Small Business Taxes & ManagementTM--Copyright 1999-2004, A/N Group, Inc.
News On The Tax Front--The latest tax news.
Health Savings Accounts (HSAs)--If you're covered by a high deductible health plan, you may be able make deductible contributions to a health savings account.
In Brief:--Tax, business, and personal finance tips.
Previously Reported In Daily Update
The IRS has issued (IR-2003-147) four items of administrative guidance as part of their ongoing effort to halt abusive tax avoidance transactions and maximize effective use of IRS audit resources. The first of the items released today is aimed at strengthening the tax system through heightened standards for tax advisors; the other three are aimed at increasing transparency and disclosure of information to the IRS:
The IRS has issued final regulations (T.D. 9109) that affect the defenses available to the imposition of the accuracy-related penalty when taxpayers fail to disclose reportable transactions or fail to disclose that they have taken a return position based on the conclusion that a regulation is invalid. The final regulations are intended to promote disclosure of reportable transactions and positions based on the conclusion that a regulation is invalid by narrowing a taxpayer's ability to establish good faith and reasonable cause as a defense. The final regulations also clarify the existing regulations with respect to the facts and circumstances to be considered in determining whether a taxpayer acted with reasonable cause and in good faith.
The IRS has issued final regulations that explain how section 263(a) of the Internal Revenue Code (Code) applies to amounts paid to acquire or create intangibles. This document also contains final regulations under section 167 of the Code that provide safe harbor amortization for certain intangibles, and final regulations under section 446 of the Code that explain the manner in which taxpayers may deduct debt issuance costs.
The IRS has issued final regulations (T.D. 9103) under section 6045(d) that reflect the changes to information reporting for payments in lieu of dividends effected by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). These regulations provide that brokers must file information returns and furnish information statements reporting substitute payments in lieu of dividends to individuals who receive substitute payments in lieu of dividends on or after January 1, 2003.
You may be able to recover your attorney fees and other costs incurred in an administrative or court proceeding with the IRS if you are the prevailing party. However, there are a number of other conditions that must be met. The IRS has just issued final regulations under Section 7430 (T.D. 9106) relating to the qualified offer rule, including the requirements that an offer must satisfy to be treated as a qualified offer and the requirements that a taxpayer must satisfy to qualify as a prevailing party by reason of having made a qualified offer.
The IRS has issued final regulations relating to the definition of qualified research under Section 41(d) for the credit for increasing research activities. These final regulations reflect changes to Section 41(d) made by the Tax Reform Act of 1986. The final regulations generally retain the provisions of the 2001 proposed regulations but clarify the provisions relating to the requirement in Section 41(d)(1)(C) that qualified research be research "substantially all of the activities of which constitute elements of a process of experimentation." These final regulations, however, do not contain final rules for research with respect to computer software "which is developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer" for purposes of Section 41(d)(4)(E). The regulations discuss the process of experimentation--in general, the requirements for experimentation, and the substantially all requirement--research after commercial production and the patent safe harbor.
The IRS has issued proposed regulations (REG-139845-02) relating to the election under Section 2032 to value a decedent's gross estate on the alternate valuation date. The proposed regulations reflect a change to the law made by the Deficit Reduction Act of 1984. As a general rule, Section 2031 provides that the value of a decedent's gross estate is to be determined as of the date of the decedent's death. Section 2032 provides that the executor may elect to value the property on an alternate valuation date. Prior to the enactment of the Deficit Reduction Act of 1984, Section 2032(c) and Sec. 20.2032-1(b) of the Regulations required the election to be made on a timely filed estate tax return, including extensions of time to file actually granted. The Deficit Reduction Act amended Section 2032, effective for estates of decedents dying after July 18, 1984, to provide that the election may be made on the estate tax return, whether it is filed timely or late, as long as the return is filed no more than 1 year after the due date, including extensions. Temporary Regulation Sec. 301.9100-6T(b), reflects this change to the law. The temporary regulation, however, also provides that once a return that fails to make the election is filed, the election may not be made on a subsequent return unless the subsequent return is filed by the due date (including extensions) of the original return. This limitation is not found in Sections 301.9100-1 and 301.9100-3 that apply to all requests for an extension of time to make an election submitted to the IRS on or after December 31, 1997. The Deficit Reduction Act of 1984 also added new Section 2032(c) that provides that, in the case of estates of decedents dying after July 18, 1984, the election to use the alternate valuation method may be made only if the election results in a reduction in both the value of the gross estate and the actual estate tax liability. The Tax Reform Act of 1986, amended Section 2032(c)(2) to provide that the election may be made only if the election results in a decrease both in the value of the gross estate and in the sum of the estate tax and generation-skipping transfer tax liability (reduced by credits allowable against these taxes).
In Notice 2004-2 (IRB 2004-2) the IRS has issued guidance in a question and answer format on Health Savings Accounts (HSAs). HSAs are established to receive tax-favored contributions by or on behalf of eligible individuals and amounts in an HSA may be accumulated over the years or distributed on a tax-free basis to pay or reimburse qualified medical expenses.
Taxpayers generally must prove the IRS is wrong in order to best the Service. As one exception to this rule, Section 7491(a) places the burden of proof on the IRS with respect to any factual issue related to a taxpayers' tax liability if they maintained adequate records, satisfied applicable substantiation requirements, cooperated with the IRS, and introduced during the court proceeding credible evidence on the factual issues. In Rafael M. Gutierrez et ux. (T.C. Memo. 2003-321) the Court found the taxpayers failed to introduce credible evidence on any factual issue. The taxpayers' testimony, the only evidence in the record, lacked credibility in that it was inconsistent and incoherent. In addition, the Court noted that the taxpayers failed to maintain adequate records and did not satisfy applicable substantiation requirements. The Court held the burden of proof remained with the taxpayers. The Court also found that, in the absence of adequate records, the IRS could reconstruct the taxpayers' income by any reasonable method that clearly reflects income. The IRS used the bank deposits method. The taxpayers could not show that any amount of the deposits came from a nontaxable source.
The IRS has issued a notice (IR-2003-141) to advise taxpayers that the Service intends to disallow improper deductions for charitable contributions of patents and other intellectual property. Taxpayers claiming improper deductions may be subject to penalties. In addition, the notice advises promoters and appraisers that the IRS intends to review promotions of transactions involving these improper deductions and that promoters and appraisers also may be subject to penalties. The IRS indicated that donations that are overly inflated or made with strings attached are going to receive increased scrutiny. The IRS is aware that some taxpayers transferring patents or other intellectual property to charitable organizations are claiming charitable contribution deductions in excess of the amounts to which they are entitled. In particular, the IRS is aware of purported charitable contributions of intellectual property involving: 1) transfers of nondeductible partial interests in intellectual property; 2) the expectation or receipt of benefits in exchange for transfers; 3) inadequate substantiation of contributions; or 4) overvaluation of intellectual property transferred.
The IRS has just released updates of Publication 15, Circular E, Employer's Tax Guide and Publication 503, Child and Dependent Care Expenses.
Damages received for personal injury or sickness are not taxable; amounts received in lieu of compensation, for economic damages, etc. are taxable. In Damian Gerard, et ux. et al. (T.C. Memo. 2003-320) the taxpayers were terminated from their professional relationships with their employer. The taxpayers sued for damages for interference with their employment relationship, defamation, infliction of emotional distress, emotional pain, suffering, inconvenience, mental anguish, loss of enjoyment of life and other applicable claims. The taxpayers contended the settlement agreement expressly allocated the settlement payments to claims for personal injuries. The Court found that there was personal injury, but it concluded that neither personal injury claims nor economic injury claims predominated in the company's reasons for making the settlement claims, but that both types weighed equally and held that one-half of the settlement payments were excludable from gross income.
The Earned Income Tax Credit (EITC) is a refundable federal income tax credit for low-income working individuals and families. The IRS has developed the Tax Preparer Electronic Toolkit to help tax professionals make sure their clients who honestly deserve the EITC file accurate tax returns. In addition to thorough information on various EITC topics, the toolkit includes downloadable materials to help preparers explain the EITC to their clients. For more information, go to the IRS site at www.eitcfortaxpreparers.com/.
The IRS announced (IR-2003-140) several steps to strengthen controls over the issuance of Individual Taxpayer Identification Numbers (ITINs are identification numbers for individuals who cannot get a Social Security number). The changes will help ensure that ITINs are issued for their intended tax administration purpose for administering the tax code and not for other reasons, such as providing personal identification. In addition, the IRS is taking steps to help ensure that applicants can continue to obtain ITINs without undue burden. Beginning December 17, 2003, new ITIN applicants must use a revised Form W-7, Individual Taxpayer Identification Number Application. ITIN applicants also must provide proof that the ITIN will be used for tax administration purposes. For applicants seeking an ITIN in order to file a tax return, the return must be filed along with the W-7. The number of documents the IRS will accept as proof of identity to obtain an ITIN has been reduced to 13 from 40.
You may be able to pay a outstanding tax liability over time using an installment agreement or pay a reduced amount by way of an offer in compromise. The IRS does not have to allow either option. In James J. Crisan and Veronica L. Crisan (T.C. Memo. 2003-318) the taxpayers made three arguments regarding the notice of determination: (1) that the taxpayers lack sufficient assets to satisfy the tax liabilities; (2) the taxpayers' offer to enter into an installment agreement was improperly rejected by respondent; and (3) the IRS did not give petitioners the opportunity to make an offer in compromise. The Court noted that at the hearing with the Appeals officer, the IRS preliminarily computed a monthly payment amount of $1,200. The Appeals officer gave the taxpayers the opportunity to resubmit a monthly installment payment amount, to which the taxpayers failed to timely respond. The Court found that the Appeals officer could have reasonably determined that taxpayers' proposed installment payment of $100 per month should be rejected on the basis of taxpayers' submitted income and expense information. In addition, the Court said the Service's determination not to enter into an offer in compromise agreement with the taxpayers was not an abuse of discretion. Section 7122(a) authorizes the IRS to compromise any civil case arising under the internal revenue laws. The regulations set forth three grounds for the compromise of a liability: (1) doubt as to liability; (2) doubt as to collectibility; or (3) promotion of effective tax administration. The Court found that none of the three grounds existed and that the Service's refusal to enter into an offer in compromise was not an abuse of discretion.
The IRS has issued final regulations (T.D. 9099) that consolidate the content requirements applicable to explanations of qualified joint and survivor annuities and qualified preretirement survivor annuities payable under certain retirement plans, and specify requirements for disclosing the relative value of optional forms of benefit that are payable from certain retirement plans in lieu of a qualified joint and survivor annuity. These regulations affect plan sponsors and administrators, and participants in and beneficiaries of, certain retirement plans.
The Large and Midsize Business Division of the IRS has issued a Field Directive on the Planning and Examination of Cost Segregation Issues in the Restaurant Industry. The directive reviews a detailed list of assets used in the restaurant industry and assigns lives that IRS examiners should allow for depreciation purposes.
The IRS has recently released the following new or updated publications:
The IRS issued a consumer alert (IR-2003-139) to help taxpayers avoid potential pitfalls when they donate their automobiles to charities. The Service advises that taxpayers contemplating such donations should ask many questions and carefully consider just how much of the proceeds from the car will go to their intended charity. A recent federal study indicates that in many instances such vehicle contributions may help the intended charities far less than taxpayers think. "We encourage people to proceed carefully when donating vehicles," said IRS Commissioner Mark W. Everson. "Supporting charitable activities through tax deductible contributions is an important element of tax law and serves the national interest. But people should know that in some cases the donation is providing little value." In one donation reviewed by the General Accounting Office (GAO), a taxpayer donated a 1983 truck valued at $2,400, but after the fundraiser sold the vehicle at auction and deducted administrative and advertising costs, the charity received $31.50. A California study revealed that 80 percent of charities contracting with fundraisers to run their car donation program received less than 60 cents for every dollar value of vehicle donated. Across the nation, an increasing number of charities have turned to car-donation programs in recent years as an effective way to raise money. And these programs, if well managed by the charity, can offer significant benefits for the exempt organization and the taxpayer. In addition, IRS officials are concerned that, as the end of the tax year approaches and taxpayers finalize their charitable donations, many may not know enough about IRS recordkeeping and filing requirements. Of 129 million individual returns filed for tax year 2000, the GAO estimates 733,000 returns had a tax deduction for a vehicle donation. The IRS provided some recommendations when donating:
The IRS has announced (Rev. Rul. 2003-126; IRB 2003-52) that the interest rate on under- and overpayments for the first quarter of 2004 will be unchanged from the fourth quarter of 2003. The under- and overpayment rate will be 4% (3% for corporate overpayments). The underpayment rate for large corporations will be 6%.
You can take a charitable contribution for the fair market value of an asset, regardless of what you paid for the item. Charitable organizations have for a number of years been soliciting autos. While the charities do receive some benefit, it's often much less than you would guess. While the IRS has known for some time that many individuals overvalue the contribution, it has done little to stop the practice. Congress has just begun to recognize the problem. That could generate a crackdown sometime in the future.
The IRS has issued amendments (T.D. 9098) to the temporary regulations under Section 1502 that govern the application of Section 108 when a member of a consolidated group realizes discharge of indebtedness income. These temporary regulations affect corporations filing consolidated returns. As explained in the preamble to the original regulations (T.D. 9089; REG-132760-03), those regulations adopt a consolidated approach that is intended to reduce all attributes that are available to the debtor member and contain a rule governing the order in which attributes are reduced. In particular, under the original regulations, the attributes attributable to the debtor member are first subject to reduction. For this purpose, attributes attributable to the debtor member include (1) consolidated attributes attributable to the debtor member, (2) attributes that arose in separate return limitation years of the debtor member, and (3) the basis of property of the debtor member. To the extent that the excluded COD income exceeds the attributes attributable to the debtor member, the original regulations require the reduction of consolidated attributes attributable to other members and attributes attributable to other members that arose (or are treated as arising) in a separate return limitation year to the extent that the debtor member is a member of the separate return limitation year subgroup with respect to such attribute. The IRS and Treasury Department have become aware that the original regulations may not provide for the reduction of all the attributes that are in fact available to the debtor member. In particular, those regulations may not require the reduction of tax attributes attributable to members other than the debtor member that arise in a separate return year and that are not subject to a SRLY limitation. Such attributes, for example, include attributes from separate return limitation years that are not subject to a SRLY limitation as a result of the application of the overlap rule of Sec.1.1502-15(g) or Sec.1.1502-21(g). These temporary regulations, therefore, amend the original regulations to include among the tax attributes that are subject to reduction, after the reduction of the tax attributes attributable to the debtor member, tax attributes attributable to members other than the debtor member (other than asset basis) that arose in a separate return year or that arose (or are treated as arising) in a separate return limitation year to the extent that no SRLY limitation applies to the use of such attributes by the group. This amendment is consistent with the approach of the original regulations to make available for reduction all of the attributes that are available to offset income of the debtor member.
Health Savings Acccounts (HSAs)
Introduction. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003, added Section 223 to the Code to permit eligible individuals to establish Health Savings Accounts (HSAs) for taxable years beginning after December 31, 2003. HSAs are designed to receive tax-favored contributions by or on behalf of eligible individuals. Amounts in an HSA may be accumulated over the years or distributed on a tax-free basis to pay or reimburse qualified medical expenses. (The approach here is different than for Archer Medical Savings Accounts (MSAs). MSAs were created under a pilot program and were available only employers of small businesses and self-employed individuals to pay health care expenses. Individuals had to be covered under a high deductible health insurance plan. The program was limited and the number of individuals who created MSAs was much less than anticipated.)
An HSA is a tax-exempt trust or custodial account (similar to an IRA) established exclusively for the purpose of paying qualified medical expenses of the account beneficiary who, for the months for which contributions are made to an HSA, is covered under a high-deductible health plan. A number of the rules that apply to HSAs are similar to those that apply to Individual Retirement Accounts (IRAs) under sections 219, 408 and 408A, and to Archer Medical Savings Accounts (Archer MSAs) under section 220.
Contributions to an HSA are deductible and income generated in the HSA is not taxed. Distributions used for qualified medical expenditures are not taxed. Other distributions are taxed and may be subject to a 10% penalty.
An HSA is only available to an "eligible individual." An eligible individual is one who:
The determination of coverage is made on a month-by-month basis.
High-deductible health plan. Generally, an HDHP is a health plan that satisfies certain requirements with respect to deductibles and out-of-pocket expenses. Specifically, for self-only coverage, an HDHP has an annual deductible of at least $1,000 and annual out-of-pocket expenses required to be paid (deductibles, co-payments and other amounts, but not premiums) not exceeding $5,000. For family coverage, an HDHP has an annual deductible of at least $2,000 and annual out-of-pocket expenses required to be paid not exceeding $10,000. In the case of family coverage, a plan is an HDHP only if, under the terms of the plan and without regard to which family member or members incur expenses, no amounts are payable from the HDHP until the family has incurred annual covered medical expenses in excess of the minimum annual deductible. (Amounts are indexed for inflation.) A plan does not fail to qualify as an HDHP merely because it does not have a deductible (or has a small deductible) for preventive care (e.g., first dollar coverage for preventive care). However, except for preventive care, a plan may not provide benefits for any year until the deductible for that year is met. Generally, an individual is ineligible for an HSA if he or she, while covered under an HDHP, is also covered under a health plan (whether as an individual, spouse, or dependent) that is not an HDHP.
Example 1--Black Cross Plan provides coverage for Fred Flood and his family. The Plan provides for the payment of covered medical expenses of any member of Fred's family if the member has incurred covered medical expenses during the year in excess of $1,000 even if the family has not incurred covered medical expenses in excess of $2,000. If Fred incurred covered medical expenses of $1,500 in a year, the Plan would pay $500. Thus, benefits are potentially available under the Plan even if the family's covered medical expenses do not exceed $2,000. Because the Plan provides family coverage with an annual deductible of less than $2,000, the Plan is not an HDHP.Coverage under certain "permitted insurance" such as workers' compensation, automobile insurance, insurance for a specified disease or illness, and insurance that pays a fixed amount per day (or other period) of hospitalization does not affect eligibility for an HSA. In addition to permitted insurance, an individual does not fail to be eligible for an HSA merely because, in addition to an HDHP, the individual has coverage (whether provided through insurance or otherwise) for accidents, disability, dental care, vision care, or long-term care.Example 2--Same facts as in example 1, except that the Plan has a $5,000 family deductible and provides payment for covered medical expenses if any member of Fred's family has incurred covered medical expenses during the year in excess of $2,000. The Plan satisfies the requirements for an HDHP with respect to the deductibles.
A self-insured medical reimbursement plan sponsored by an employer can be an HDHP.
How can you establish an HSA? Beginning January 1, 2004, you can establish an HSA with a qualified HSA trustee or custodian, in much the same way that you establish IRAs with qualified IRA trustees or custodians. No permission or authorization from the Internal Revenue Service (IRS) is necessary to establish an HSA. An eligible individual who is an employee may establish an HSA with or without involvement of the employer.
Any insurance company or any bank (including a similar financial institution as defined in Section 408(n)) can be an HSA trustee or custodian. In addition, any other person already approved by the IRS to be a trustee or custodian of IRAs or Archer MSAs is automatically approved to be an HSA trustee or custodian. While you can open an HSA at any qualified institution, the trustee or custodian may require proof or certification that the account beneficiary is an eligible individual, including that you are covered by a health plan that meets all of the requirements of an HDHP.
Contributions to HSAs. Any eligible individual may contribute to an HSA. For an HSA established by an employee, the employee, the employee's employer or both may contribute to the HSA of the employee in a given year. For an HSA established by a self-employed (or unemployed) individual, the individual may contribute to the HSA. Family members may also make contributions to an HSA on behalf of another family member as long as that other family member is an eligible individual.
The maximum annual contribution to an HSA is the sum of the limits determined separately for each month, based on status, eligibility and health plan coverage as of the first day of the month. For calendar year 2004, the maximum monthly contribution for eligible individuals with self-only coverage under an HDHP is 1/12 of the lesser of 100% of the annual deductible under the HDHP (minimum of $1,000) but not more than $2,600. For eligible individuals with family coverage under an HDHP, the maximum monthly contribution is 1/12 of the lesser of 100% of the annual deductible under the HDHP (minimum of $2,000) but not more than $5,150. In addition to the maximum contribution amount, catch-up contributions, may be made by or on behalf of individuals age 55 or older and younger than 65. The contribution limit is computed each month.
Example 1--Fred has self only coverage under a plan that has a $2,400 deductible. He can contribute $2,400 annually (the lesser of 100% of the deductible or $2,600) to his HSA.All HSA contributions made by or on behalf of an eligible individual to an HSA are aggregated for purposes of applying the limit. The annual limit is decreased by the aggregate contributions to an Archer MSA. The same annual contribution limit applies whether the contributions are made by an employee, an employer, a self-employed person, or a family member. Unlike Archer MSAs, contributions may be made by or on behalf of eligible individuals even if the individuals have no compensation or if the contributions exceed their compensation. If an individual has more than one HSA, the aggregate annual contributions to all the HSAs are subject to the limit.Example 2--The facts are the same as above, but the deductible under Fred's plan is $3,000. The lesser of 100% or $2,600 is $2,600, so his maximum contribution for the year is $2,600.
Example 3--The facts are the same as in example 1, but Fred is covered under a new plan with a $500 deductible beginning August 1. Thus, Fred can only contribute for the first 7 months of the year. His monthly contribution would have been $200 ($2,400/12) so his maximum contribution for the year is $1,400.
For individuals (and their spouses covered under the HDHP) between ages 55 and 65, the HSA contribution limit is increased by $500 in calendar year 2004. This catch-up amount will increase in $100 increments annually, until it reaches $1,000 in calendar year 2009. As with the annual contribution limit, the catch-up contribution is also computed on a monthly basis. After an individual has attained age 65 (the Medicare eligibility age), contributions, including catch-up contributions, cannot be made to an individual's HSA.
Example--An individual attains age 65 and becomes eligible for Medicare benefits in July, 2004 and had been participating in self-only coverage under an HDHP with an annual deductible of $1,000. The individual is no longer eligible to make HSA contributions (including catch-up contributions) after June, 2004. The monthly contribution limit is $125 ($1,000 /12+ $500/12 for the catch-up contribution). The individual may make contributions for January through June totaling $750 (6 x $125), but may not make any contributions for July through December, 2004.In the case of married individuals, if either spouse has family coverage, both are treated as having family coverage. If each spouse has family coverage under a separate health plan, both spouses are treated as covered under the plan with the lowest deductible. The contribution limit for the spouses is the lowest deductible amount, divided equally between the spouses unless they agree on a different division. The family coverage limit is reduced further by any contribution to an Archer MSA. However, both spouses may make the catch-up contributions for individuals age 55 or over without exceeding the family coverage limit.
Contributions to an HSA must be made in cash; stock or other property is not allowed. Payments for the HDHP and contributions to the HSA can be made through a cafeteria plan.
Contributions made by an eligible individual to an HSA are deductible by the eligible individual in determining adjusted gross income. The contributions are deductible whether or not the individual itemizes. However, you cannot also deduct the contributions as medical expense deductions under section 213.
Contributions made by a family member on behalf of an eligible individual to an HSA are deductible by the eligible individual in computing adjusted gross income. The contributions are deductible whether or not the eligible individual itemizes deductions. An individual who may be claimed as a dependent on another person's tax return is not an eligible individual and may not deduct contributions to an HSA.
In the case of an employee who is an eligible individual, employer contributions to the employee's HSA are treated as employer-provided coverage for medical expenses under an accident or health plan and are excludable from the employee's gross income. The employer contributions are not subject to withholding from wages for income tax or subject to the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), or the Railroad Retirement Tax Act. Contributions to an employee's HSA through a cafeteria plan are treated as employer contributions. The employee cannot deduct employer contributions on his or her federal income tax return as HSA contributions or as medical expense deductions under section 213.
Contributions for the taxable year can be made in one or more payments, at any time prior to the time prescribed by law (without extensions) for filing the eligible individual's federal income tax return for that year, but not before the beginning of that year. For calendar year taxpayers, the deadline for contributions to an HSA is generally April 15 following the year for which the contributions are made. Although the annual contribution is determined monthly, the maximum contribution may be made on the first day of the year.
Contributions by individuals to an HSA, are not deductible to the extent they exceed the limits. Contributions by an employer to an HSA for an employee are included in the gross income of the employee to the extent that they exceed the limits or if they are made on behalf of an employee who is not an eligible individual. In addition, an excise tax of 6% for each taxable year is imposed on the account beneficiary for excess individual and employer contributions.
However, if the excess contributions for a taxable year and the net income attributable to such excess contributions are paid to the account beneficiary before the last day (including extensions) for filing the account beneficiary's federal income tax return for the year, then the net income attributable to the excess contributions is included in the account beneficiary's gross income for the taxable year in which the distribution is received but the excise tax is not imposed on the excess contribution and the distribution of the excess contributions is not taxed.
Rollover contributions from Archer MSAs and other HSAs into an HSA are permitted. Rollover contributions need not be in cash. Rollovers are not subject to the annual contribution limits. Rollovers from an IRA, from a health reimbursement arrangement (HRA), or from a health flexible spending arrangement (FSA) to an HSA are not permitted.
Distributions from HSAs. An individual is permitted to receive distributions from an HSA at any time. Distributions from an HSA used exclusively to pay for the individual's qualified medical expenses, his or her spouse, or dependents are excludable from gross income. In general, amounts in an HSA can be used for qualified medical expenses and will be excludable from gross income even if the individual is not currently eligible for contributions to the HSA. However, any amount of the distribution not used exclusively to pay for qualified medical expenses of the account beneficiary, spouse or dependents is includable in gross income and is subject to an additional 10% tax on the amount includable, except in the case of distributions made after the account beneficiary's death, disability, or attaining age 65.
The term "qualified medical expenses" are expenses paid by the account beneficiary, his or her spouse or dependents for medical care as defined in section 213(d) (including nonprescription drugs as described in Rev. Rul. 2003-102, 2003-38 I.R.B. 559), but only to the extent the expenses are not covered by insurance or otherwise. The qualified medical expenses must be incurred only after the HSA has been established. For purposes of determining the itemized deduction for medical expenses, medical expenses paid or reimbursed by distributions from an HSA are not treated as expenses paid for medical care under section 213. Generally, health insurance premiums are not qualified medical expenses except for the following: qualified long-term care insurance, COBRA health care continuation coverage, and health care coverage while an individual is receiving unemployment compensation. In addition, for individuals over age 65, premiums for Medicare Part A or B, Medicare HMO, and the employee share of premiums for employer-sponsored health insurance, including premiums for employer- sponsored retiree health insurance can be paid from an HSA. Premiums for Medigap policies are not qualified medical expenses.
If you are no longer an eligible individual (e.g., over age 65 and entitled to Medicare benefits, or no longer have an HDHP), distributions used exclusively to pay for qualified medical expenses continue to be excludable from the individual's gross income.
HSA trustees or custodians are not required to determine whether HSA distributions are used for qualified medical expenses. Individuals who establish HSAs make that determination and should maintain records of their medical expenses sufficient to show that the distributions have been made exclusively for qualified medical expenses and are therefore excludable from gross income. Employers who make contributions to an employee's HSA are not responsible for the determination whether HSA distributions are used exclusively for qualified medical expenses.
Upon death, any balance remaining in the account beneficiary's HSA becomes the property of the individual named as the beneficiary of the account. If the account beneficiary's surviving spouse is the named beneficiary of the HSA, the HSA becomes the HSA of the surviving spouse. The surviving spouse is subject to income tax only to the extent distributions from the HSA are not used for qualified medical expenses. If, by reason of the death of the account beneficiary, the HSA passes to a person other than the account beneficiary's surviving spouse, the HSA ceases to be an HSA as of the date of the account beneficiary's death, and the person is required to include in gross income the fair market value of the HSA assets as of the date of death.
Other Issues. If an employer makes HSA contributions, the employer must make available comparable contributions on behalf of all "comparable participating employees" (i.e., eligible employees with comparable coverage) during the same period. Contributions are considered comparable if they are either the same amount or same percentage of the deductible under the HDHP.
The comparability rule is applied separately to part-time employees (i.e., employees who are customarily employed for fewer than 30 hours per week). The comparability rule does not apply to amounts rolled over from an employee's HSA or Archer MSA, or to contributions made through a cafeteria plan. If employer contributions do not satisfy the comparability rule during a period, the employer is subject to an excise tax equal to 35% of the aggregate amount contributed by the employer to HSAs for that period.
Example--Madison Inc. offers its collectively bargained employees three health plans, including an HDHP with self-only coverage and a $2,000 deductible. For each employee electing the HDHP self-only coverage, Madison contributes $1,000 per year on behalf of the employee to an HSA. Madison makes no HSA contributions for employees who do not elect the HDHP. Madison's plans and HSA contributions satisfy the comparability rule.Both an HSA and an HDHP may be offered as options under a cafeteria plan. Thus, an employee may elect to have amounts contributed as employer contributions to an HSA and an HDHP on a salary-reduction basis.
Employer contributions to an HSA must be reported on the employee's Form W-2. In addition, information reporting for HSAs will be similar to information reporting for Archer MSAs. The IRS will release forms and instructions, similar to those required for Archer MSAs, on how to report HSA contributions, deductions, and distributions.
HSAs are not subject to COBRA continuation coverage requirements.
Additional details are contained in Notice 2004-2, IRB 2004-2.
Do HSAs make sense? For a number of reasons they certainly make more sense than MSAs. Health insurance policies with deductibles of $1,000 ($2,000 for family coverage) are not as unusual as they once were. Individuals can make contributions of 100% of the deductible amount, but not more than $2,600 for individual or $5,150 for family coverage. Thus, an individual with a $1,500 deductible could make a $1,500 contribution for the year. That contribution is fully deductible (not subject to the 7.5% of AGI restriction for other medical expenses), grows tax deferred, and, if used for qualified medical expenses will permanently escape taxation. If you already have a HDHP making a contribution to an HSA is a win-win situation.
What if you don't have an HDHP? Should you consider moving to such a plan? That depends on a number of factors, most importantly your health situation. Increasing the deductible reduces your insurance premiums. That makes sense if you rarely approach your current deductible (say $250 a year), you have a large co-pay amount, or you rarely file claims. If you're in a group plan with a low deductible and the savings from switching to a higher deductible would be minor, increasing your deductible probably doesn't make sense. You've got to analyze the numbers for your situation. And, keep in mind that once you qualify for medicare, you can no longer contribute. Thus, switching when you're age 63 probably doesn't make sense. Even if you don't think you'll ever need to tap the HSA before age 65, making the contribution currently makes sense since the amount is tax deductible and will grow tax deferred. And, there's a very high probability you'll never pay tax on the amount.
What does this mean for employers? With insurance premiums increasing rapidly, employers are using almost any trick to hold down costs. While some employees would disagree, the most important benefit of health insurance is covering catastrophic expenses. Asking employees to cover the first $2,000 (family coverage) or even $4,000 isn't too much to ask if it means significant savings to the business. In addition, even smaller companies are now changing from regular coverage to self insurance on the first $5,000 or more of covered expenses and covering the remainder with a catastrophic policy.
Be sure to be able to document distributions from the HSA as qualifying. That means keeping records of doctor's bills, prescriptions, etc.
Before making any changes, get good advice, from an independent source. Carefully analyze all the costs, including administrative expenses. For employers, changing deductibles or switching plans is a major decision. It's important for individuals too. You may have difficulty switching back later if the savings don't pan out.
Summary. Here are the most important points to keep in mind:
Previously Reported In Daily Update
New markets vs. minding the store . . . Some companies pursue growth just for the sake of higher sales, more outlets, etc. Don't fall into the trap. Managing several stores can be much more challenging that operating just one or two. More than one business has failed because it expanded too rapidly. And many entrepreneurs are great a starting a business but not at managing growth. Before committing to expansion plans, get good advice and make sure you and your employees have the skills to handle the larger business.
Charitable contributions . . . While it may be beneficial to the organization, the cost of a lottery or raffle ticket, bingo card, or expenditures to play any game of chance run by a charitable organization aren't deductible. You've got to treat it just as if you were gambling--that is, losses are only deductible up to your winnings and any winnings are reportable as income.
Leasing equipment to your business? . . . Owning real estate in your own (or your children's) name and leasing it to your corporation or other business entity can make sense. In addition to potential tax benefits, it keeps an asset off the books in case the business is sued or goes bankrupt. But leasing equipment to the business is another issue. Equipment leases can create self-employment income and the accompanying self-employment tax. How much of a disadvantage depends on whether or not the lessor (you) will be over the FICA threshold for the year. In addition, a noncorporate lessor (individual, partnership, S corporation, estate, etc.) can't take the Section 179 expense deduction unless the lease term is less than 50% of the property's class life and the business expense deductions related to the property (other than rental payments and reimbursements) exceed 15% of the first 12 months' rental income under the lease. There are some exceptions. Check with your tax advisor.
Give customers a deal . . . Even rich people like to save money. In fact, they're frequently more cost conscious than middle-class customers. There's something primal about saving money. If you're trying to decide on a way to lure customers to buy or to get new customers, offering a discount, particularly for a limited time, is usually the best way to increase business. While a discount generally works better than other types of inducements, a combination (e.g., a discount plus appealing to emotion), can further improve results.
Consider a seminar to promote your business . . . It won't work for every business, but you'd be surprised how adaptable a seminar, show, party, etc. can be. We know of at least one auto repair shop that held a workshop on auto basics--how to check the tires, change a flat, check oil and transmission fluid, etc. The cost is cheap. That means you only need to convert a few participants to customers to come out ahead. A dress shop can hold a fashion show for charity. Seminars tend to produce repeat customers; that's much better than the one-shot customers discount ads often generate.
Section 179 trap . . . Everything becomes more complicated if you decide to file married, separate. Many limitations written into the law are split 50-50 when you decide to file that way. In the case of the Section 179 election to expense equipment, both the limitation on the equipment placed in service ($400,000 for 2003) and the maximum deduction ($100,000 for 2003) for each individual is 50% of the total that would apply to a couple filing jointly. But you can change that by making an election to split the total differently. That can result in one individual taking more or all of the deduction. If you and your spouse are filing married, separate for tax reasons, that's easy. If you're doing so because your marital situation is less than amicable, you'll probably have to come to some agreement that could involve a financial tradeoff.
Estate tax alternate valuation . . . The estate tax is not dead yet. If you're filing an estate tax return (whether you're preparing the return or you're just the executor), you have the option of valuing the property on the decedent's date of death or an alternate valuation date (either six months later or the date of disposition of the property, if that's earlier). Using the alternate valuation date can, in some cases, significantly reduce the value and the tax on the estate. Generally, the election to use the alternate valuation date is made on a timely filed return. The election, once made, cannot be revoked. The election can be made on a late filed return, provided it is filed not later than 1 year after the due date, including extensions and it is the first return filed. Be sure to file Schedule A-1 and its required attachments with Form 706 for this election to be valid.
Placing an ad? . . . While it may boost your ego to place an ad in a regional or national publication, if your market is limited, you may be wasting your money. You can usually get more results for less money by placing a large ad in a small circulation publication. (There are limits to the size of the ad and the publication.) If you're trying to reach a broad group of people (e.g., you have a restaurant), you'll probably draw most of your business from a small area. (There are exceptions, of course.) A big ad in a local publication should give you better results. If your business is national in scope, but your market limited (you sell primarily to the graphic arts industry), you'll probably do better with a trade publication than a general interest publication that's distributed to both professionals and casual readers.
Cosmetic surgery . . . Surgery is generally a deductible medical expense. However, Cosmetic surgery is not. The law defines cosmetic surgery as any procedure that has as its objective the improvement of the patient's appearance without also meaningfully promoting the proper function of the body or preventing or treating illness or disease. But there's an exception to the exception. If the surgery is necessary to ameliorate a deformity arising from, or directly related to, a congenital abnormality, a personal injury resulting from an accident or trauma, or a disfiguring disease. In a recent letter ruling (LTR 200344010) the IRS ruled that surgery to correct a facial deformity that resulted from surgeries to correct congenital abnormalities, was deductible.
Disguised sales to partnerships . . . It would be nice if you could sell property that's appreciated and avoid tax on the sale. That might be possible by contributing the property to a partnership and letting the partnership sell the property and distribute the proceeds to you. That used to be easy. However, the disguised sale provision (Sec. 707) is designed to prevent parties from characterizing a sale or exchange of property as a contribution to a partnership followed by (or preceded by) a distribution from the partnership with the object of deferral or avoidance of tax. Section 707(a)(2)(B) provides that if (i) there is a direct or indirect transfer of money or other property by a partner to a partnership, (ii) there is a related direct or indirect transfer of money or other property by the partnership to such partner (or another partner), and (iii) the transfers described in clauses (i) and (ii), when viewed together, are properly characterized as a sale or exchange of property, such transfers will be treated as if the transaction was not between a partner and the partnership and will be taxable. Section 1.707-3(c) of the regulations provides that if within a two-year period a partner transfers property to a partnership and the partnership transfers money or other consideration to the partner (without regard to the order of the transfers), the transfers are presumed to be a sale of the property to the partnership unless the facts and circumstances clearly establish that the transfers do not constitute a sale.
Save when buying ad space . . . Many publications have small amounts of unused ad space when putting together an issue. They frequently fill the space with public service ads, but you can often buy the space at a much reduced price. You won't have a choice on placement or size and you may not be able to put it in any particular issue and the deadlines are short, but the price is right. You should have ads of various sizes to fit different space available near the closing date. If you're a regular customer and make it known you'll take the space, you'll have a better chance.
Software audit . . . Software piracy is not a joke to the industry. They're serious about nailing counterfeiters. And, if you have a business (large or small) you could find yourself the subject of an audit. Take the initiative. Look at the computers in your company (both desktops and laptops) and look for unauthorized copies. There's a good chance one or more of your employees has brought in unlicensed software from home or downloaded it from the internet. Check your machines and remove any unlicensed copies. (There is free software available that can help you.) At the same time document your efforts to prevent illegal use. If you can document that you have an ongoing program to prevent abuse (e.g., checking machines several times a year, making employees sign a statement that they won't download or bring in unlicensed products, etc.) you'll be on better ground should you be audited and unlicensed products found.
Copyright 2003-2004 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536