Tax Reform Report • Hurricane Katrina Casualty Losses • Retirement Plan COLAs • Disregarded Entities’ Liability for Excise and Employment Taxes
 

Lesli S. Laffie, J.D., LL.M.

AICPA Activities

Tax Reform Report

The AICPA has released a report, Understanding Tax Reform: A Guide to 21st Century Alternatives, describing the nature of the issues leading to a tax reform debate, suggesting a balanced approach for reform proposals and summarizing key issues to be addressed, whether taxing income or consumption.

In addition to being an essential resource for anyone engaged or interested in the tax reform debate, the report provides a clear understanding of the issues and alternatives involved, details particular tax provisions that should be looked at closely and explains some of the most onerous problems taxpayers may face during what the AICPA believes will be a very difficult transition from one system to the next.

The report is available at www.aicpa.org/taxreform. It supplements work done on tax reform issues in 1995; see AICPA Tax Division, Flat Taxes and Consumption Taxes: A Guide to the Debate (December 1995), available at www.aicpa.org/download/tax/AICPA_Flat_Tax_Study_Dec_1995.pdf.

For questions about the report, please contact Carol Ferguson at (202) 434-9235 or cferguson@aicpa.org. 

From the IRS

Hurricane Katrina Casualty Losses

According to IR-2005-119, taxpayers who suffered casualty or theft losses as a result of Hurricane Katrina can take advantage of eased loss limits.

Background: Ordinarily, a deduction for a personal casualty or theft loss is computed by reducing each loss by $100 and aggregate losses by 10% of adjusted gross income. Only the excess over the $100 and 10% limits is deductible. The new law removes these limits for Hurricane Katrina losses, so that the entire amount is deductible.

Eligibility: To qualify, a loss must be attributable to Hurricane Katrina and have occurred after Aug. 24, 2005, in the Presidentially declared disaster area. The $100 and 10% limits still apply to losses not caused by Hurricane Katrina.

Like all casualty and theft losses, Hurricane Katrina losses can only be claimed as an itemized deduction. In addition, no deduction is allowable for any part of a loss for which the taxpayer receives (or expects to receive) insurance or other reimbursement.

Further, losses are generally deductible only in the year the casualty occurred or the theft was discovered. However, because a Hurricane Katrina loss is a disaster loss, it can be deducted on 2004 returns. The $100 and 10% limits will not apply to that loss in redetermining 2004 tax. Taxpayers who have already filed 2004 returns can claim the loss by filing an amended return for that year. However, claiming the loss on a 2005 return could generate greater tax savings.

Taxpayers filing or amending their 2004 return and whose only casualty or theft losses to personal-use property were caused by Hurricane Katrina, should write in red ink “Hurricane Katrina” at the top of Form 1040X, Amended U.S. Individual Income Tax Return. They must also attach the 2004 version of Form 4684, Casualties and Thefts, writing “Hurricane Katrina” on the dotted line next to line 11 and entering “0” on lines 11 and 17. Special rules apply for taxpayers with both Katrina-related and non-Katrina-related casualty or theft losses. For 2005, Form 4684 is being revised to reflect the new law for Hurricane Katrina losses.

Information on disaster areas can be found at the Federal Emergency Management Agency’s website, www.fema.gov/news/disasters.fema.

Taxpayers affected by Hurricane Katrina can call the IRS disaster hotline at (866) 562-5227.

Retirement Plan COLAs

IR-2005-120 announced cost-of-living adjustments (COLAs) for (1) dollar limits on benefits under qualified retirement plans and (2) other provisions affecting such plans that take effect on Jan. 1, 2006. Also provided were the statutory dollar amounts that were reset or established by the Economic Growth and Tax Relief Reconciliation Act of 2001. The maximum limit for the  Sec. 415(b)(1)(A) annual benefit for defined-benefit plans increases from $170,000 to $175,000, while the Sec. 415(c)(1)(A) limit for defined-contribution plans increases from $42,000 to $44,000. Also, for participants who separated from service before 2006, the Sec. 415(b)(1)(B) limit is computed by multiplying the participant’s compensation limit, as adjusted through 2005, by 1.0383. Various other dollar amounts are adjusted as follows:

• The Sec. 402(g)(1) limit on the exclusion for elective deferrals under Sec. 402(g)(3), which affects elective deferrals to Sec. 401(k) plans and to the government’s Thrift Savings Plan, among other plans, increases from $14,000 to $15,000.

• The Sec. 409(o)(1)(C)(ii) dollar limit for determining the maximum account balance in an employee stock ownership plan subject to a five-year distribution period increases from $850,000 to $885,000. The dollar amount used to determine the lengthening of the five-year distribution period increases from $170,000 to $175,000.

• The Sec. 414(q)(1)(B) limit used in the definition of a highly compensated employee increases from $95,000 to $100,000.

• The annual compensation limit under Secs. 401(a)(17), 404(l), 408(k)
  (3)(C) and (6)(D)(ii) increases from $210,000 to $220,000. The annual compensation limit under Sec. 401(a)(17) for eligible participants in certain governmental plans that, under the plan as in effect on July 1, 1993, allowed COLAs to the compensation limit under the plan to be taken into account, increases from $315,000 to $325,000.

• The Sec. 408(k)(2)(C) compensation amount for simplified employee pension plans remains unchanged, at $450.

• The Sec. 408(p)(2)(E) limit on savings incentive match plans for employees (SIMPLE) retirement accounts remains unchanged, at $10,000.

• The Sec. 457(e)(15) limit on deferrals on deferred compensation plans of state and local governments and tax-exempt organizations increases from $14,000 to $15,000.

• The compensation amounts under Regs. Sec. 1.61-21(f)(5)(i), concerning the definition of “control employee” for fringe benefit valuation purposes, remains unchanged at $85,000. The compensation amount under Regs. Sec. 1.61-21(f)(5)(iii) increases from $170,000 to $175,000.

• The Sec. 416(i)(1)(A)(i) dollar limit for the definition of a key employee in a top-heavy plan increases from $135,000 to $140,000.

• The Sec. 414(v)(2)(B)(i) dollar limit for catch-up contributions to an applicable employer plan (other than a plan described in Sec. 401(k)(11) or 408(p)) for individuals aged 50 or over increases from $4,000 to $5,000. The Sec. 414(v)(2)(B)(ii) limit for catch-up contributions to an applicable employer plan described in Sec. 401(k)(11) or 408(p) for individuals aged 50 or over increases from $2,000 to $2,500.

Regulations

Disregarded Entities’ Liability for Excise and Employment Taxes

Qualified subchapter S subsidiaries (QSubs) and certain other single-owner disregarded entities would be responsible for paying employment and excise taxes under new IRS guidance. According to the Service, the proposed rules (REG-114371-05, 10/17/05) would treat those disregarded entities as separate, “regarded” entities for purposes of paying and reporting Federal employment and excise taxes, a shift from the existing system. The rules would apply to QSubs and single-owner eligible entities disregarded for Federal tax purposes under Sec. 7701.

Big change: The proposed rules are a significant change from the current structure. Under existing rules, either the disregarded entity or its owner can calculate and pay these taxes, but the ultimate responsibility for them remains with the entity’s owner. By contrast, the new guidance would shift employment and excise tax responsibility entirely to the affected disregarded entities. Disregarded status would be eliminated for these entities for this limited purpose, although it would continue for other Federal tax purposes.

The change means entity owners would no longer be responsible for excise and employment taxes at all.

Easing compliance: The IRS proposed this change because the existing system, allowing payment and calculation of tax by either the entity or its owner, has caused significant difficulties for both taxpayers and the government.

According to the regulations’ preamble, “[t]he Treasury Department and the IRS believe that treating the disregarded entity as the employer for purposes of federal employment taxes will improve the administration of the tax laws and simplify compliance.”

Under the proposed rules, a disregarded entity would become liable for employment taxes on wages paid to its employees. It also would be responsible for backup withholding, making timely deposits of taxes, filing returns and providing wage statements to employees.

The IRS said the regulations’ employment tax provisions are proposed to apply to wages paid on or after January 1 following the date the regulations appear in the Federal Register. Until that time, affected entities can continue to use Notice 99-6. If the owner currently satisfies its subsidiaries’ employment tax obligations, it must continue to do so until Notice 99-6 is invalidated.

For excise taxes, the new rules are proposed to apply to liabilities imposed and actions first required or permitted in periods beginning on or after January 1 following the date the rules are published as final. Until that point, owners will be treated as meeting their excise tax obligations, if they are satisfied either by the owner or by the disregarded entity on the owner’s behalf.