Tax Related Identity Theft on the Rise

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1 TAX RELATED IDENTITY THEFT ON THE RISE...1 ISSUE WINTER 2014 SIMPLIFIED HOME OFFICE DEDUCTION PENALTY FOR PAYING OR REIMBURSING EMPLOYEE INDIVIDUAL HEALTH PLAN PREMIUMS... 2 DEFENSE OF MARRIAGE ACT (DOMA) DECLARED UNCONSTITUTIONAL...3 FATCA WITHHOLDING EFFECTIVE DATE LOOMING... 3 CHANGE IN RESPONSIBLE PARTY Tax Watch A NEWSLETTER FOR THE CLIENTS AND FRIENDS OF EPPING AND ASSOCIATES, CPAS, P.A. Tax Related Identity Theft on the Rise Incidences of Social Security numbers being stolen to fraudulently claim tax refunds has exploded in recent years. In 2012 the IRS issued $4 billion in fraudulent tax refunds to people using stolen identities. A common practice for thieves is to file fraudulent tax returns early in the filing season to claim refunds before legitimate taxpayers file their returns. The IRS actually makes this easier by issuing quick refunds, often before it receives documents verifying wages, income and tax withholdings. For example, employers are required to provide employees a Form W-2 by the end of January for the prior year s wages but have until the end of February to forward this information on to the IRS. Holding up refunds until returns can be cross-checked would reduce the number of fraudulent refunds but at the cost of significantly slowing refund processing. The IRS indicates that it has over 3,000 agents fighting identity theft. At the IRS.gov website you can find a listing of identity protection tips. Some of the suggestions are quite simple such as not carrying your Social Security card in your wallet or purse. One tip that everyone should understand is that the IRS never contacts taxpayers using social media tools or to request personal or financial information. The IRS does not conduct electronic audits and it does not notify you by that you are getting a refund. If you receive such an , the IRS asks that you forward it to them at phishing@irs.gov. If you unfortunately become a victim of tax-related identity theft (such as learning when you e-file your return that it is rejected because a return has already been filed under your Social Security number), you must notify the IRS using Form Identity Theft Affidavit. You will be required to include copies of an acceptable form of identification to prove who you are such as a passport, driver s license, Social Security card or other U.S. Federal or State government issued identification. The form should be filed with your paperfiled return if possible. If your return has already been filed then the form should be mailed to the same address as the return. Should you become aware that your Social Security number has been stolen, please let us know so that we can assist you with the proper notification with the IRS. SIMPLIFIED HOME OFFICE DEDUCTION Many taxpayers, who use a room in their home for qualifying business purposes, chose not to claim an allowed tax deduction because of the complexities associated with the deduction. Effective for 2013 returns, qualifying taxpayers can elect a simplified home office deduction. The simplified deduction does not change the qualified business use requirement that must be satisfied to claim a home office deduction (described below) but it does substantially simplify the calculation and associated recordkeeping. Provided a taxpayer meets the requirements for

2 claiming a home office deduction, the simplified method allows the taxpayer to compute the deduction by multiplying $5 times the square footage of the part of the residence that is used for business, up to a maximum of 300 square feet. This effectively caps the home office deduction at $1,500. Using the simplified method means that a taxpayer cannot claim the actual expenses associated with the qualified business use of the home including depreciation and utilities. However, home-related expenses that would be deductible even without the qualified business use of the home (such as qualified residential interest and property taxes) can be fully claimed as itemized deductions. Just like the regular home office deduction, the simplified home office deduction cannot create or increase a business loss. Any excess home office expenses can be carried forward for use in future tax years. The simplified home office deduction method cannot be used by employees who receive advances, allowances or reimbursements for expenses related to a qualified business use of their home under a reimbursement or other expense allowance arrangement with their employer. The simplified home office deduction does not treat any of the maximum $1,500 deduction as depreciation expense. This avoids an income tax cost when the home is sold for a profit. While principal residences can qualify for up to $500,000 in gain exclusion ($250,000 for single tax payers) for income taxes purposes, the exclusion does not apply to gain arising from recapturing and reporting as ordinary income previously allowed or allowable depreciation. The simplified home office deduction eliminates this concern. The requirement that must be satisfied to claim a home office deduction is qualified business use of a residence. Qualified business use of a residence requires that part of the home be used regularly and exclusively as either: 1. A principal place of business; or 2. A place to meet or deal with customers or clients in the ordinary course of business. For taxpayers who are employees, the use of the home office must also be for the convenience of the employer. Special rules also apply to homes used to for product storage, dwelling unit rentals or homes used in providing day care for children, the elderly or the incapacitated. Penalty for Paying or Reimbursing Employee Individual Health Plan Premiums In September 2013 the IRS issued Notice providing guidance effective for 2014 on when employers may use arrangements such as health reimbursement arrangements (HRA) or a health flexible spending arrangement (health FSA) to provide employees with a fixed amount to pay for health care premiums and other eligible medical expenses. Generally, the notice precludes employers from maintaining an HRA, health FSA, or other type of tax-free reimbursement arrangement that may be used to pay for or reimburse premiums for health insurance on the individual market (including but not limited to the new Federal and states health care exchanges). An HRA remains viable only if it is integrated with a non- HRA employer-provided group health plan. The IRS notice takes the position that reimbursement-only plans impose annual dollar limits on essential health benefits in violation of the market reforms in the Patient Protection and Affordable Care Act (commonly referred to as Obamacare ). Beginning in 2014, failure to comply with the market reforms can result in an excise tax of $100 per day per affected participant. Employers that have either directly paid or reimbursed employees for health insurance premiums on individual issue health insurance policies should discontinue the practice for This rule does not apply to employer payments for health insurance through employer-sponsored health insurance plans. There is also an exception to this rule if the employer premium reimbursement is limited to only one current employee at the beginning of the year. It is not clear whether S corporation shareholders (owning 2% or more of the corporation) are considered employees for purpose of this notice. Until clarification is forthcoming, it would be prudent for S corporations not to pay or reimburse their 2% or more shareholders individual health insurance policy premiums. 2

3 DEFENSE OF MARRIAGE ACT (DOMA) DECLARED UNCONSTITUTIONAL On June 26, 2013 the U.S. Supreme Court in United States v. Windsor declared the federal Defense of Marriage Act (DOMA) unconstitutional. In Revenue Ruling effective September 16, 2013 the IRS issued guidance on a variety of questions arising as a result of the decision including responses to frequently asked questions. A few of the key matters for taxpayers and their employers that were addressed are summarized below: For Employers and Employees 1. The IRS recognizes the validity of a same-sex marriage that was legally valid in a state where it was entered into even if the taxpayers now live in a state that does not recognize same-sex marriages. 2. Because health care benefits provided to same-sex spouses were considered taxable benefits subject to Federal income tax through 2012, employers can now file amended payroll tax returns to recover the payroll taxes paid on those benefits (employer and employee Social Security and Medicare). The statute of limitations for filing claims for refund for calendar year 2010 is April 15, For Employers 1. Health care benefits covering same-sex spouses were reported on W-2s as subject to Federal income tax through For 2013, employers should exclude these benefits from taxable W-2 wages but include them in total cost of employer-sponsored health coverage reported in the Box 12 with Code DD. For Employees 1. For legally married same-sex couples, all personal Federal income tax returns filed on or after September 16, 2013 must be filed using either the Married Filing Jointly or the Married Filing Separately filing status. This includes 2012 tax returns that had not been filed by that date. 2. Same-sex couples that previously filed their Federal income tax returns are permitted but not required to amend their previously filed returns claiming either Married Filing Jointly or Married Filing Separately filing status. This applies to all tax years that remain open under the statutes of limitations. Generally, returns can be amended up to three years after they are filed. When considering the impact of a change in filing status, taxpayers should also consider the impact of certain previously taxable benefits such as health care insurance for spouses now excludable from taxable income. FATCA Withholding Effective Date Looming The Foreign Account Tax Compliance Act (FATCA) was enacted in March 2010 in an effort by the U.S. government to curb offshore tax evasion. The law s foreign financial asset disclosure requirements became effective for tax year 2011 for individual taxpayers with specified foreign financial assets exceeding certain aggregate value thresholds. The law also imposes effective July 1, 2014, a new withholding requirement on U.S. taxpayers considered to be domestic withholding agents. Affected taxpayers, which includes most businesses that make payments to foreign financial institutions (FFI) or nonfinancial foreign entities (NFFEs) are advised to plan their compliance processes to meet the new withholding requirement. The definition of an NFFE is broad, essentially encompassing any foreign entity (excluding individuals) that is not an FFI. Withholding Requirement The FATCA withholding requirement is established in the new Chapter 4 of the Internal Revenue Code and is applied before (but does not negate) the traditional withholding requirement on payments to foreign entities found in Chapter 3 of the Internal Revenue Code. Effective for payments on or after July 1, 2014, Chapter 4 withholding is required for payments 3

4 when the following conditions are all present: 1. The payee is foreign; 2. The payment is not a specifically identified exempt payment which is to say it is a withholdable payment ; 3. The payer is not in possession of a Form W-8BEN-E, Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities) that certifies that either: a. The foreign payee is excepted; b. The foreign payee has substantial U.S. owners and these owners are disclosed; or c. The foreign payee has no substantial U.S. owners. If all of the above conditions are present, a withholding agent is required to withhold 30% on qualifying payments. The new withholding requirement is all or nothing if applicable. This means U.S. income tax treaties are overridden for purposes of reduced withholding. The Form W-8BEN-E must be in the possession of the payer before payment is made in order to forgo the 30% FATCA withholding. If withholding does not occur and it is later determined that withholding should have been applied, the withholding agent will be liable for the tax. Form W-8BEN-E is a new form that to date has only been issued by the IRS in draft form. The draft form is 8 pages long and supersedes the existing single page Form W-8BEN for foreign entities. Existing forms W-8BEN in the possession of withholding agents will not suffice for payments made after June 30, 2014 because the form only addresses Chapter 3 tax withholding and not the newly introduced Chapter 4 FATCA withholding requirement. The existing form W-8BEN will continue to be used by foreign individuals as distinguished from foreign entities. Exempt and Withholdable Payments Generally speaking, withholdable payments are from sources within the United States that constitute fixed or determinable annual or periodic income. For example, interest paid on a bank account in a U.S. bank would be a withholdable payment because it would be from a source within the United States. A payment to a foreign bank account for goods imported from China would not be a withholdable payment since the goods are not U.S. sourced. However, a payment to a foreign bank for goods purchased within the United States would be a withholdable payment since the goods are from a U.S. source. Certain payments are not considered withholdable payments including (but not limited to): 1. A payment considered to be effectively connected income (payments effectively connected to the conduct of a trade or business in the United States and included in the beneficial owner s U.S. gross income for the taxable year). This exclusion does not apply to payments of effectively connected income when the beneficial owner claims an exemption from U.S. income tax under an income tax treaty because the income is not attributable to a permanent establishment in the United States; 2. Excluded nonfinancial payments including; a. For services (including wages and other employee compensation, such as stock option income); b. The use of property; c. Offices and equipment leases; d. Software licenses; and e. Transportation and freight Additionally, certain payments that would otherwise be considered withholdable payments are specifically exempted as payments because they relate to grandfathered obligations. The most common grandfathered obligations are those that are outstanding at January 1, 2014 and have not been subsequently materially modified or renewed. Foreign Payee Exceptions Certain foreign payees are exempt from FATCA withholding. These exemptions are documented in the form W-8BEN-E and help explain why the draft form is 8 pages long. Many of the exemptions 4

5 relate to the various categories of FFIs that are deemed to be participating with the IRS on FATCA compliance. There are two important foreign payee exceptions applicable to NFFEs, a public company exception (including affiliates of the public company) and an active NFFEs exception. The public company exception requires that at least 50% of the value of the company stock be listed on a qualifying exchange and that at least 10% of the average number of shares outstanding traded on the public exchange during the prior calendar year. Qualifying exchanges include foreign government sanctioned exchanges with an annual trading value exceeding $1 billion during each of the three preceding calendar years, exchanges registered with the Securities and Exchange Commission and exchanges designated under a Limitation of Benefits article in a currently in-force income tax treaty with the United States. An active NFFE is an entity in which less than 50% of its gross income for the preceding calendar year is passive income and less than 50% of its weighted average percentage of assets either produce or are held for the production of passive income. Common types of passive income include dividends, interest and rents and royalties. Conclusion U.S. businesses that make payments to foreign entities need to make sure they are prepared for the new withholding rules that become effective July 1, In addition, U.S. businesses should identify which of their payments are exempted or excluded and which of their payees need to provide them with new withholding certificates that document that they are not subject to FATCA withholding. Absent such documentation, businesses will need to withhold 30% of their payments or risk becoming liable for the withholding themselves. Change in Responsible Party Must be Reported to the IRS Effective January 1, 2014, any entity assigned an employer identification number (EIN) must provide updated responsible-party information to the IRS whenever a change in the identity of the responsible party occurs. For entities traded on a public exchange or registered with the SEC, the responsible party is the principal officer, general partner, grantor, owner or trustor. For all other entities, a responsible party is the person who has a level of control over, or entitlement to, the funds or assets in the entity that as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets. Form 8822-B must be filed within 60 days of the change in the identity of the responsible party (or the change in the responsible party s identifying information such as a name change). If a change occurred prior to 2014, Form 8822-B must be filed by the entity by March 1, Businesses should review the responsible party information originally filed on Form SS-4 Application for Employer Identification Number, and file Form 8822-B with the IRS to report changes by March 1, Clients of the Firm should contact us regarding prior changes and any time a change occurs to officers or owners to allow us to assist with the form if it is required. Notable Numbers for 2014 Standard mileage rates: Business-56.0 cents Medical and moving-23.5 cents Charitable-14.0 cents Maximum 401(k) contributions: Regular contributions-$17,500 Over 50 catch-up contributions- $5,500 Annual Gift Tax Exclusion: Individual-$14,000 Gift splitting-$28,000 Call us if you have any questions about what you have read in this newsletter. We are here to serve you. U.S. Treasury Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or state or local law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication. Epping & Associates, CPAs, P.A. P.O. Box Charlotte, NC