees for 2012 will increase to $240, up $10 from the limit in 2011.

Several bills have been introduced in Congress to extend the expiring incentives. However, the bills have languished in committee. One reason for the lack of movement is that Congress can extend the incentives in 2012 and make them retroactive to January 1, 2012. The extenders are also separate from the temporary Bush-era tax cuts, which are scheduled to expire after December 31, 2012. Many lawmakers do not want to link the extenders to the more-controversial Bush-era tax cuts.

IRS budget

One bill that did pass Congress at year-end 2011 was a fiscal year 2012 budget for the IRS. Congress voted to cut $305 million from the IRS’s FY 2012 budget. How this cut will impact IRS operations is unknown. In November 2011, the IRS offered buyouts and early outs to back-office employees to reduce its greatest expense: employee payroll. The IRS could also delay some business systems modernizations to save money. The IRS will likely keep customer service as close as possible to full funding, especially during the busy 2012 filing season.

Tax planning

One of the most significant challenges to long-term tax planning is the on-again, off-again nature of many tax incentives. Temporary incentives, such as the research tax credit and the state and local sales tax deduction, have become de facto permanent incentives because they are regularly extended.  Nonetheless, they are temporary. Because of their temporary nature, taxpayers must have two tax plans: one that takes into account an extension of the incentives, and a second plan that does not.

If you have any questions about tax planning and tax legislation in 2012, please contact our office.

IRS releases business standard mileage rate for 2012

The business standard mileage rate, which many employers use to reimburse employees for business miles driven, is 55.5 cents-per-mile for 2012, the IRS has announced.  This reflects no change from the second half of 2011.

Deduction

Under Code Sec. 162(a), taxpayers are allowed a deduction for the ordinary and necessary expenses a taxpayer incurs while operating an automobile for trade or business purposes. Depending on their automobile usage, taxpayers may have several options for calculating the deduction. They may use the actual expense method, which requires them to determine the actual costs to operate the car for business uses. (Actual expenses include gas, oil, repairs, tires, insurance, registration fees, licenses, and other qualified expenditures.)

In the alternative, taxpayers may use the business standard mileage rate set by the IRS. (Although, in order to use the business standard mileage rate, the taxpayer must not operate five or more vehicles at the same time—as for example in a fleet vehicle operation.)

Business standard mileage rate

In June 2011, the IRS announced a mid-year increase in the business standard mileage rate. The business standard mileage rate increased from 51 cents-per-mile to 55.5 cents-per mile for the second half of 2011.

For 2012, the business standard mileage rate will be 55.5 cents-per-mile, which reflects no change from the second half of 2011. 

Other rates

For 2012, the standard mileage rate for medical and moving expenses will be 23 cents-per-mile, reflecting a 0.5 cents-per-mile reduction from 2011. The statutorily-determined rate for the charitable deduction remains unchanged at 14 cents-per-mile for 2012.

Early planning can make 2012 filing season easier

 The new year brings a new tax filing season. Mid-April may seem like a long time away in January but it is important to start preparing now for filing your 2011 federal income tax return.  The IRS expects to receive and process more than 140 million returns during the 2012 filing season. Early planning can help avoid any delays in the filing and processing of your return.

Records

Initially, you will need to gather your records for 2011. A helpful jumping-off point is to review your 2010 return. Your personal situation may be unchanged from when you filed your 2010 return or it may have changed significantly. Either way, your 2010 return is a good vantage point for assembling the materials you will need to prepare your 2011 return.

If you need a copy of your previous year(s) return information, you have several options. You can order a copy of your prior-year return. Alternatively, you may order a tax return transcript or a tax account transcript. A tax return transcript shows most line items from your return as it was originally filed, including any accompanying forms and schedules. However, a tax return transcript does not reflect any changes you or the IRS made after the return was filed. A tax account transcript shows any later adjustments you or the IRS made after the tax return was filed. 

If you changed your name as a result of marriage or divorce since you filed your 2010 return, you must advise the IRS. Your name as it appears on your return needs to match the name registered with the Social Security Administration. A mismatch will likely delay the processing of your return.

Forms W-2

Many taxpayers cannot begin preparing their 2011 income tax returns until they have their Forms W-2, Wage and Tax Statement. Employers have until January 31, 2012 to send you a 2011 Form W-2 earnings statement. If you do not receive your W-2 by the deadline, contact your employer. If you do not receive your W-2 by mid-February, contact the IRS.  You still must file your return or request an extension to file even if you do not receive your Form W-2. In certain cases, you may be able to file Form 4852, Substitute for Form W-2, Wage and Tax Statement.

Filing deadline

April 15, 2012 is a Sunday. Returns would normally be due the next day, April 16, 2012. However, April 16 is a holiday in the District of Columbia (Emancipation Day). As a result, the due date for 2011 returns is April 17, 2012. If the mid-April tax deadline clock runs out, you can get an automatic six-month extension of time to file through October 17. However, this extension of time to file does not give you more time to pay any taxes due.  To obtain an extension, you need to file Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return.

Casualty losses

Many taxpayers experienced family, business and personal losses from hurricanes, tropical storms, wild fires, floods, and other natural disasters in 2011. For federal tax purposes, a casualty loss can result from the damage, destruction or loss of your property from any sudden, unexpected, or unusual event such as a hurricane, tornado, fire, or other disaster.

Casualty losses are generally deductible in the year the casualty occurred. However, if you have a casualty loss from a federally-declared disaster, you can choose to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened. This means you can deduct a 2011 loss on your 2011 return or amended return for that preceding tax year (2010). If you have any questions about a casualty loss, please contact our office.

Retirement savings

Just because the calendar moved from 2011 to 2012 doesn’t necessarily mean you missed out on contributing to a retirement savings plan. You can contribute up to $5,000 to a traditional IRA for 2011 and you can make the contribution as late as April 17, 2012. However, if you or your spouse is covered by an employer retirement plan, this will affect how much, if any, of your contribution is tax deductible. Individuals age 50 and older may qualify for a catch-up contribution of $1,000 on top of the $5,000 maximum. Different rules apply to other types of retirement savings plans.  Our office can review these rules in detail with you.

IRS Fresh Start Initiative

In 2011, the IRS announced a new program, called the Fresh Start Initiative, to help distressed taxpayers. The IRS adjusted its lien policies, increased the dollar threshold when liens are generally issued, made it easier for taxpayers to obtain lien withdrawals, and extended the streamlined offer-in-compromise program. Previously, the IRS had given its employees greater authority to suspend collection actions in certain hardship cases where taxpayers are unable to pay. This includes instances where a taxpayer has recently lost a job, is relying solely on Social Security, or is paying significant medical bills.

If you are experiencing hardship, the most important thing you can do is to remain in compliance with your tax obligations. If you owe back taxes, now is the time to pay them, if possible, or enter into an installment agreement, if you qualify, with the IRS. The IRS wants to see you making a good faith effort to pay your taxes.

Tax law changes

Along with assembling records and reviewing activities in 2011, it’s a good idea to review some of the tax law changes in 2011 that may affect your return. Our office can review your 2010 return and see which areas may have been affected by tax law changes for your 2011 return. In some cases, popular tax incentives that were available in 2010 were extended into 2011. You don’t want to miss out on any available tax breaks.  

If you have any questions about preparing for the 2012 filing season, please contact our office.

January 2012 tax compliance calendar

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 tax reporting and filing data for individuals, businesses and other taxpayers for the month of January 2012.

January 6

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 31-January 3.

January 10

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

January 11

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 4-6.

January 13

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 7-10.

January 17

Monthly depositors. Monthly depositors must deposit employment taxes for payments in December.

January 19

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 11-13.

January 20

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 14-17.

January 25

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 18-20.

January 27

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 21-24.

January 31

Employers. Employers give employees copies of Form W-2 for 2011.

Employers. Employers file Form 945 to report income tax withheld for 2011 on all nonpayroll items. Deposit any undeposited tax (if more than $2,500).

Employers. Employers file Form 941 for the fourth quarter of 2011. Deposit any undeposited tax (if more than $2,500).

Employers file Form 940 to report federal unemployment tax for 2011. Deposit any undeposited tax (if more than $500).

Small employers. Certain small employers file Form 944 to report Social Security, Medicare, and withheld income tax for 2011. Deposit any undeposited tax (if more than $2,500).

February 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 25-27.

February 3

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 28-31.