A second situation occurs when you receive a notice from the IRS that you have unreported wage income from an employer you don’t know.  It is likely that an undocumented worker has used your social security number to obtain employment and used your social security number.

If you are the victim of tax-related identity theft you should respond immediately to any notice received from the IRS, explaining why you feel you are a victim.  If you believe you may be at risk because your personal information has been compromised you should file a police report with local law enforcement.  In addition you should phone the IRS Identity Protection Specialized Unit at 800-908-4490.  You should also contact your financial institutions.  Finally, contact credit bureaus to place a fraud alert on and get copies of your credit reports.

In addition to identity theft, you may also be a victim of online tax related fraud.  You should know that the IRS does not initiate taxpayer communications through e-mail nor do they request detailed personal information through e-mail   I hate to disappoint you but that e-mail message you got last week stating you have an $853.69 refund with the IRS is a fraud.   Avoid opening attachments on any such e-mail messages and forward the message to phishing@irs.gov.

A significant source of internet tax-related fraud originates with e-file phishing sites.  These appear to be legitimate online sites for self-preparing and e-filing your tax return.  They are often advertised through commercial pay-per-click sites.  These returns are usually submitted through valid Electronic Return Originators, so your return does get properly filed.  However, before filing your return these sites capture your tax information and reroute your refund to the phisher’s bank account.  You don’t know anything is wrong until you don’t receive your refund and check with the IRS only to find out it was sent several weeks ago.

For the latest information on tax related identity theft you can go to www.irs.gov and search on “identity theft.”  Taxpayer security has always been a hallmark of the IRS and they are on the forefront of combatting tax related identity theft.  But the bottom line is that you need to be proactive about protecting yourself.  Don’t give out your personal information indiscriminately and know who you are dealing with – online or face-to-face.

In order to deduct any expenses associated with volunteer work, you must itemize your deductions, as these are considered charitable contributions on Schedule A.  You can deduct certain out-of-pocket expenditures if:

• The expenses were incurred in the rendition of volunteer services for a qualified charity.  A qualified charity is one that is approved by the IRS as a not-for-profit organization that may receive deductible contributions. If in doubt, you can check with the administrator of the charity or go to http://www.irs.gov/app/pub-78/ for the online listing of qualified organizations.
• The expenses must be unreimbursed.
• The expenses must be incurred only because of the volunteer services. If the expenses would have been incurred even without doing the volunteer services, they are not deductible.
• The expenses cannot be for your personal, living, or family use.

Some examples of what would be deductible would be the cost of purchasing and cleaning uniforms worn by a hospital volunteer.  Travel expenses would be deductible.  For example, if you go on a mission trip to Africa, the cost of your airfare, other travel, meals, and lodging would be deductible.  The trip must be primarily for the purpose of serving the organization, but an element of personal pleasure may be included.

If you use your personal vehicle on behalf of the charitable organization, you can deduct mileage at 14 cent per mile.  This rate is designed to cover gas and oil, but no costs of owning and operating the vehicle.  You may also deduct parking fees and tolls.

In order to take a deduction, the volunteer must keep a reliable written record of any out-of-pocket expenses.  For expenses of $250 or more you need a statement from the charity describing the volunteer services as well as a statement of any goods and services it provided to you.

You cannot deduct the costs of childcare incurred to allow you to volunteer, clothing that is suitable for non-volunteer use, or the cost of meals if you do not need to stay away from home overnight.  In addition, the cost of a “vacation” is not deductible if the amount of work performed for the charity is not significant.

A volunteer is not permitted to take a deduction for the value of his/her services.  For example, assume a CPA serves as Treasurer of a charity and normally charges $100 an hour for his/her services.  If he works 10 hours, he has done $1,000 of work for the charity.  While the charity may count this as gifts-in-kind, the CPA is not allowed a deduction for the $1,000.

Another issue relates to the use of property by a charity.  Suppose you have a rental house that you allow the charity to utilize.  You do not get a deduction for the use of the property.  You can deduct any out-of-pocket expenses (such as utilities you pay), but not the rental value.

What is the responsibility of the organization in regard to their volunteers?  It should maintain accurate, contemporaneous written records of any reimbursements paid to volunteers.  The organization does not issue a 1099 for reimbursed expenses, regardless of amount.

Due to recent changes on the Form 990, a charitable organization needs to keep track of the number of full and part-time volunteers during the year.  Although a reasonable estimate is acceptable, the organization must show on the return how they determined the number of volunteers.  In addition, it must disclose any services and benefits provided by volunteers.

Volunteers are the lifeblood of most charitable organizations, and the organization should properly be appreciative of their efforts.  However, the organization should be careful about how it thanks it volunteers.  It is perfectly acceptable to provide free food and drink at a “thank you” event.  Likewise, it is permissible to provide plaques or similar mementos honoring volunteer service.  However, the organization may not provide cash or “near cash” awards to volunteers.  The IRS has determined that gift cards are considered near cash and not permissible.  Cash or near cash can cause the volunteer to be considered an employee, requiring a W-2 and related taxes.

Don’t let the tax rules dissuade you from volunteering your services.  They are needed and appreciated.  Just be certain that everything is done “by the book.”

The first test that must be met for any person to be claimed as a dependent is the citizenship or resident test.  This test simply states that the person being claimed as a dependent must be a United States citizen or a resident of the United States, Canada, or Mexico for some part of the year.  A non-resident may not be claimed as a dependent regardless of the support you provide or your relationship to that person.

Additionally, the person being claimed as a dependent cannot be claimed by another taxpayer and the person cannot file a joint return (unless there is no tax liability and the filing is only to obtain a refund).

Once that test is met, the person must qualify as a dependent under one of two paths.  They may be a qualifying child or a qualifying relative.  In addition, there are special rules for children of divorced or separated parents.

There are four tests that must be met to be a qualifying child.  All four must be met in order to be claimed as a dependent.

The relationship test requires that the person being claimed as a dependent be your son, daughter, stepchild, foster child, brother, sister (including half and step brothers and sisters) or a descendent of any of them.  Therefore, your grandchild as well as your niece or nephew would also qualify.

The age test states that the child must be under age 19 at the end of the year or a full-time student under age 24 at the end of the year.  Note that the date of determination is December 31.  A child turning 19 at any time during the year who is not a full time student does not qualify.

A child is defined as a full-time student if he or she is a full-time student as defined by the institution for part of five months during the year.

There is an exception to the age rule for permanently and totally disabled children.  They would qualify regardless of age.

The residency test requires that the child must have lived with you for more than half the year.  Temporary absences, such as for illness, education, vacation, business, or military service count as time lived with you.  A child who is born or dies during the year is treated as having lived with you for the entire year if they were alive at any time during the year.

The support test is met if the child did not provide more than half of his or her own support during the year.  Scholarships are not considered support provided by the child.

In the case of separated or divorced parents, the custodial parent is usually considered the one who qualifies for the exemption.  The custodial parent may sign a written declaration that he or she will not claim the exemption and is allowing the noncustodial parent to take the exemption.  Additionally, if there is a qualified domestic relations order specifying who gets the exemption, the IRS will normally abide by that order.

If the would-be dependent does not meet the criteria for a qualifying child, it may be possible to claim the person as a qualifying relative.  This is somewhat of a misnomer, as the person does not have to be a blood relative to qualify under these rules.  Additionally, there is no age limit for meeting the qualifying relative criteria.

The first test is that the person cannot be a qualifying child of any other taxpayer.

The member of household or relationship test has two sections.  First, the person must live with you as a member of your household for the entire year.  As with the residency test under qualifying child, temporary absences for specified reasons count as living with you.    Second, there is an exception.  Certain relatives do not have to live with you to qualify under this test.  These include your child, stepchild, foster child or any descendent of them; your brother or sister (including half and step); your parents or other direct ancestor; aunt, uncle, niece, or nephew.  Any of these relationships that were established by marriage are not ended by death or divorce.

The gross income test specifies that the person’s gross income for the year be less than the amount of the dependency exemption.  For 2010, this is $3,650.  Gross income is “all income in the form of money, property, and services that is not exempt from tax.”  Thus, income such as social security is not included in gross income for this purpose.

Finally, the support test requires that you provide over half the person’s support during the year.  If no one provides over half the support, those supporting the person may enter into a multiple-support agreement under which one person is designated as having permission to claim the dependency exemption.

I would add that there is one other specification under the IRS rules.  In order to claim the dependency exemption, the relationship between the parties must not be in violation of state or local law.  For example, if a person has multiple wives, state laws against polygamy would serve to prevent the husband from claiming multiple wives as dependents.

Hopefully, this has shed some light on the topic of dependency exemptions.  It is by no means exhaustive, as there are an unlimited number of situations that do not always fit the rules perfectly.

I was a member of the His Nets team that recently went to Ghana to distribute nets.  To quote Charles Dickens, “it was the best of times, it was the worst of times.”  To see the joy on the faces of the mothers who received a net and received a new lease on life for their children is a memory that will be etched on my mind for the rest of my life.  But alongside that image is the bitter disappointment on the faces of those who were not able to receive a net.  We gave out 2,000 nets; I wish we had 10,000.  It is better to do some good than to do nothing at all.  James 4:17 states “Anyone, then, who knows the good he ought to do and doesn’t do it, sins.”  Giving out 2,000 nets is good we ought to do.

This trip to Ghana for me was about people and faces.  As mentioned the joy on the faces of those receiving nets was indescribable.  Our Ghanaian friend, Pastor Timothy brought the reality of malaria home, stating that he gets it a couple of times a year.  In Ghana, as in other parts of Africa, it is not a question of “will you get malaria?” but “will you die from malaria?”  Expectant mothers and young children are most susceptible to the ravages of this disease.  So giving nets to mothers is giving them and their children a chance to live.  Can they be faulted for aggressively trying to get one of these precious items?  In the same situation, what would you do?  Conversely, the disappointment on the faces of those who did not get nets is haunting.  A chance for life snatched away because of a limited number of nets.

I think also of the face of Francis, one of our drivers.  Francis is a tall, imposing man and was our enforcer.  If problems arose, Francis would take care of them.  But Francis has a big, soft heart.  Daily, we would be traveling to a site and would see an expectant mother walking along the road.  Francis would stop the caravan, jump out of his truck and find a net, giving it to the new mother.  The smile on his face after these events said it all.

Then there was the face of Rita, one of our team members. Rita is a school teacher and we had the opportunity to visit a local elementary school.  It was more than she could bear.  “They have nothing,” she cried.  Yet, they seemed happy.  The children would frequently ask us to take their picture, then crowd around the camera to see their faces. Yet when the mask of childhood joy would slip away, we could see a longing for something more.  Perhaps at that young age they realized the harm that could befall them from malaria and were hoping that what we were bringing would help them.

Pastor Timothy arranged the distribution locations for us.  Timothy is a tireless servant of God, planting churches in the Volta region of Ghana.  You could see etched on his face the concern he felt for the souls of his countrymen.  Yet he knew we were about the Father’s business and he never flagged in zeal.  His wife, Faustina, supports him and assists his ministry.  She was always up early, fixing our breakfast, arranging other meals.  She made shirts and dresses as gifts for each team member.  Yet her face was always serene and composed.  This despite the fact that one of her children, little Onesimus, was in the local hospital battling malaria – the very disease we were there to fight. His quiet sadness at the hospital is another image that I will not forget.

And there is the face of  T Thomas, His Nets founder and executive director.  We know of his zeal for His Nets and for missions.  But to see him in Ghana, telling the people about God, malaria, and mosquito nets is to see passion in action.

I committed to go on this distribution, figuratively kicking and screaming.  My wife and T were both encouraging me to go.  But my face was not set toward Ghana.  I said, “Why do they need me there?  They can distribute 2,000 nets without me.  And I could take the money I would spend and buy a bunch of nets.”  As I sought the face of God on this matter, he made it very clear to me that I was to go.  I did not really understand why, but who am I to argue with God?  After being there, I have a much deeper realization of the importance of the task that His Nets has undertaken.  I may or may not go on future distributions, but I will set my face to raise more funds so more lives can be saved with mosquito nets.

A $6 contribution will buy one net. www.hisnets.org

Mandatory E-filing As most of my readers know, in 2011, it has been legislated that all returns filed by a paid tax preparer must be e-filed.  However, the IRS has modified that requirement slightly.  In 2011, any preparer who expects to prepare 100 or more returns must submit the returns via e-file.  In 2012, that requirement tightens up so that any paid preparer who expects to prepare 10 or more must e-file.  The original legislation stated that the returns filed by the preparer must be e-filed.  The IRS has interpreted this so that filing equals preparation.

However, the IRS has created an opt-out provision.  Any taxpayer who does not want his or her return e-filed can inform the preparer that they choose to opt-out of having the return submitted via e-file.  This is a matter between the preparer and the taxpayer, the IRS does not plan to issue a form on which a taxpayer can opt out.  However, my advice is that all preparers should get a signed statement from the taxpayer, indicating the desire to opt out.  This will protect the preparer in the event the IRS inquires as to why the preparer is not e-filing certain returns.

Emphasis on Enforcement I cannot tell you how many times I heard the word “enforcement” uttered by IRS personnel at the Forum.  However, I can tell you that I heard “service” mentioned once.  With the large budget deficits, and pressure to reduce the tax gap, the IRS is on a major enforcement initiative.  Wherever the IRS perceives that there are significant uncollected tax dollars, there is likely to be an increased emphasis on collection in that area.  Having said that, I do not recommend that taxpayers avoid taking legitimate deductions in the hope of avoiding an IRS investigation.  Take any deduction you are entitled to.  But the critical factor is to maintain good records of all expenditures and receipts so you can successfully defend yourself against an IRS audit.

Internet Fraud The IRS is taking steps to reduce fraud via the internet.  You should know that the IRS does not contact taxpayers via e-mail and does not ask that personal information be entered on their internet website.  Additionally, there are websites out there that will allow you to prepare your taxes online, submit them by e-file, and have your refund direct deposited to your account.  These unscrupulous websites, however, change your bank account number before the return is filed, so that your refund goes to them.  Know who you use to prepare and file your taxes.

Paid Preparer Registration The IRS is registering paid preparers.  Starting in the Fall, any preparer must obtain a preparer taxpayer identification number (PTIN).  If a preparer already has a PTIN, they must re-register, but can keep the same number.  Registration will require a fee, currently estimated by the IRS to be between $75 and $300 every three years.  This is not a popular topic with preparers.  In one session I attended, those in attendance booed the IRS representative when she was discussing this topic.  In addition, registration will require preparers who are not CPA, Attorneys, or Enrolled Agents to pass a test and take continuing education in order to maintain their registration.

Many changes are coming in the area of taxation, and they are coming soon.  From the standpoint of a preparer, there is much to be done in order to stay current on the latest from the IRS.  For the taxpayer, you should carefully select who you choose to prepare your taxes.

The current plan for registration of preparers has four components: 1) Registration, 2) Competency Testing, 3) Continuing Education, and 4) Ethical Standards.  Let’s look briefly at each of these.

Registration. Any preparer who signs as a paid preparer will be required to register with the IRS and pay an annual fee.  Registration would be good for three years.  It is anticipated that preparers will be registered and in possession of a Preparer Tax Identification Number (PTIN) by January 1, 2011.

Competency Testing.  Preparers will be required to pass a competency test.  Initially, there will be two levels of testing – Wage and non-business Form 1040 series and Wage and Small Business Form 1040 series.  Additional competency testing is contemplated.  Preparers would initially have three years to meet the competency requirements.  There is no grandfathering of existing preparers but attorneys, certified public accountants, or enrolled agents who are active and in good standing with their respective licensing agencies are exempt from testing.

Continuing Education. Paid preparers will be required to complete 15 hours of continuing education annually including three hours of federal tax law updates and two hours of tax ethics.  Attorneys and CPAs are exempt from this requirement.  Enrolled Agents already have a more rigorous CPE requirement.

Ethics. All tax return preparers would be subject to Treasury Department Circular 230.

In my opinion, the IRS has an agenda beyond preparer registration and competency.  In a recent statement before the New York State Bar Association Tax Section, IRS Commissioner Doug Shulman made the following statement:

“I believe that at the end of the day, taxpayers and tax authorities pretty much want the same thing out of the tax system. They want certainty regarding a taxpayer’s tax obligations sooner rather than later. They want consistent treatment across taxpayers. They want an efficient use of government and taxpayer resources by focusing on the issues and taxpayers that pose the greatest risk. And that’s all about working smarter.

Working smarter also includes maximizing the use of our resources, while leveraging other players in the tax system to help us ensure compliance with the law.”

Let’s take a look at that statement, particularly the second paragraph.  The IRS wants to “leverage other players in the tax system.”  Your tax return preparer represents you.  He or she is paid by you to help you pay the minimum amount of tax that you legally owe.  Your preparer may not report “errors” on your present or prior returns to the IRS.”  Your preparer is your advocate with the IRS.  But the IRS apparently wants to change this.

In financial circles “leverage” includes the use of borrowed funds to increase an investor’s return on his investment.  The IRS wants to increase their return on dollars spent by leveraging “other players in the tax system.”  Obviously, these “other players” are not IRS employees.  The IRS is seeking, in essence, to have the paid tax professional to do their work without being employed by the IRS.  They want to use preparers as their surrogates in helping increase tax compliance.  Not only are preparers not paid by the IRS, they must pay a registration fee for the privilege of being a registered preparer.  I guess that’s how the IRS works smarter.

The IRS proposal is not about increasing tax preparer competency. If competency were the objective, why are experienced, competent but uncertified preparers not being grandfathered in?

Addionally, this proposal does nothing to address the issue of unethical preparers who prepare the return for a fee, but do not sign the return.  Their line often goes something like this: “Due to the limitations in the tax law you can’t deduct my fee.  So, I will charge you an amount less than my full fee, and I will not sign the return.”  If you fall for this, you are on thin ice.  If there is a problem with your return in the future, you cannot turn to that preparer as there is no record that he prepared it.

Despite the best efforts of the IRS, these procedures do not fully address the problem of incompetent or unethical tax return preparers.  It is estimated that there are approximately one million or more paid tax return preparers.  One thing the IRS registration would do is provide a data base of registered preparers that taxpayers can search in order to find a preparer in their area.  It has been my experience that people often have difficulty finding qualified people to prepare their returns at a reasonable rate.  They do not want to go to large CPA firms, and they do not want to frequent the store-front operations.  I have experienced contacts from people around the world, seeking tax return help.

There are still a number of unanswered questions in this area of tax preparer registration.  How will this affect store-front operations?  Will the requirements be strengthened?  What levels of competency will eventually be tested?  All we know for certain at this point is that registration is coming.  It will affect preparers and taxpayers.

The first expansion of 1099 reporting was enacted in 2008 and goes into effect in 2011.  This one even generated a new offspring of the 1099 series, the 1099-K.  This form requires reporting by financial firms that process credit or debit card payments.  Fortunately, the threshold for reporting is rather high, so it should not have a massive effect until the limits are lowered.  A 1099-K must be issued by the card processor to any merchant having at least 200 transactions totaling more than $20,000 in any given year.  To put this in simpler terms, Bank X processes credit cards for Joe’s Car Wash.  Over the course of the year, Joe has 10,000 credit card transactions totaling $60,000.  Bank X must issue Joe a 1099-K for the amount of these credit card payments.

But let’s bring this closer to home.  You sell merchandise on eBay and accept payment through PayPal.  If you have over 200 transactions in a year totaling $20,000 or more, PayPal will issue you a 1099-K.  IRS Commissioner Doug Shulman stated that this gives the IRS a tool to reduce the tax gap and provide better documentation for the business taxpayer to report their income and expenses.  In other words, the IRS is going to collect more tax.

The 1099 provisions included in the health reform act have a number of important, far-reaching consequences.  At present, a business must report certain payment to individuals for services rendered when those services equal or exceed $600 in a given year.  There are two important words in that previous sentence – “individual” and “services.”  Payments to corporations and payments for merchandise do not currently require 1099 reporting.  However, that is about to change.

Under the new rules, any business making any payment to a corporation or other business must issue a 1099 when the amount paid to the vendor is $600 or more in a given year. This includes not-for-profit organizations.  You have a small Schedule C business and you buy your office supplies from Staples.  Buy more than $600 per year, you must issue Staples a 1099.  Buy a computer from Dell, send them a 1099.

This means you must obtain the tax ID number for anyone you buy from and you must supply your TIN to your business customer.  You don’t have the TIN number?  That’s OK; you can overcome the problem by doing backup withholding.  This simply means you withhold 28% federal income tax on the payment.  So you buy $1,000 of merchandise from a vendor.  You don’t have their TIN.  Send them $720 and remit the balance to the IRS.  But what if you buy $500, then later in the year you buy another $100 from a company and don’t have their TIN?  Better get the TIN.  If anyone thinks that all businesses are going to file all of this properly and the IRS is going to process it correctly, I have a bridge I’d like to sell you.

A second problem I foresee with this is that the requirement is that gross proceeds be reported.  This is going to create a couple of issues.  I sell an item for $1,000 that cost me $600 for a $400 profit.  Only the $1,000 gets reported to the IRS.  They don’t see where I report it, so they send me a bill for tax on $1,000 – similar to the existing scenario with Form 1099-B.  A second issue is how is the IRS going to sort out my $100,000 in sales between what is reported on a 1099 and what is not reported.

A third problem is the undue burden this requirement places on businesses.  This is going to require small businesses to keep better records (not a bad idea, incidentally) and incur significant expense in tracking and reporting these payments.   Many small businesses are likely to turn to bookkeeping and tax preparation firms for the record-keeping and form preparation.

This is not something companies can ignore and hope it will go away.  The risk is too great, as the penalty for not filing a proper 1099 is $50 per form for an inadvertent failure and $100 per form for intentional failures. Those penalty dollars can mount up quickly.  A company that does not properly use backup withholding when required can be held liable for the amount required to be withheld.

If there is any good news in this, it is that these new requirements do not go into effect until 2012, so companies have over a year to get ready for them.

In order to take a deduction for a home office you must have an area in your home that is used regularly and exclusively for business.  This does not have to be an entire room, but it must be an area that is solely used for business purposes on a regular basis.  On your sole proprietorship Schedule C, this is deductible using Form 8829.  If you incorporate, you lose the advantage of deducting the home office on Schedule C.

This leaves you with three alternatives to handling the home office deduction.  First, the home office expenses may be deducted as employee business expenses on Schedule A under miscellaneous itemized deductions.  This can create a couple of problems.  First, the deduction is limited to any amounts that exceed 2% of your adjusted gross income.  This means that you will not get a full deduction for the home office expenses.  Second, if you do not itemize your deductions, you get no tax benefit from the home office.

Obviously, this is not a good solution in most cases.  The other two alternatives offer a better solution to deducting your home office expenses.  Your second choice is to have the corporation pay you rent for your home office.  This rent is deductible by the corporation, and you must report the rent on your 1040 via Schedule E.  However, you can set the amount of rent equal to the expenses associated with the home office and show no gain/no loss on the rental activity on your 1040.

Using this method you can create some personal cash flow as deducting depreciation on the office as an allowable expense.  You should be aware that, if you sell the home, any gain represented by depreciation taken on the office will be taxable.

The third alternative is to have to corporation pay you for any out-of-pocket costs of a home office under an accountable plan.  Reimbursed expenses must be actual job-related expenses that you must substantiate by providing the corporation with receipts or other documentation.  These expenses can include a portion of mortgage interest, property taxes, utilities, insurance, security service, and repairs.  They would be reimbursed based on the percentage of the home that is represented by the office area.  Any deductible personal expenses that are reimbursed, such as mortgage interest or property taxes, must be reduced on Schedule A by the amount of reimbursement.

The last two alternatives are clearly superior to deducting the expenses as a miscellaneous itemized deduction.  The choice between the two may depend on a number of personal factors.  However, make no mistake that both of these choices require rigorous record-keeping.  Failure to maintain a proper accountable plan or to have incomplete records can result in a denial of the entire deduction.  This will result in additional tax plus penalties and interest.  Additionally, the distinction between the corporation and the individual must be maintained to preserve the integrity of the corporate form of organization.

Small businesses (25 or fewer employees and average annual wages of less than $50,000) and individuals are eligible for a tax credit designed to increase levels of health insurance coverage.  The credit is up to 50% of certain contributions the business makes on behalf of its employees for health insurance premiums.  Tax-exempt organizations would get a 35% credit against payroll taxes.  Get smaller, get more credit.  Employers with 10 or fewer employees and average wages of less than $25,000 would get a 100% credit.  To me this sounds like a disincentive for employers to hire more employees and an incentive to keep their wages low.  This is being phased in as of 2010.

Large employers get the other end of the stick.  They are hit with a penalty of $166.67 for each employee in excess of 30 for any month they are subject to the penalty.  They will be subject to the penalty if:

• The employer does not offer coverage for its full-time employees,
• The employer offers minimum essential coverage that is unaffordable, or
• The plan’s share of the total allowed cost of benefits is less than 60%.
• And any full-time employee is certified as having purchased health insurance through a state exchange.

This provision goes into effect January 1, 2013.

Beginning in 2011, employers who subsidize prescription drug coverage for employees eligible for Medicare Part D will not receive a deduction for those expenses.

The Patient Protection Act requires insurers to report health insurance coverage information to the covered individual and to the IRS.  The required information includes:

• Name, address, and taxpayer ID of the primary insured along with the name and taxpayer ID for any individual obtaining coverage under the policy.
• The dates during which the individual was covered
• Whether the coverage is a qualified health plan offered through an exchange.
• The amount of any premium tax credit or cost-sharing reduction received by the individual related to the coverage, and
• Such other information as the secretary of the Treasury may require.

This reporting requirement begins in 2014.  An additional reporting requirement is effective beginning in 2011 and requires that each employee’s W-2 reflect the value of the employee’s health insurance coverage provided by the employer.  Big brother is watching.

Beginning October 1, 2012, there is a fee of $1 times the number of lives covered under the policy.  The issuer of the policy is liable for the fee.  A similar fee is imposed on self-insured health plans.  A year later the fee doubles.

If you opt for a high-cost plan in your business, be prepared to pay an “excise tax.”  If the value of the plan exceeds a threshold of $10,200 for individual coverage or $27,500 for family coverage a tax will be assessed on the insurer.  This tax is 40% of the amount that the value of the plan exceeds the threshold amount.  This is effective beginning in 2018 and the threshold amounts are indexed for inflation.

A final provision levies a 2.3% tax on “any medical device intended for humans.”  Exempted are items such as eyeglasses, hearing aids, and medical devices generally sold at retail to the public for individual use.  This exception apparently applies to items that can normally be purchased by a consumer in a pharmacy.  It is not clear at this point exactly what is covered in this exception.  Not covered under the exception are Class II and Class III medical devices under the FDA classification system. These are typically implanted devices such as hip replacements, stents, pacemakers, and similar medical devices but also include some orthotics and prosthetics such as cranial helmets.  Medical technology is subject to the tax.  This is effective beginning in 2013 and is expected to generate $20 billion in tax revenues.  Obviously, much this tax will be passed on to the consumer, raising the costs of certain aspects of health care.

As certain provisions of these bills are further interpreted by the secretary of Treasury or other officials, it will become clearer how the provisions will be applied in practice.  Stay tuned.  It looks like an interesting few years for anyone involved in our nation’s tax system.

Some of the changes will be effective beginning in 2011, other changes will be phased in over a number of years.  Two provisions, however, are effective immediately.  In the past, parents could include their children on their health insurance policy up to age 23.  Under the Reconciliation Act, the definition of dependent is changed to allow parents to carry their children on the policy to age 27.

Second, the Patient Protection Act allows the IRS to disclose taxpayer information upon written request of the secretary of Health and Human Services or from the commissioner of Social Security.   This took effect with the implementation of the legislation.  This erosion of taxpayer privacy should be a matter of great concern.

Effective January 1, 2011, the Patient Protection Act does not allow reimbursements for over-the-counter medicines from health savings accounts (HSAs), Archer medical savings accounts (MSAs), Health FSAs, or other health reimbursement arrangements.  Qualified medical expenses for drugs are defined as a prescribed drug.   A second provision in the act also takes effect this coming January, increasing the penalty for unqualified distributions from HSA or Archer MSA accounts to 20%.

Several major provisions of the legislation become effective January 1, 2013.  Today, most people cannot take an itemized deduction for medical expenses on Schedule A, as only those expenses that exceed 7.5% of adjusted gross income can be deducted.  This threshold increases to 10% of AGI beginning in 2013.  There is an exception for taxpayers or spouses who turn 65 before the end of the tax years 2013-16.  For these taxpayers, the threshold remains at 7.5%.  Deductions for medical expenses will become almost non-existent with this threshold.

A second provision that becomes effective in 2013 is an increase in the current 1.45% Medicare tax.  This is increased by 0.9% on wages that exceed a threshold amount.  In an interesting twist, the tax is imposed on the combined wages of the taxpayer and spouse in the case of a joint return.  The threshold amount is $250,000 for joint filers, $125,000 for married filing separate, and $200,000 for all others.

The Medicare tax is given an additional expansion as a 3.8% tax will be applied to the lesser of an individual’s net investment income or a modified adjusted gross income that exceeds a threshold amount.  This threshold is the same as for the additional tax in the previous paragraph.

The year 2014 will see the beginning of two of the major features of the Patient Protection Act, both involving the tax code.  The premium assistance credit is a refundable tax credit that eligible taxpayers can use to help cover the costs of premiums for health insurance purchased through a state health benefit exchange.  Each state is required to establish such an exchange.  The credit will be paid directly to the insurance plan or the taxpayer can choose to pay the premium and claim the credit on the 1040.

The second provision taking effect in 2014  levies a tax on uninsured individuals.  It is this aspect of the bill that is being challenged by the Attorneys General of several states as being unconstitutional.  The Act requires U. S. citizens and legal residents to maintain minimum amounts of health insurance coverage.  When fully implemented, failure to carry the minimum amount of insurance will subject taxpayers to a tax of $695 per individual or 2.5% of the amount by which your household income exceeds the minimum income required for filing a return.  The tax is the greater of these two.  This feature phases in, and will not reach these levels until 2016.  This appears to be a provision that is short on enforcement as liens and seizures of the taxpayer’s property are not authorized to enforce the penalty and non-compliance is not subject to criminal penalties.

There are three non-health care aspects of the bill that will have an impact on individuals.  Beginning in 2011, the adoption credit has been expanded by $1,000 to $13,170, and will be indexed for inflation.  A second provision levies a 10% tax on the use of indoor tanning services.  This tax is to be paid by the user, collected by the tanning facility.

Finally, an important feature codifies the economic substance doctrine.  For those who are not “tax nerds” this probably carries very little meaning.  The economic substance doctrine was established by the courts many years ago.  Since it was neither a legislative enactment nor a treasury regulation, there has been a great deal of uncertainty surrounding this doctrine.  The economic substance doctrine states that a transaction must change a taxpayer’s position in a meaningful way apart from the tax benefits and the taxpayer has a substantial (non-tax) purpose for entering into the transaction. Failure to demonstrate that a transaction has economic substance can now subject the taxpayer to penalties.

In my next posting, I will discuss the effect of these two pieces of legislation on businesses.