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The IRS has announced a significant increase in enforcement actions for syndicated conservation easement transactions. This is a "priority compliance area" for the agency.

Throughout the IRS, coordinated examinations are being conducted in the Small Business and Self-Employed (SB/SE) Division, Large Business and International (LB&I) Division, and Tax Exempt and Government Entities (TE/GE) Division. The IRS Criminal Investigation (CI) Division has also been initiating investigations. The audits and investigations cover billions of dollars of potentially inflated deductions, as well as hundreds of partnerships and thousands of investors.

"We will not stop in our pursuit of everyone involved in the creation, marketing, promotion and wrongful acquisition of artificial, highly inflated deductions based on these aggressive transactions. Every available enforcement option will be considered, including civil penalties and, where appropriate, criminal investigations that could lead to a criminal prosecution," said IRS Commissioner Charles "Chuck" Rettig. "Our innovation labs are continually developing new, more extensive enforcement tools that employ advanced techniques. If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options. It is always worthwhile to take advantage of various methods of getting back into compliance by correcting your tax returns before you hear from the IRS. Our continued use of ever-changing technologies would suggest that waiting is not a viable option for most taxpayers," he added.

Syndicated Conservation Easements

The IRS issued Notice 2017-10, I.R.B. 2017-4, 544, in 2016, which designated certain syndicated conservation easements as listed transactions. In these types of transactions, investors in pass-through entities receive promotional material which offer the possibility of a charitable contribution deduction worth at least two-and-a-half times their investment. The deduction taken in many transactions has been significantly higher than 250 percent of the investment.

Syndicated conservation easements were included on the IRS’s 2019 "Dirty Dozen" list of tax scams to avoid.

Not only do these transactions grossly overstate the value of the easement that was purportedly donated to charity, they often also fail to comply with the basic requirements for claiming a charitable deduction for a donated easement.

Taxpayers may avoid the imposition of penalties for improper contribution deductions if they fully remove the improper contribution and related tax benefits from their returns by timely filing a qualified amended return or timely administrative adjustment request.

Enforcement Actions

The IRS has prevailed in many cases involving the charitable deduction basic requirements, and has established a body of law that it believes supports disallowance of the deduction in a significant number of pending conservation easement cases. The IRS will soon be moving the Tax Court to invalidate the claimed deductions in all cases where the transactions fail to comply with the basic requirements, leaving only the final penalty amount to be determined.

In addition to auditing participants in syndicated conservation easement transactions, the IRS is pursuing investigations of promoters, appraisers, tax return preparers and others, and is evaluating numerous referrals of practitioners to the IRS Office of Professional Responsibility. The IRS will develop and assert all appropriate penalties, including:

penalties for participants (40 percent accuracy-related penalty);
penalties for appraisers (penalty for substantial and gross valuation misstatements attributable to incorrect appraisals);
penalties for promoters, material advisors, and accommodating entities (penalty for promoting abusive tax shelters, and penalty for aiding and abetting understatement of tax liability); and
penalties for return preparers (penalty for understatement of taxpayer’s liability by a tax return preparer).

Rettig, Desmond Highlight Heightened Focus

Rettig and IRS Chief Counsel Michael J. Desmond have each highlighted the IRS’s heightened, agency-wide focus on syndicated conservations easements.

While speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C., Rettig and Desmond both separately underscored the IRS’s increased enforcement efforts toward abuses of certain tax-advantaged land transactions under Code Sec. 170(h).

"We appreciate the value of conservation easements," Rettig said. "We do not appreciate the activities that have gone on with respect to the syndicated conservation easements—there are some artificial appraisals there… some fatal flaws."

Reiterating the IRS’s tough stance on the matter, Rettig said that the IRS is not going to "stand down." The information in IR-2019-182 issued on November 12 was "fair warning," Rettig said.

Likewise, Desmond stressed that the challenges surrounding syndicated conservation easements are an "institutional concern" for the IRS, "one that we will be responding to," he emphasized.

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Treasury and the IRS are expected to release proposed rules in "early 2020" that would clarify certain limitations on the carried interest tax break, according to David Kautter, Treasury’s assistant secretary for tax policy. Kautter briefly addressed the proposed regulations’ timeline while speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C.

Carried Interest Limitation

The forthcoming regulations are expected to restrict S corporations from taking advantage of a carried interest exemption provision under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The TCJA requires certain money managers to hold investments for at least three years before becoming eligible for the lower, 20 percent capital gains rate. However, it exempted corporations from this holding period, which Treasury and many lawmakers on Capitol Hill say resulted in an unintended "loophole."

The proposed regulations are expected to clarify the law’s intent that S corporations are subject to the three-year holding period for carried interest, according to Treasury’s last press release on the matter issued in March 2018 (see "Treasury, IRS Issue Guidance On Carried Interest," at https://home.treasury.gov/news/press-releases/sm0302).

Legal Questions May Arise

Most notably, however, the TCJA does not expressly contain this limitation on S-corporations, which has left some on Capitol Hill questioning Treasury and the IRS’s authority to implement such a restriction via regulations. The IRS on November 15 directed Wolters Kluwer to Treasury for confirmation on this anticipated rule and projected timeline. As of press time, Treasury had not responded to Wolters Kluwer’s request for comment.

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Hopes for a year-end tax extenders package appear to be dwindling on Capitol Hill.

Tax Extenders Need a Legislative Vehicle

Over 30 expired or soon-to-be expired tax breaks known as tax extenders were originally considered a top contender for hitching a ride on a larger, must-pass government funding bill. Considering the lack of time left on the legislative calendar this year, a stand-alone tax bill has been considered an unlikely initiative. Thus, a must-pass appropriations bill was seen by several lawmakers as the likely legislative vehicle for tax extenders and other tax items such as technical corrections to Republicans’ 2017 tax reform law.

However, a spokesperson for Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, confirmed to Wolters Kluwer on October 28 that Grassley believes there is "no hope" for action this year on a tax extenders package if lawmakers do not move quickly with respect to its legislative driver. Many within the practitioner community following these developments have said that the chances of providing taxpayers with certain tax breaks retroactively significantly decrease if Congress moves into next year leaving them expired.

Another Stopgap Spending Bill Appears Likely

Currently, the federal government is operating on a stopgap spending bill temporarily extending fiscal year (FY) 2019 funding levels through November 21. Previously, several lawmakers, in particular Grassley, had hoped that a tax extenders package would be attached to a larger, more comprehensive appropriations bill next month. However, Senate Appropriations Committee Chair Richard Shelby, R-Ala., told reporters that another short-term stopgap spending bill is the more likely option to keep the government open after November 21. "Unless a miracle happens around here with the House and Senate, we will have to put forth another [continuing resolution] CR," Shelby told reporters.

Notably, another short-term government funding bill is considered unlikely to have any policy riders. Generally, stop gap spending bills are usually considered "clean," for the most part. Also playing a role in tax extenders’ fate is whether President Trump would sign a more comprehensive appropriations bill. At this time, his support for a larger FY 2020 funding bill, apart from tax policy reasons, remains unclear.

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Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, and other top Senate tax writers are calling for Senate action on the bipartisan Setting Every Community Up for Retirement Enhancement Secure bill (HR 1994) (SECURE Act). The House-approved, bipartisan retirement savings bill has remained stalled in the Senate since May.

SECURE Act’s Route to Senate Floor Remains Unclear

Grassley’s communications director Michael Zona told Wolters Kluwer on October 21 that it remains "unclear at this point" whether the SECURE Act will move through committee, reach the Senate floor by unanimous consent, or be attached to a larger, year-end tax package. "Grassley supports the House-passed SECURE Act. There are several holds on the bill, and he is working to get them lifted," Zona said.

The SECURE Act cleared the House on May 23 by a 417-to-3 vote. The bipartisan measure, which proposes sweeping changes to retirement savings tax policy, was originally expected to quickly clear the Senate after its approval in the House. However, Sen. Ted Cruz, R-Tex., blocked the bill from reaching the Senate floor. Cruz blocked the bill in protest of House Democrats’ 11th hour-removal of a provision from the original bill that would have expanded tax-advantaged Section 529 education savings plans to include homeschooling and certain elementary and secondary expenses. Cruz and Sen. Patty Murray, D-Wash., are reportedly still holding up the measure from reaching the Senate floor.

Catch-All Tax Package

However, the SECURE Act, among other bipartisan tax-related items including tax extenders, could be attached to a catch-all tax package that is expected on Capitol Hill to hitch a ride on a year-end government funding bill. A "must-pass" appropriations bill, like the one currently being negotiated to keep the government open after funding expires on November 21, could serve as the tax package’s legislative vehicle, thus fast tracking its approval.

"As the economy continues to change, the way we approach retirement savings must change as well. Otherwise, too many Americans will be left behind," Grassley said on October 21, noting that the SECURE Act is under "active consideration."

Similar to Grassley’s push, Sen. Tim Scott, R-S.C., led a letter sent to Senate Majority Leader Mitch McConnell, R-Ky., urging immediate Senate consideration of the SECURE Act. "This bipartisan legislation would expand access to retirement plans for millions of Americans, allow older workers and retirees to contribute more to their retirement accounts, increase 401(k) coverage to part-time employees, prevent as many as 4 million people in private-sector pension plans from losing future benefits, protect 1,400 religiously affiliated organizations whose access to their defined contribution retirement plans is in jeopardy, and do the right thing for Gold Star families," according to Scott.

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The Senate blocked a Democratic resolution on October 23 to overturn Treasury rules preventing certain workarounds to the $10,000 state and local tax (SALT) federal deduction cap.

SALT Cap Workaround

Senate Democrats’ resolution, S.J. Res. 50, forced a vote on Wednesday to nullify Treasury regulations that block taxpayers from circumventing the SALT cap through certain states’ programs that convert state and local taxes into fully deductible charitable contributions. The resolution failed by a largely party-line vote of 43-to-52.

Sen. Michael Bennet, D-Colo., voted against the Democratic measure while Sen. Rand Paul, R-Ky., supported it. While the resolution would not repeal the SALT cap itself, House Democrats are reportedly crafting legislation to do so. Democrats and some Republicans, particularly from high-tax states, have criticized the SALT cap since its enactment in 2017 under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97).

Debate on SALT Cap, Treasury Rules

"Without any clear authority to do so, the Treasury Department reversed a long-standing IRS position that had allowed taxpayers a full deduction for charitable contributions to state tax credit programs," Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said on the Senate floor before the vote. "My view is the Treasury Department should not be putting its thumb on the scale on behalf of Republican interests, and it shouldn’t be using phony regulatory justifications to fix Republicans’ extraordinarily poorly drafted law."

However, several Republicans cited to a recent report from the nonpartisan Joint Committee on Taxation (JCT), which estimated that repealing the SALT cap beginning in 2019 would result in over $40 billion of the associated tax cut going to taxpayers with incomes of at least $1 million ( JCX-35-19).

"It’s bad enough that my Democratic colleagues want to unwind tax reform, but it’s downright comical that their top priority is helping wealthy people in blue states find loopholes to pay even less," Senate Majority Leader Mitch McConnell, R-Ky., said from the Senate floor on October 23. "Repealing the SALT cap would give millionaires an average tax cut of $60,000. Meanwhile, the average tax cut for taxpayers earning between $50,000 and $100,000 would be less than ten dollars."

Vaping Tax

In other news, the House Ways and Means Committee approved a bipartisan vaping tax bill, ( HR 4742), on October 23 by a 24-to-15 vote. The bill would establish a $27.81 tax per gram of nicotine used in vaping devices.

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Treasury and the IRS on October 31 announced the release of a new, draft form implementing certain reporting requirements under the Tax Cuts and Jobs Act Opportunity Zone program.

The proposed Form 8996 for Qualified Opportunity Funds (QOFs) comes after numerous calls on Capitol Hill for more transparency within the Opportunity Zone program. "The form is designed to collect information on the amount of investment by opportunity funds in business property by census tract," according to a Treasury press release.

Opportunity Zones’ Architect Applauds Treasury’s Steps Toward Reporting Requirements

Ken Farnaso, press secretary for Sen. Tim Scott, R-S.C., chief architect of the TCJA’s bipartisan Opportunity Zone program, told Wolters Kluwer on October 31 that reporting requirements, "an important piece of the puzzle," were, in fact, originally in the bill. "Unfortunately, during the tax reform process, Senate Democrats blocked these requirements from being included in the Tax Cuts and Jobs Act. Since then, Senator Scott has continued working to restore those reporting requirements," Farnaso said.

Additionally, Farnaso told Wolters Kluwer that Scott applauds Treasury’s steps to ensure a clearer picture of the impact the Opportunity Zones initiative can have on the country. "Senator Scott will also continue to push for his current bill restoring robust reporting requirements to create a holistic picture of how the initiative is functioning," Farnaso said. "Overall, today is a good day for Opportunity Zones. We look forward to the more than $44 billion in currently anticipated investment being deployed in distressed communities across the nation, and that number growing even larger in the future."

Opportunity Zones Tax Incentive

The Opportunity Zone Program enacted under TCJA ( P.L. 115-97) is considered on Capitol Hill as one of the most generous and ambitious tax incentives for investors in distressed communities. Under Code Sec. 1400Z-2, investors may defer taxation of capital gains that are invested in a QOF.

Generally, the following investor tax benefits were created under the Opportunity Zone program:

a temporary tax deferral for capital gains realized on the sale of appreciated assets and reinvested within 180 days in a QOF;
the elimination of up to 10 or 15 percent of the tax on the capital gain that is invested in the QOF and held between five and seven years; and
the permanent exclusion of tax when exiting a qualified opportunity fund investment held for at least 10 years.

Draft IRS Form 8996

Specifically, the new, draft Form 8996 for the 2019 tax year requires QOFs to report the following information:

the Employer Identification Number (EIN) of each business in which the QOF has an ownership interest;
the census tract location of the tangible property of the business;
the value of the QOF’s investment; and
the value and census tract location of qualified business property directly owned or leased.

"This is an important step towards a thorough evaluation of the Opportunity Zone tax incentive," Treasury Secretary Steven Mnuchin said. "We want to understand where Opportunity Zone investments are going and strengthening the economy so that investors and communities can learn from the successes of this bipartisan, pro-growth policy."

Generally, the collection of this information will play a role in allowing lawmakers and the public to evaluate the effects of the tax incentive and to understand why some locations may be more successful than others at attracting investment, according to Treasury.

Opportunity Zones Criticism

The Opportunity Zone program has not come to fruition without its share of criticism, however. Although lawmakers have called for reporting requirements related to QOFs since the TCJA’s enactment, the program has recently come under increased scrutiny and criticism. Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., has said that the lack of reporting requirements are "inexcusable."

"Requiring taxpayers to prove they’re actually following the rules of the Opportunity Zone program is a positive first step, but it’s one that should have been taken two years ago…," Wyden said in an October 31 statement. "The Opportunity Zone program has been operating without any effort to ensure compliance and that’s inexcusable."

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A California-based medical marijuana dispensary corporation’s motion for summary judgment challenging the constitutionality of Code Sec. 280E was denied. The Tax Court also addressed whether Code Sec. 280E applies to marijuana businesses legally operating under state (California) law, and whether the prohibition on deductions is limited to ordinary and necessary business expenses.

Section 280E

Congress enacted Code Sec. 280E after the court had allowed certain deductions for expenses incurred in connection with an illegal drug trade. Generally, Code Sec. 280E disallows any deductions attributable to a taxpayer’s illegal drug related trade or business. Taxpayers may reduce their income by the cost of goods sold (COGS), and Code Sec. 280E does not generally disallow deductions attributable to a taxpayer’s non-drug-related business.

Constitutionality

The Eighth Amendment of the Constitution prohibits excessive fines or penalties. The dispensary in this case claimed that Code Sec. 280E is a punitive provision that violates the Eighth Amendment. However, because Congress generally has the power to levy taxes under the Sixteenth Amendment, the Tax Court found that the law’s denial of certain deductions cannot be construed as a penalty.

Legality Under State Law

The dispensary also argued that its actions could not be considered "trafficking" for purposes of Code Sec. 280E because its activities were not illegal under California law. The court noted that because marijuana is still considered a Schedule I controlled substance and is banned under federal law, the application of Code Sec. 280E does not depend on the legality of marijuana sales under California law.

Additional Deductions

Finally, the dispensary argued that Code Sec. 280E only applies to deductions under Code Sec. 162, and that other deductions such as those under Code Secs. 164 and 167 should be permitted. However, the text of Code Sec. 280E broadly states that "no deduction or credit shall be allowed." It does not limit the deductions to those claimed under Code Sec. 162.

Dissenting Opinions

The Tax Court decision included several concurring and dissenting opinions, which primarily addressed the issue as to whether Code Sec. 280E is in fact a penalty provision that would violate the Eighth Amendment.

The dissenting opinions found that Code Sec. 280E is punitive in nature. One dissenter noted that rather than specify a narrow range of disallowed expenses, Code Sec. 280E attacks the entire marijuana industry with a broad denial of otherwise allowable deductions. The opinion stated that Congress passed Code Sec. 280E order to deter the sale of controlled substances and to penalize the drug trade. That intent was found to be "clearly in the nature of a penalty." Both dissents concluded with two additional questions, which the dissenters felt need to be addressed:

Is the punitive nature of Code Sec. 280E excessive to the point where it violates the Eighth Amendment?, and
Does the Eighth Amendment apply to corporation taxpayers?

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The IRS has proposed regulations that define an eligible terminated S corporation (ETSC), and provide rules relating to distributions of money by an ETSC after the post-termination transition period (PTTP). The proposed regulations also extend the treatment of distributions of money during the PTTP to all shareholders of the corporation, and update and clarify the allocation of current earnings and profits to distributions of money and other property.

Code Sec. 1371(f), as added by the Tax Cuts and Jobs Act ( P.L. 115-97) extends the period during which C corporation shareholders can benefit from the corporation’s accumulated adjustment account (AAA) generated during its former status as an S corporation. Specifically, the provision allows the C corporation to source qualified distributions of money to which Code Sec. 301 would otherwise apply to in whole or part to AAA. The provision only applies if the corporation is an ETSC as defined in Code Sec. 481(d).

Under the proposed regulations, the revocation of S corporation status may be made during the two-year period beginning on December 22, 2017, even if the effective date for the revocation occurs after the conclusion of the two-year period.

Shareholder Identity Requirement

A former S corporation is not an ETSC unless the owners of its stock are the same owners (and in identical proportions) on December 22, 2017, and on the date of the S corporation revocation. The proposed regulations identify various categories of stock transfers that are not considered an ownership change for purposes of this rule.

ETSC Proration

A distributing ETSC’s AAA is allocated to qualified distributions and the distributions are chargeable to the ETSC’s accumulated earnings and profits (AE&P) based on the ETSC proration. The ETSC proration is implemented in a manner that facilitates the prompt distribution of AAA and full transition to C corporation status. Specifically, the proposed regulations:

specify the time at which amounts of AAA and AE&P are determined for purposes of the ETSC proration;
provide AAA and AE&P ratios used to the implement the proration; and
describe in detail the method of characterizing qualified distributions.

The proposed regulations adopt a "snapshot" approach under which amounts of AAA and AE&P are determined on a specified date. As a result, the same ETSC proration is applied to all qualified distributions. Under the proposed regulations, the determination date is the date when the S corporation revocation election is effective. A "dynamic" approach that recalculated the amounts before each qualified distribution was rejected as administratively cumbersome.

The proposed regulations provide two ratios for determining the part of a qualified distribution that is sourced from AAA and from AE&P. The AAA ratio is the ratio of historical AAA to the sum of historical AAA and historical AE&P. The AE&P ratio is the ratio of historical AE&P and the sum of historical AAA and historical AE&P. The qualified distribution is multiplied by these ratios to determine the amount sourced from AAA and AE&P.

The proposed regulations provide a priority rule under which ETSC proration first applies to qualified distributions during the tax year. The rules of Code Sec. 301 and allocation rules of Code Sec. 316 then apply to any nonqualified distributions that are not fully accounted for by the ETSC proration because the corporation’s AAA or AE&P are exhausted.

Effective Date

The proposed regulations will be effective in tax years beginning after the date they are published as final regulations. A taxpayer may apply the regulations in their entirely to tax years that begin on or before the date of publication as final regulations.

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It is never too early to begin planning for the 2016 filing season, the IRS has advised in seven new planning tips published on its website. Although the current filing season has just ended, there are steps that taxpayers can take now to avoid a tax bill when April 2016 rolls around. For example, the IRS stated that taxpayers can adjust their withholding, take stock of any changes in income or family circumstances, maintain accurate tax records, and more, in order to reduce the probability of a surprise tax bill when the next filing season arrives.

IRS Recommended Action Steps

Specifically, the IRS advised the taxpayers take the following steps now to jump start a successful 2016 filing season for their 2015 tax year returns:

Consider filing a new Form W-4, Employee's Withholding Allowance Certificate, with an employer if certain life circumstances have changed (such as a change in marital status or the birth of a child). A new child could mean an additional exemption and/or tax credits that might lower your tax liability. Therefore you might benefit from claiming an extra withholding allowance. Conversely, getting married (or divorced) could change your income, making it advantageous to readjust your withholding accordingly.
Report any changes or projected changes in income to the Health Insurance Marketplace (if taxpayer obtained insurance through a marketplace). Income affects the calculation of subsidy payments. Recipients of the advance premium tax credit may owe tax for 2015 if their subsidy payments are too high.
Maintain accurate and organized tax records, such as home loan documents or financial aid documents. Many deductions must be substantiated with evidence, and staying organized now could facilitate the tax return filing process in the future.
Find a tax return preparer. Looking for a qualified tax return preparer may be easier in the off-season, when you are under no immediate pressure to select a person. This can provide taxpayers with more time to evaluate a preparer's credentials.
Plan to increase itemized deductions. If a taxpayer plans to purchase a house, contribute to charity, or incur medical expenses that may not be reimbursed during 2015, it may be beneficial to consider whether itemizing deductions would be more beneficial than claiming the standard deduction for 2015.
Stay informed of the latest tax law changes. Keeping on top of developments can reduce confusion in the long run.

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A major repair to a business vehicle is usually deductible in the year of the repair as a "maintenance and repair" cost if your business uses the actual expense method of deducting vehicle expenses. If your business vehicle is written off under the standard mileage rate method, your repair and maintenance costs are assumed to be built into that standard rate and no further deduction is allowed.

Standard mileage rate

The standard mileage rate for business use of a vehicle is 48.5 cents per mile for 2007. The standard mileage rate replaces all actual expenses in determining the deductible operating business costs of a car, vans and/or trucks. If you want to use the standard mileage rate, you must use it in the first year that the vehicle is available for use in your business. If you use the standard mileage rate for the first year, you cannot deduct your repairs for that year. Then in the following years you can use the standard mileage rate or the actual expense method.

Actual cost

You can deduct the actual vehicle expenses for business purposes instead of using the standard mileage rate method. In order to use the actual expenses method, you must determine what it actually cost for the repairs attributable to the business. If you have fully depreciated your vehicle you can still claim your repair expenses.

Exceptions

Of course, the tax law is filled with exceptions and that includes issues relating to the deductibility of vehicle repairs and maintenance. Some ancillary points to consider:

If you receive insurance or warranty reimbursement for a repair, you cannot "double dip" and also take a deduction;
If you are rebuilding a vehicle virtually from the ground up, you may be considered to be adding to its capital value in a manner in which you might be required to deduct costs gradually as depreciation;
If you use your car for both business and personal reasons, you must divide your expenses based upon the miles driven for each purpose.

You may want to calculate your deduction for both methods to determine which one will grant you the larger deduction. If you need assistance with this matter, please feel free to give our office a call and we will be glad to help.

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In many cases, employees can elect to reduce their salary and contribute the amounts to a retirement plan. These plans include 401(k) cash or deferred arrangements, 403(b) tax-sheltered annuities, eligible Code Sec. 457 deferred compensation plans of state and local governments and tax-exempt entities, simple retirement accounts, and plans for self-employed persons such as a SEP individual retirement account (SEP IRA).

Each retirement plan limits the amount that can be contributed annually to the plan:

IRAs - Contribution limits are $4,000 for 2006 and 2007; $5,000 for 2008.
401(k), 403(b), 457, SEP IRA - Contribution limits are $15,000 for 2006 and $15,500 for 2007. The contribution limits are indexed.
Simple retirement accounts - The limit is $10,000 for 2006; $10,500 for 2007. The contribution limit is indexed.

Many retirement plans allow participants age 50 and older to make "catch-up" contributions. Participants can contribute an additional amount in excess of the normal limits. Making a catch-up contribution increases the amount available at retirement and is beneficial if the employee can afford it.

There is a separate limit for catch-up contributions. The limits are as follows:

IRAs - $1,000 for 2007. This amount is not indexed.
401(k), 403(b), 457 and SEPs - $5,000 in 2006; indexed in $500 increments but unchanged for 2007.
SIMPLE plans - $2,500 for 2006, indexed but unchanged for 2007.

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Parents of a child under age 13 can take a tax credit for child care expenses to enable them to work. The credit can be taken for care of two or more children. Child care expenses are amounts you paid for someone to come to your home, for care at the home of a day care provider, and for care at a day care center.

Parents of a child under age 13 can take a tax credit for child care expenses to enable them to work. The credit can be taken for care of one or more children. Child care expenses are amounts you paid for someone to come to your home, for care at the home of a day care provider, and for care at a day care center.

The credit is a percentage of qualified child care costs. Qualified costs are limited to $3,000 for one child and $6,000 for two or more children. The credit is taken on the lowest of your earned income, your spouse's earned income, or your qualified costs. Generally, if the spouse is not working, no credit is allowed, unless the spouse is a student or is disabled.

The cost of child care includes incidental amounts for food and schooling, but not items with a separate cost. The cost of schooling does not qualify if the child is in kindergarten or above. The credit can also be claimed for the cost of taking care of a disabled spouse who cannot care for himself or herself, and for any other disabled person that you can claim as a dependent.

Married couples must file a joint return to claim the credit. You also qualify to claim the credit if you file as a single person, head of household, or qualifying widow(er).

To compute the amount of the credit, you multiply the amount determined from costs or earned income by a specified percentage. The percentage starts at 35 percent, if you have $15,000 or less of adjusted gross income. The percentage is reduced by one percentage point for every $2,000 of additional income for the next $23,000 in income above $15,000. You can use the minimum percentage of 20 percent if your income is $43,000 or more. Thus, the maximum credit is $1,050 (35 percent of $3,000) for one child and $2,100 for two or more children (35 percent of $6,000); and the minimum, no matter how much money you make, is $600 for one child and $1200 for more than one child.

The credit is taken on Form 2441. You must provide the name and address of the day care provider, the provider's taxpayer identification number, and the expenses paid to the provider. The day care provider cannot be your spouse, a parent of the child, or another person you claim as a dependent. However, payments to your child age 19 or older will qualify for the credit. You must also provide the names of your children and a social security number for each child.

If you are enrolled in a flexible spending account (FSA) with your employer, you may have elected to pay for child care expenses with funds from the FSA. These amounts are tax-free. To prevent a double benefit, you must reduce the child care credit by amounts used from the FSA to pay for child care.

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In a final session, Congress approved a $45.1 billion package of tax extenders and other tax breaks during the night of December 8-9. The Tax Relief and Health Care Act of 2006 (H.R. 6111) renews many valuable - but temporary - tax breaks for individuals and businesses, including the state and local sales tax deduction, the higher education tuition deduction and employer tax incentives. The new law also extends some energy tax breaks, makes Health Savings Accounts (HSAs) more attractive and creates new tax incentives.

Temporary versus permanent tax cuts

Tax cuts come in two types: permanent and temporary. In recent years, Congress has favored temporary tax cuts over permanent ones largely because of how they are reflected in the federal budget. Temporary tax cuts appear to cost less over one, two or three years than permanent tax cuts.

The drawback is that they are temporary. They ultimately expire unless Congress extends them.

That's exactly what happened with the extenders. Nearly all of them expired at the end of 2005. The new law extends them through 2007.

Here's a rundown of the tax incentives that are extended through 2007:

--Deduction for state and local taxes;

--Higher education tuition deduction;

--Work Opportunity and Welfare-to-Work tax credits;

--Teacher's classroom expense deduction;

--Research tax credit;

--Archer Medical Savings Accounts;

--Indian employment tax credit;

--Accelerated depreciation for business property on a Native American reservation;

--15-year recovery period for some leasehold and restaurant improvements;

--Tax incentives for the District of Columbia;

--Brownfields remediation expensing;

--Cover over of tax on distilled spirits;

--Parity in application of mental health benefits; and

--Zone academy bonds.

State and local sales tax deduction

The new law allows taxpayers to deduct either state and local income taxes or state and local sales taxes as an itemized deduction. You have two options. You can calculate your deduction either by saving receipts or using the IRS' Optional State Sales Tax Tables. Be careful, the deduction phases-out for higher-income taxpayers. Even if you think the state and local income tax deduction would be larger, it's worthwhile to calculate both, especially if you may be liable for AMT. Our office can help you with all the calculations.

Teacher's classroom expense deduction

Teachers, aides and other education workers often pay for classroom expenses out of their own funds. The classroom expense deduction permits education workers to deduct some out-of-pocket classroom expenses up to $250. Many classroom purchases qualified for the deduction, such as paper and pens, books, computer software, and so on. However, you cannot take the deduction if your employer reimburses you for the classroom supplies.

Higher education tuition deduction

This deduction is often confused with the deduction for interest paid on a student loan. That's a separate tax break. The higher education tuition deduction is an above-the-line deduction for qualifying tuition and related expenses. However, you cannot deduct housing, transportation, food, insurance, and some other expenses. Taxpayers claiming the higher education tuition deduction also cannot take the HOPE and Lifetime Learning tax credits. Because this deduction has so many rules, it's important that our office carefully review your tax situation.

Welfare-to-Work and Work Opportunity tax credits

These credits are designed to encourage employers to hire economically-disadvantaged individuals. The credits are very similar and are equally complex. Only individuals in "targeted" groups qualify. Wages also cannot exceed certain thresholds. The new law extends them and consolidates them making tax planning very important.

Archer Medical Savings Accounts

If you own a small business, you know that health care costs are a huge drain on profits. Over the years, Congress has tried several "fixes." Archer Medical Savings Accounts were created to help workers save for health care expenses. They weren't very popular and today seem to be eclipsed by Health Savings Accounts. However, every employer is different. Archer Medical Savings Accounts may a good fit for you and your employees. The new law extends them through 2007.

New tax incentives

The Tax Relief and Health Care Act of 2006 creates two new tax breaks that could be very valuable: a temporary refundable credit for certain taxpayers with long-term unused AMT credits who have AMT income from incentive stock options and a new deduction for premiums paid for qualified mortgage insurance. Both of these tax breaks have some very important limitations. Our office can help decipher them for you.

Energy tax breaks

A surprise last-minute addition to the new law was a package of energy tax extenders. The big news here is what was not extended. Congress did not extend the tax break for individuals who make energy-efficiency improvements to their homes, such as energy-efficient windows and doors. Instead, Congress extended energy tax breaks targeted mostly to businesses and authorized more tax credits for research into alternative energy production.

Health Savings Accounts

HSAs are similar to IRAs. Your contributions are deductible and are tax-free if used for qualified health care expenditures. With proper planning, HSAs can be a great asset.

The new law makes HSAs even more attractive by allowing a one-time transfer of IRA savings to an HSA. You can also make a one-time transfer of savings in a health flexible spending account (FSA) or a health reimbursement arrangement (HRA) to an HSA. These are valuable tools if you plan correctly. Give our office a call if you have any questions about HSAs.

Important planning steps

The lateness of the new law makes tax planning very important for these last few weeks of 2006.

Give our office a call. We can schedule an appointment to sit down and discuss the new law in detail. There are a lot more tax breaks than we covered in this short article. Don't miss out on some potentially very valuable tax savings.

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Only 50 percent of the cost of meals is generally deductible. A meal deduction is customarily allowed when the meal is business related and incurred in one of two instances:

(1) while traveling away from home (a circumstance in which business duties require you to be away from the general area of your tax home for longer than an ordinary day's work); and

(2) while entertaining during which a discussion directly related to business takes place.

Entertainment expenses generally do not meet the "directly related test" when the taxpayer is not present at the activity or event. Both your meal and the meal provided to your business guest(s)' is restricted to 50 percent of the cost.

Related expenses, such as taxes, tips, and parking fees must be included in the total expenses before applying the 50-percent reduction. However, allowable deductions for transportation costs to and from a business meal are not reduced.

The 50-percent deduction limitation also applies to meals and entertainment expenses that are reimbursed under an accountable plan to a taxpayer's employees. It doesn't matter if the taxpayer reimburses the employees for 100 percent of the expenses. "Supper money" paid when an employee works late similarly may be tax free to the employee but only one-half may be deducted by the employer. The same principle applies to meals provided at an employees-only business luncheon, dinner, etc.

A special exception to the 50 percent rule applies to workers who are away from home while working under Department of Transportation regulations. For these workers, meals are 75 percent deductible in 2006 and 2007.

When a per diem allowance is paid for lodging, meal, and incidental expenses, the entire amount of the federal meals and incidental expense (M&IE) rate is treated as an expense for food or beverages subject to the percentage limitation on deducting meal and entertainment expenses. When a per diem allowance for lodging, meal, and incidental expenses for a full day of travel is less than the federal per diem rate for the locality of travel, the payer may treat 40 percent of the per diem allowance as the federal M&IE rate.

"Lavish" meals out of proportion to customary business practice are generally not deductible to the extent they are lavish. Generally, meals taken alone whentraveling generally have a lower threshold for lavishness than meals considered an entertainment expense for which a client or other business contact is "wined and dined."

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