Quickfinder ®

Small Business Quickfinder® Handbook(2012 Tax Year)

Updates for the American Taxpayer Relief Act of 2012

Instructions: This packet contains “marked up” changes to the pages in the Small Business Quickfinder® Handbook that were affected by the American Taxpayer Relief Act of 2012, which was enacted after the handbook was published. To update your handbook, you can make the same changes in your handbook or print the revised page and paste over the original page.

Note: For many pages, the change is simply a matter of crossing out a paragraph and/or inserting an amount or date.

2012 Tax Year | Small Business Quickfinder® Handbook COV-1Replacement Page 01/2013

Forms: 1065, 1120, 1120S, 1041, 706,

709 and 9902012 Tax Year

Filing InformationTax Return Return Due Extensions

Form 1065: Partnership/LLC

15th day of fourth month following close of tax year.

Form 7004 extends deadline five months.

Forms 1120/1120S: Corporation

15th day of third month following close of tax year.

Form 7004 extends deadline six months.

Form 1041: Estates and Trusts

15th day of fourth month following close of tax year.

Form 7004 extends deadline five months.

Form 706: Estates Nine months after date of decedent’s death.

Form 4768 extends deadline six months.

Form 709: Gift Tax April 15th following close of tax year of gift.

Form 4868 or 8892 extends deadline six months.

Form 990: Exempt Organizations

15th day of fifth month following close of tax year.

Form 8868 extends deadline three months. A second Form 8868 extends three additional months.

Forms 706 and 709Estate and Gift Tax Rate Schedule

—Quick Tax Method—For gifts made and estates of decedents dying in 2012

TAXABLE AMOUNT × % MINUS $ = TAX1

$ 0 – $ 10,000 × 18% minus $ 0 = Tax

10,001 – 20,000 × 20% minus 200 = Tax

20,001 – 40,000 × 22% minus 600 = Tax

40,001 – 60,000 × 24% minus 1,400 = Tax

60,001 – 80,000 × 26% minus 2,600 = Tax

80,001 – 100,000 × 28% minus 4,200 = Tax

100,001 – 150,000 × 30% minus 6,200 = Tax

150,001 – 250,000 × 32% minus 9,200 = Tax

250,001 – 500,000 × 34% minus 14,200 = Tax

500,001 and over × 35% minus 19,200 = Tax

1 Less applicable credit amount. See the charts at the beginning of Tab H.

2012 Exclusion AmountsEstate Tax Exclusion1

Gift Tax Exclusion1

Annual Gift Exclusion

$5,120,000 $5,120,000 $13,0001 Plus the amount, if any, of deceased spousal unused exclusion amount—see

Tab H.

Form 1120Corporation Tax Rate Schedule

—Quick Tax Method—For tax years beginning after December 31, 1992

TAXABLE INCOME × % MINUS $ = TAX$ 0 – $ 50,000 × 15% minus $ 0 = Tax

50,001 – 75,000 × 25% minus 5,000 = Tax75,001 – 100,000 × 34% minus 11,750 = Tax

100,001 – 335,000 × 39% minus 16,750 = Tax335,001 – 10,000,000 × 34% minus 0 = Tax

10,000,001 – 15,000,000 × 35% minus 100,000 = Tax15,000,001 – 18,333,333 × 38% minus 550,000 = Tax18,333,334 and over × 35% minus 0 = Tax

Note: See Basics of Corporations on Page C-1 for exceptions to above tax rates and an example of how to use the Quick Tax Method.

Form 10412012 Fiduciary Tax Rate Schedule

—Quick Tax Method— TAXABLE INCOME × % MINUS $ = TAX$ 0 – $ 2,400 × 15% minus $ 0.00 = Tax

2,401 – 5,600 × 25% minus 240.00 = Tax5,601 – 8,500 × 28% minus 408.00 = Tax8,501 – 11,650 × 33% minus 833.00 = Tax

11,651 and over × 35% minus 1,066.00 = Tax

Note: The 10% tax bracket that applies to individuals does not apply to estates and trusts.

2012 Business Quick FactsSection 179 Deduction:Maximum deduction ...................................................................... $ 139,000Qualifying property limit ................................................................. 560,000SUV deduction limit ....................................................................... 25,000Depreciation Limits (First Year):Luxury autos—no bonus ................................................................ $ 3,160Luxury autos—with bonus ............................................................. 11,160Light trucks and vans—no bonus .................................................. 3,360Light trucks and vans—with bonus ................................................ 11,360Business Standard Mileage RateJanuary – December ..................................................................... $ .555Depreciation component ................................................................ . 23

Small Business

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TAX PREPARATION

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2,000,000

500,000

Replacement Page 01/2013

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Where to File: Business Returns Filing Addresses—2012 ReturnsNote: At the time of publication, the IRS had not released the 2012 filing addresses for business returns. This information will be posted to the Updates section of Quickfinder.com when available. See Where to File 2012 Form 1040 in Tab 3 of the 1040 Quickfinder® Handbook for filing addresses for individuals.

Principal Business Activity Codes—Forms 1065, 1120 and 1120SNote: At the time of publication, the IRS had not released the 2012 principal business activity codes for business returns. This information will be posted to the Updates section of Quickfinder.com when available.

Business Quick Facts Data Sheet1

2013 2012 2011 2010 2009FICA/SE Taxes

Maximum earnings subject to tax:Social Security tax $ 113,700 $ 110,100 $ 106,800 $ 106,800 $ 106,800Medicare tax No Limit No Limit No Limit No Limit No Limit

Maximum tax paid by:Employee—Social Security $ 7,049.40 $ 4,624.20 $ 4,485.60 $ 6,621.60 $ 6,621.60SE—Social Security 14,098.80 11,450.40 11,107.20 13,243.20 13,243.20Employee or SE—Medicare No Limit No Limit No Limit No Limit No Limit

Business DeductionsSection 179 deduction—limit $ 500,000 $ 500,000 $ 500,000 $ 500,000 $ 250,000Section 179 deduction—SUV limit (per vehicle) 25,000 25,000 25,000 25,000 25,000Section 179 deduction—qualifying property phase-out threshold 2,000,000 2,000,000 2,000,000 2,000,000 800,000Depreciation limit—autos (1st year with special depreciation) 2 11,160 11,060 11,060 10,960Depreciation limit—autos (1st year with no special depreciation) 2 3,160 3,060 3,060 2,960Depreciation limit—trucks and vans (1st year with special depreciation) 2 11,360 11,260 11,160 11,060Depreciation limit—trucks and vans (1st year with no special depreciation) 2 3,360 3,260 3,160 3,060

Retirement PlansSIMPLE IRA plan elective deferral limits:

Under age 50 at year end $ 12,000 $ 11,500 $ 11,500 $ 11,500 $ 11,500Age 50 or older at year end 14,500 14,000 14,000 14,000 14,000

401(k), 403(b), 457 and SARSEP elective deferral limits:Under age 50 at year end 17,500 17,000 16,500 16,500 16,500Age 50 or older at year end 23,000 22,500 22,000 22,000 22,000

Profit-sharing plan/SEP contribution limits 51,000 50,000 49,000 49,000 49,000Compensation limit (for employer contributions to profit-sharing plans) 255,000 250,000 245,000 245,000 245,000Defined benefit plans—annual benefit limit 205,000 200,000 195,000 195,000 195,000Key employee compensation threshold 165,000 165,000 160,000 160,000 160,000Highly compensated threshold 115,000 115,000 110,000 110,000 110,000

Estate and Gift TaxesEstate tax exclusion $ 5,250,0003 $ 5,120,0003 $ 5,000,0003 $ 5,000,0004 $ 3,500,000Gift tax exclusion 5,250,0003 5,120,0003 5,000,0003 1,000,000 1,000,000GST tax exemption 5,250,000 5,120,000 5,000,000 5,000,000 3,500,000Gift tax annual exclusion 14,000 13,000 13,000 13,000 13,0001 See Tab 3 in the 1040 Quickfinder® Handbook for an expanded Quick Facts Data Sheet.2 2013 amount not yet released by IRS. These have been left blank and can be filled in later.3 Plus the amount, if any, of deceased spousal unused exclusion amount—see Tab H.4 For decedents who died in 2010, executors could elect for the estate not to be subject to estate tax and have the modified carryover basis rules apply to estate assets.

Reference Materials and Worksheets

Tab A TopicsWhere to File: Business Returns Filing

Addresses—2012 Returns ...................................Page A-1Principal Business Activity Codes—Forms

1065, 1120 and 1120S ..........................................Page A-1Business Quick Facts Data Sheet ..........................Page A-1Guide to Information Returns ..................................Page A-2Types of Payments—Where to Report ...................Page A-4S Corporation Shareholder’s Adjusted

Basis Worksheet ...................................................Page A-5Partner’s Adjusted Basis Worksheet .......................Page A-6Tax Info for Partnership, Corporation, LLC

and LLP Returns ...................................................Page A-7Transferor’s Section 351 Statement .......................Page A-9

Tax Info Sheet for Gift Tax Returns .......................Page A-10Estate Inventory Worksheet .................................. Page A-11Reconciliation of Income Reported on

Final Form 1040 and Estate’s Fiduciary Return (or Beneficiary’s Return) .........................Page A-12

Depreciation Schedule ..........................................Page A-13Allocation of Indirect Costs to Ending Inventory

Under Section 263A............................................Page A-14Business Valuation Worksheet .............................Page A-15Foreign Asset Reporting—Forms 8938 and

TD F 90-22.1 ......................................................Page A-16Types of Foreign Assets and Whether They

are Reportable ....................................................Page A-16

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Court Case #1: Two individuals agreed to pay business expenses out of their personal funds in exchange for stock in a corporation. Even though the result-ing capital contributions were made over a period of time, the court ruled that the amounts were a direct purchase of the stock, relying in large part on the original intent of the shareholders. The Tax Court overruled a previous IRS determination and allowed the taxpayers to treat the entire amount paid as basis under Section 1244. (Miller, TC Memo 1991-126)Court Case #2: In another case, the court determined that the amount originally paid for stock ($7,500) was the only amount allowable under Section 1244. Subsequent contribution of capital of $189,000 was considered “allocable to stock which is not Section 1244 stock.” (Bledsoe, TC Memo 1995-521)

Strategy: Careful planning of stock purchases can preserve the benefits of Section 1244 for shareholders. Especially if there is a significant risk of loss on investment in Section 1244 stock, the purchaser should make sure ad-ditional shares are issued for each contribution made to capital. If shares are purchased over time, as in the case of agreement to pay corporate expenses in exchange for stock, a written plan should be drafted and carefully followed.Partners and S corporation shareholders. If a partnership acquires Section 1244 stock and later sells at a loss, an ordinary loss deduction may be claimed only by individuals who were partners when the stock was issued. However, loss incurred by an S corporation on the sale of Section 1244 stock cannot be passed on to the shareholders as an ordinary loss [Reg. §1.1244(a)-1(b)]. They must treat the loss as a capital loss.

Small BuSineSS StockIRC §1202 and §1045

Options by Holding Period for Small Business Stock1 Yr or less Over 6 Months Over 1 Yr Over 5 YrsShort-term capital gain

Section 1045 rollover gain

Long-term capital gain

Section 1202 gain exclusion

Individuals may be able to (1) exclude up to 50% (75% for stock acquired 2/18/09–9/27/10; 100% for stock acquired 9/28/10–12/31/11) of gain or (2) defer gain from the sale of qualified small business stock (QSBS).Exclusion of gain from the sale of small business stock (IRC §1202). An individual may exclude 50% (75% for stock acquired 2/18/09–9/27/10; 100% for stock acquired 9/28/10–12/31/11) of the gain from sale of qualified small business stock (QSBS). The stock must have been issued by a C corporation after August 10, 1993, and held more than five years. The exclu-sion may not exceed 10 times the taxpayer’s basis or $10 million, whichever is greater. Gain remaining after the exclusion is taxed at a maximum rate of 28%, resulting in an effective tax rate of 14%, for example, for 50% exclusion gain.N Observation: Because of the five-year holding period require-ment, 2014 will be the earliest a taxpayer can take advantage of the 75% gain exclusion (2015 for the 100% exclusion). Note: The maximum tax rate for most capital gains is 15% through 2012. With an effective tax rate of 14% for 50% exclusion QSBS, the benefit of the exclusion is greatly reduced, and only favors taxpayers with taxable income above the 15% bracket.For taxpayers qualifying for the 0% capital gains rate in 2012, the Section 1202 exclusion may create higher tax liability than if the exclusion had not been in place. However, should capital gains rates return to their pre-2003 Tax Act levels as they are scheduled to do on 1/1/13, the Section 1202 provisions may once again be beneficial, especially when the 75% exclusion (7% effective tax

rate) or 100% exclusion (no tax) applies. In addition, Section 1045 rollover remains a benefit of meeting the QSBS requirements (see Rollover of gain from sale of small business stock below).Alternative minimum tax. The excluded portion of gain on QSBS is a tax preference item in computing alternative minimum taxable income (AMTI). Seven percent of the amount of gain excluded under Section 1202 in 2012 is the preference amount [IRC §57(a)(7)]. However, for 100% gain exclusion QSBS acquired 9/28/10–12/31/11, none of the excluded gain is added back in computing AMTI. Expired Provision Alert: It’s possible Congress will extend the 100% gain exclusion for QSBS to 2012, but had not done so at the time of this publication. Similarly, unless extended, the 7% AMT preference rules apply to tax years beginning before 1/1/13, so in tax years beginning after 2012 the percentage of otherwise-excluded gain that is a tax preference item in computing AMTI will be 28% (for stock acquired after 2000) or 42% (for stock acquired before 2001), unless it is 100% gain exclusion QSBS.Empowerment zone businesses. The exclusion is 60% for stock acquired after 12/21/00 (75% for stock acquired from 2/18/09–9/27/10; 100% for stock acquired 9/28/10–12/31/11) for gains attributable to periods before 12/31/16 in corporations that conduct business within an empowerment zone, as designated by the Secretaries of Agriculture and HUD [IRC §1202(a)(2)]. The District of Columbia Empowerment Zone is not treated as an empowerment zone for purposes of the exclusion. Capital gain from the sale of qualified empowerment zone assets held for more than one year may be rolled over if new property in the same zone is purchased within 60 days of the sale. (IRC §1397B)Rollover of gain from sale of small business stock (IRC §1045). An election is available for tax-deferred rollover of gain from the sale of qualified small business stock (QSBS) held more than six months. The taxpayer must purchase new QSBS within 60 days to qualify for the election. The entire gain is deferred if the new stock costs at least as much as the amount realized from the sale of the old stock. If the new stock costs less than the amount realized, the difference is taxable up to the amount of gain. Basis of new stock is reduced by the amount of gain deferred. Holding period: The new stock must continue to meet the active business requirement for at least six months after purchase to qualify for Section 1045 rollover. (See Active business requirement on Page C-8.) For determining capital gain rates on a subsequent sale, the holding period of the new stock generally includes the holding period of the old stock. However, the holding period of the old stock does not count for meeting the six-month test.Regulations: For guidance on sales by partnerships (and partner distributees) of QSBS, see Regulation Section 1.1045-1.

Qualified Small Business Stock (QSBS)C corporation. The stock must be issued by a C corporation with total gross assets of $50 million or less at all times after August 9, 1993, and before it issued the stock, and immediately after it issued the stock.The corporation cannot be a:1) Domestic international sales corporation or

former DISC,2) Regulated investment company (RIC),3) Real estate investment trust (REIT),4) Real estate mortgage investment conduit

(REMIC),5) Cooperative or6) Corporation electing the Puerto Rico and possessions tax credit

or having a direct or indirect subsidiary so electing.on higher-income individuals increasing

with

12/31/13

through 12/31/18

12/31/13

12/31/13

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available for dividend distributions) to be recorded in the retained earnings account on the corporation balance sheet.The difference between book net income (E&P) and tax return net income is reconciled on Schedule M-1 or M-3, Form 1120. See Corporation Example on Page C-17.

E&P ExampleBeginning balance sheet of WSP Corporation:Assets:Cash ........................................................... $ 6,000Inventory ..................................................... 8,000Total assets .................................................................................. $ 14,000

Liabilities and Equity:Total liabilities .............................................................................. $ 0Common stock ............................................ $ 1,000Retained earnings (E&P) ............................ 13,000Total equity .................................................................................. 14,000Total liabilities + equity ................................................................. $ 14,000

Corporation transactions during the tax year:Gross sales receipts ..................................................................... $ 90,000Taxable interest income ................................................................ 500Tax-exempt interest income .......................................................... 250Merchandise purchases ............................................................... 30,000Advertising expenses ................................................................... 5,000Wages .......................................................................................... 20,000Office expenses ............................................................................ 13,500Purchase of equipment ................................................................. 25,000Estimated federal tax payments ................................................... 2,700Ending inventory ........................................................................... 8,600

Corporation tax return:Gross sales ................................................................................... $ 90,000Beginning inventory .................................... $ 8,000

>Merchandise purchases ............................. 30,000Minus ending inventory ............................... < 8,600Cost of goods sold ........................................................................ $ 29,400Gross profit ................................................................................... $ 60,600Interest income ............................................................................. 500Total income ................................................................................. $ 61,100Advertising .................................................. $ 5,000Wages ........................................................ 20,000Office expenses .......................................... 13,500Depreciation ($25,000 × 14.29%) ............... 3,573Total operating expenses .............................................................. $ 42,073Net taxable income ....................................................................... $ 19,027Federal income tax ($19,027 × 15%) ........................................... 2,854Minus estimated tax ...................................................................... < 2,700>Balance due .................................................................................. $ 154

Book income for purposes of E&P:Gross sales ................................................................................... $ 90,000Beginning inventory .................................... $ 8,000

>Merchandise purchases ............................. 30,000Minus ending inventory ............................... < 8,600Cost of goods sold ........................................................................ $ 29,400Gross profit ................................................................................... $ 60,600Interest income ............................................................................. 750Total income ................................................................................. $ 61,350Advertising .................................................. $ 5,000Wages ........................................................ 20,000Office expenses .......................................... 13,500Depreciation ($25,000 × 5.00%) ................. 1,250Total operating expenses .............................................................. $ 39,750Net income before tax .................................................................. $ 21,600Minus federal income tax per tax return ....................................... < 2,854> Net income after tax (E&P) ........................................................... $ 18,746

Ending balance sheet:Assets:Cash ........................................................... $ 550

>

Inventory ..................................................... 8,600Equipment .................................................. 25,000Minus accumulated depreciation ................ < 1,250Total assets $ 32,900

Liabilities and Equity:Federal tax payable (total liabilities) ............................................ $ 154EquityCommon stock ............................................ $ 1,000Retained earnings (E&P) (13,000 + 18,746) 31,746Total equity .................................................................................. $ 32,746Total liabilities + equity .................................................................. $ 32,900

Ending E&P calculation:Beginning E&P balance .............................. $13,000Plus taxable income ................................... 19,027Plus tax-exempt interest ............................. 250Plus accelerated depreciation in excess of SL ($3,573 - $1,250)............. 2,323Minus federal income taxes ........................ < 2,854 >Minus dividend distributions ....................... < 0 >Equals ending E&P ....................................................................... $ 31,746

Tax Effect of Tax-Exempt IncomeAlthough a C corporation does not pay tax on earnings from tax-exempt income such as municipal bond interest, the income will increase E&P. Thus, the amount of taxable dividends available to shareholders is increased by tax-exempt income.Nondeductible expenses such as penalties, fines, capital losses in excess of capital gains, etc. reduce E&P and the amount of taxable dividends available for distribution to shareholders.

accumulated earningS taxA C corporation that accumulates earnings beyond reasonable business needs is assumed to be accumulating earnings for the purpose of tax avoidance, unless the taxpayer can prove otherwise [IRC §533(a)]. The accumulated earnings tax (AET) is not reported on the tax return; it is a penalty imposed after an IRS audit. The tax applies regardless of the number of shareholders.The AET is currently 15% of accumulated taxable income (IRC §531). The 15% rate is scheduled to expire for tax years beginning after December 31, 2012, at which time the AET will be imposed at the highest individual tax rate.Accumulated taxable income is the corporation’s taxable income for the year reduced by items such as federal tax, excess charitable contributions, dividends paid deduction and the accumulated earnings credit. [IRC §535(a)]The accumulated earnings credit represents the amount accumulated for reasonable business needs. If audited, the burden of proof is on the corporation to demonstrate that an accumulation is reasonable [IRC §533(a)]. Note: Businesses that function as mere holding or investment companies are assumed to operate with a tax avoidance motive [IRC §533(b)]. Such businesses are allowed a minimum credit, but are not allowed additional accumulation for reasonable business needs.Minimum credit. Retained earnings of $250,000 or less [$150,000 for personal service corporations (PSCs)] are considered to be within reasonable business needs. [IRC §535(c)(2)]Reasonable business needs are analyzed in Regulation Sections 1.537-1 and 1.537-2. Items identified include:•Expansion.Includespurchaseofassets,acquisitionofanother

business enterprise or plant replacement.•Payingoffbusinessdebts.Example continued in the next column

For tax years beginning after December 31, 2012, the AET rate is 20%.

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Example #2: Assume the same facts as Example #1, except BNG loses $10,000 from operations instead of $30,000. Taxable income before the dividends-received deduction is $80,000 ($90,000 – $10,000). After claiming a dividends-received deduction of $72,000 ($90,000 × 80%), the corporation has net income of $8,000 ($80,000 – $72,000).Since in this example there is no NOL after a full dividends-received deduction, the allowable dividends-received deduction is limited to 80% of taxable income, or $64,000 ($80,000 × 80%). BNG calculates income as follows:Operating losses ............................................... < $ 10,000>Dividend income ............................................... 90,000Dividends-received deduction (limited to 80% of taxable income) ................... < 64,000>Taxable income ................................................. $ 16,000

Charitable ContributionsC corporations are allowed to deduct charitable contributions as a business expense. No deduction is allowed if any of the net earnings of the receiving organization are used for the benefit of any private shareholder or individual. The deduction is limited to 10% of the corporation’s taxable income. [IRC §170(b)(2) and (c)]Taxable income for limitation purposes is calculated without taking into account the deductions for:•Charitablecontributions.•Dividendsreceived.•Premiumonrepurchaseofconvertibledebt.•Domesticproductionactivitiesdeduction.•Dividendspaidoncertainpublicutilitypreferredstock.•Netoperatinglosscarrybacks.•Capitallosscarrybacks.Unused contributions from this limitation can be carried forward for five years. No carryback is allowed. [IRC §170(d)(2)]Enhanced charitable deduction for qualified book and quali-fied computer donations. These enhanced deductions expired December 31, 2011. [IRC §170(e)(3)(D)(iv) and (e)(6)(G)] Expired Provision Alert: It’s possible Congress will extend them to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information. Research property. An exception to the contribution limits applies to contributions of scientific equipment for use in experimentation or for certain research training. This exception is only available for C corporations other than PHCs or service organizations as described in Section 414(m)(3) [IRC §170(e)(4)]. These contribu-tions are subject to the special computation rules discussed at Charitable Contributions of Inventory in the next column.

Intellectual property. In addition to the initial deduction, a tax-payer who has donated qualified intellectual property may claim a subsequent charitable contribution based on a percentage of the net income received by the charity (other than certain private foundations) from the property. [IRC §170(m)]

Substantiation requirements. Strict rules exist for substantiating charitable contributions. For all monetary contributions, the cor-poration must maintain a bank record or a receipt, letter or other written communication from the donee organization indicating the organization’s name, the date of the contribution and the amount [IRC §170(f)(17)]. There is no de minimis exception. For contribu-tions of $250 or more of either cash or property, the taxpayer must have a contemporaneous written acknowledgement from the donee (a canceled check will not suffice). [Reg. §1.170A-13(f)]Charitable contributions of property over $5,000. C corpo-rations are required to obtain a qualified appraisal for donated

property if the claimed deduction exceeds $5,000. If the claimed deduction of property other than cash, inventory or publicly traded securities exceeds $500,000, a qualified appraisal must be at-tached to the donor’s tax return.Conservation easements. A deduction is available for qualified donations. See Conservation easements on Page N-14.

Charitable Contributions of InventoryThe deduction for a charitable contribution of inventory or other ordinary income producing property is generally limited to the adjusted basis of the property.A provision in the Code allows a C corporation (not an S corpora-tion) to donate inventory to charity and deduct up to one-half of FMV above cost as a charitable contribution [IRC §170(e)(3) and Reg. §1.170A-4A]. For purposes of this provision, depreciable property under Section 1221(a)(2) also qualifies for the deduction.The following rules must be met: [IRC §170(e)(3)]1) The charity must be a Section 501(c)(3) organization,2) The charity must use the donated property solely for the care

of the ill, the needy or infants,3) The charity cannot exchange the donated property for money,

other property or services,4) The corporation must be given a written statement from the

charity that says it will follow rules (2) and (3) above,5) If the property is subject to the Federal Food, Drug and Cos-

metic Act regulations, all such regulations must be satisfied and6) Use of the donated property must be related to the purpose or

function that gives the charity its exempt status.The charitable deduction is computed by taking the FMV of the donated property at the time of contribution and subtracting one-half the gain that would not have been long-term capital gain if the property had been sold at its FMV. The deduction is further limited to twice the basis of the donated property.If the donated property has any potential recapture of ordinary income under Section 617, 1245, 1250 or 1252 (depreciation recapture), then the FMV for the above computation purposes must first be reduced by the recapture amount before making the above charitable deduction computation. [IRC §170(e)(3)(E)] Note: If the inventory’s cost is incurred in the same year as the contribution, the amount is included in cost of goods sold (COGS). The contribution is not subject to the 10% of taxable income limitation. If the contribution is made from beginning inventory, the item is removed from inventory and shown as a charitable contribution subject to the 10% limitation. [Reg. §1.170A-1(c)(4)]

Example: GIJ Corporation donates inventory to Toys for Tots. The FMV of the inventory equals $1,000, and GIJ’s basis in the inventory equals $200. If GIJ had sold the inventory for its FMV, the amount of gain that would not be long-term capital gain is $800 ($1,000 – $200). One-half of $800 is $400. The charitable deduction would be $600 ($1,000 – $400) except for the fact that the deduction is limited to twice its basis ($200 × 2 = $400). GIJ can take a charitable contribution deduction of $400 and must reduce its COGS by $200.

Expired Provision Alert: The Section 170(e)(3)(C) special rules for contributions of food inventory expired at the end of 2011. It’s possible Congress will extend them to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information. N Observation: Some corporations making donations that qualify for the enhanced deduction for inventory may, because of the 10% of taxable income limitation, prefer to limit their deduction and the required cost of goods sold adjustment to the inventory’s basis. While it studies this issue, the IRS will not challenge either method. (Notice 2008-90) have been extended through 2013.

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U Caution: The taxation of dividends paid to individuals at long-term capital gain rates is scheduled to expire after 2012. In addition, indi-vidual long-term capital gain and ordinary income tax rates are scheduled to increase after 2012. Regard-less of whether these provisions are extended, the marginal tax rates (current and projected) of specific shareholders and corporations should be used in determining the most tax-favorable form of business organization (such as a C corporation versus an S corporation).Factors to consider:•TheaccumulatedearningstaxforCcorporationshas been lowered

from the top individual rate to 15% (through 2012). (IRC §531)•AnScorporationthatelectstorevokeitsSstatusmustgenerally

wait five years before it can again elect S corporation status.[IRC §1362(g)]

•PreviouslytaxedScorporationprofitsnotdistributedwithinoneyear from the date of S corporation termination are converted to taxable earnings and profits (E&P). See Post-Termination Transition Period on Page D-11.

•C corporationsmaybe subject to personal holding company(PHC) or personal service corporation (PSC) taxes. See Tab F.

•CcorporationswithaccumulatedE&Pmaybesubjecttoad-ditional taxes upon conversion to an S corporation. See S Corporation Taxes on Page D-6.

•Scorporationlossesflowthroughtoshareholders.Ccorporationsdo not pass losses through.

S Corporation Requirements•AllshareholdersmustconsenttoScorporationstatus.•Limitedto100shareholders.•Thecorporationcanhaveonlyoneclassofstock.SeeOne Class

of Stock on Page D-3.•Mustbeadomesticcorporation.Individualshareholdersmustbe

U.S. citizens or residents. A resident alien [one who (1) has been lawfully admitted for permanent residence in the U.S., (2) meets a substantial presence test as outlined in Section 7701(b)(3) or (3) elects to be treated as a U.S. resident, but is not a citizen] can be a shareholder, but a nonresident alien (someone who is neither a citizen of the U.S. nor meets any of the tests for resident alien status) cannot. [Reg. §1.1361-1(g)(1)]

•Thecorporationmustuseapermittedtaxyear,orelecttouseatax year other than a permitted tax year. See Required Tax Year on Page L-6.

•Onlyindividuals,estates,certaintrustsandcertaincharitiesmaybe shareholders. (IRC §1361)

Ineligible shareholders. Corporations, partnerships (unless the stock is held as a nominee for an individual treated as the shareholder), LLCs, LLPs, nonresident aliens and IRAs are ineligible. Exception: Certain single-member LLCs can be S corporation share-holders. (Letter Ruls. 200008015 and 9745017)U Caution: Actions by one shareholder can

terminate S status.

IRS Ruling: A minority shareholder in an S corporation sold one share of stock to an ineligible shareholder in a dispute over dividends. The corporation’s S status was terminated. The IRS did allow the corporation to reelect S status without the normal five-year waiting period, but the corporation needed to obtain a private letter ruling to do so. (Letter Rul. 9616022)

Strategy: An S corporation should keep control of stock trans-fers with a shareholder transfer agreement, right of first refusal, call option or other buy/sell agreement terms.

Stock Ownership RequirementsA C corporation is not eligible to hold stock in an S corporation; however, an S corporation can own up to 100% of the stock of a C corporation. An S corporation cannot file a consolidated return with an affiliated C corporation. The C corporation may, however, still file a consolidated return with its affiliated C corporations.Qualified Subchapter S subsidiary (QSub). An S corporation can elect to treat a wholly owned subsidiary as part of the S corporation for tax purposes—the subsidiary is disregarded. The subsidiary does not need to be an S corporation, but it must be a corporation that would qualify for S status if its stock was held by the shareholders of the parent S corporation. [IRC §1361(b)(3)]U Caution: A QSub is treated as a separate corporation for pur-poses of employment taxes (including FICA and FUTA, Railroad Retirement and FIT withholding) and certain excise taxes (such as the retail excise taxes of Chapter 31 of the Code and the facilities and services taxes of Chapter 33). [Reg. §1.1361-4(a)(7) and (8)]A QSub-eligible subsidiary is a domestic corporation that is owned 100% by an S corporation and is not one of the following:•Afinancialinstitutionthatusesthereservemethodofaccounting

for bad debts under Section 585,•An insurancecompanysubject to taxunder therulesofSub-

chapter L of the Code,•Acorporationthathaselectedtobetreatedasapossessions

corporation under Section 936 or•Adomesticinternationalsalescorporation(DISC)orformerDISC.Form 8869, Qualified Subchapter S Subsidiary Election, may be filed at any time during the tax year, but the effective date of elec-tion cannot be more than:•Twomonthsand15dayspriortodateoffilingtheelection,or•Twelvemonthsafterthedateoffilingtheelection.Late filed election. The IRS has the authority to waive inadver-tently invalid QSub elections or terminations of these elections. To obtain relief, the QSub and the S corporation parent must: (1) take steps to qualify the corporation as a QSub within a reason-able period of time after discovering the circumstances causing the invalid election or termination, and (2) agree to any adjustments proposed by the IRS to treat the corporation as a QSub during the relevant period. [IRC §1362(f)]Tax effects of election:•Existing Corporation. If an election is made to treat an existing

corporation as a QSub, the transaction is treated as a deemed liquidation of the subsidiary under Sections 332 and 337. See Parent-Subsidiary Liquidations on Page N-8.

•New Corporation. If a QSub election is in effect when the sub-sidiary is formed, liquidation is not considered to have occurred. The QSub is disregarded for tax purposes.

Eligible Trusts [IRC §1361(c)(2), (d) and (e)]1) Grantor trusts owned by a U.S. citizen or resident. The trust can

continue as an eligible shareholder for two years beginning on the grantor’s date of death.

2) Testamentary trusts to which stock is transferred under the terms of a will. The trust is an eligible shareholder for two years after the stock is transferred to it. The decedent’s estate is considered the shareholder for the 100-shareholder limit.

3) Trusts created to exercise voting power of stock transferred to them. Each beneficiary of the trust is treated as a shareholder for the 100-shareholder limit.

4) Qualified Subchapter S trusts (QSSTs). May have only one in-come beneficiary and must distribute or be required to distribute all accounting income each year. Principal distributed during the beneficiary’s life must be distributed to the beneficiary.

has been extended to 2013 and later, but with an increased tax rate of 20% on higher-income taxpayers.on higher-income taxpayers

the tax years involved,rate

is

in 2012 (20% for tax years beginning after December 31, 2012).

2012 Tax Year | Small Business Quickfinder® Handbook D-7Replacement Page 01/2013

Example #1: A C corporation with accumulated E&P elects to be an S corporation. In 2012, its gross receipts total $100,000. Included in the gross receipts is $40,000 of passive investment income. Expenditures directly connected to the production of the passive investment income total $10,000. The net passive income equals $30,000 ($40,000 – $10,000).25% of gross receipts equals $25,000 ($100,000 × 25%). The amount by which passive investment income in 2012 exceeds 25% of gross receipts equals $15,000 ($40,000 passive investment income – $25,000).ENPI calculation: $15,000 ÷ $40,000 × $30,000 = $11,250Passive investment income tax for 2012: $3,938 ($11,250 × 35%)Example #2: Assume that in Example #1, the $40,000 of passive investment income consisted of $12,000 from interest and $28,000 from rents. The amount of the $3,938 passive income tax allocated to interest is $1,181 ($3,938 × $12,000 ÷ $40,000). The amount allocated to rents is $2,757 ($3,938 × $28,000 ÷ $40,000). The amount reported on Schedule K for interest and rental income is reduced by the tax allocated above.

The tax is reported on Form 1120S, line 22a; it is computed using a worksheet provided in the 1120S instructions.

Built-In Gains (BIG) Tax (IRC §1374)Combined FMV

of Assets – Combined Basis of Assets = Net Unrealized

Built-In Gain

Built-in gains are triggered by property disposition. At the time a C corporation elects S status, if the combined FMV of its assets exceeds basis, the difference is net unrealized built-in gains. If the assets with built-in gains are later sold, a special tax applies. These rules apply only to corporations that elected S status after 1986, and affect dispositions of property for 10 years after the date of S election (the recognition period). Note: If FMV is less than basis as of the date of S election, the built-in gains rules do not apply.When determining whether a corporation is subject to the BIG tax, the corporation’s most recent S election applies, not an earlier election that was revoked or terminated (Regs. §1.1374-8 and §1.1374-10). Built-in gains and losses are computed for each asset at the beginning of the first tax year of the S corporation. Unrealized gain or loss then carries with each asset and is recognized when the property is disposed of.Net unrealized built-in gains are listed in the available space on line 6 of Schedule B (Form 1120S). When the built-in gain assets are sold, the number shown on line 6 is reduced by the amount of gain recognized in prior years.

Example: Welcome, Inc., a C corporation, elects S corporation status. On the first day of the S election, Welcome’s assets have FMV and basis as follows:

FMV Basis DifferenceMachine .......................... $ 9,000 $ 4,000 $ 5,000Truck ............................... 7,000 9,000 < 2,000>Building ........................... 55,000 52,000 3,000Totals .............................. $ 71,000 $ 65,000 $ 6,000

Welcome, Inc., has net unrealized built-in gains of $6,000 at the date of S election. The machine and building are built-in gain assets; the truck is a built-in loss asset.

U Caution: Fair market value is a frequent IRS target with regard to BIG tax. It may be wise to obtain a professional appraisal of a corporation’s assets to avoid IRS adjustment.

BIG tax generally will not apply for assets acquired while the cor-poration is an S corporation, or if the corporation elected S status for all years. Exception: If an S corporation acquires an asset from a C corporation (or another S corporation that is subject to the BIG tax) and the asset’s basis is the transferred basis from the other corporation, BIG tax may apply.Calculating BIG tax. Net recognized built-in gain is subject to the top corporate tax rate of 35%. BIG tax is reported on Sched-ule D, Part III of Form 1120S. Net recognized built-in gain is the smallest of:1) The overall limit—net unrealized built-in gain,2) The current recognition limit—the amount that would be taxable

income if only recognized built-in gains and losses were taken into account or

3) The taxable income limit—the corporation’s taxable income for the year, computed as if it were a C corporation.

Carryovers. If net recognized built-in gain for the year is reduced by the taxable income limit (item 3 above), the remainder is carried forward and subject to BIG tax in the following year. However, if a sale of built-in gain property results in a net loss, the loss is not carried forward. Strategy: If sale of an asset triggers built-in loss, offset the loss by selling an asset with built-in gain. This will take the asset with built-in gain off the table without triggering BIG tax.Loss carryovers/accrued expenses. Capital losses or NOLs that carry over from a C to an S corporation reduce the S corporation’s net recognized built-in gain; carried over minimum tax credits and business tax credits reduce the BIG tax. Also, for cash basis tax-payers, expenses paid after the S election that would have been deducted by an accrual method taxpayer before the S election are deductible against recognized built-in gains.

Example #1: Liner, Inc., an S corporation sells a machine with basis of $4,000 for $10,000. The machine carried a built-in gain of $5,000. The corporation pays built-in gains tax of $1,750 ($5,000 × 35%) on the $5,000 built-in gain and passes $4,250 of gain ($6,000 – $1,750) through to its shareholders.Example #2: TUGG, Inc., a cash basis S corporation collects $5,000 in ac-counts receivable for sales that occurred before the corporation elected S status. In the same tax year, TUGG pays $2,000 in expenses that would have been deductible prior to the S election if the taxpayer had been on the accrual basis. The net built-in gain from these items for the year is $3,000 ($5,000 built-in gain – $2,000 built-in loss).

Exceptions: Built-in gains tax does not apply to gain from the sale of standing timber or subsequently produced coal or domestic iron ore (Rev. Rul. 2001-50). Similarly, the sale of oil and gas subsequently produced from a working interest held on the date of the corporation’s S election is not subject to the built-in gains tax. [Reg. §1.1374-4(a)]Temporary suspension. The BIG tax was suspended for certain tax years for qualifying S corporations. BIG tax was not imposed during 2009 and/or 2010 if the seventh tax year of the corpora-tion’s 10-year recognition period ended before that tax year. For tax years beginning in 2011, the BIG tax was not imposed if the fifth year of the recognition period ended before that tax year. [IRC §1374(d)(7)(B)]Unless the S corporation’s 10-year recognition period expired in 2009, 2010 or 2011, the S corporation is again subject to the BIG tax for the tax year beginning in 2012.

Example: XL, Inc., a calendar year C corporation, elected S status on March 1, 2002, effective January 1, 2002. The seventh tax year of XL’s 10-year recognition period ended on December 31, 2008. Thus, XL’s net recognized BIG during 2009―2011 was not subject to the BIG tax. XL’s 10-year recogni-tion period ends on December 31, 2011, therefore XL is not subject to the BIG tax for 2012.

2014.

s is

2011–2013

,

2012 or 2013,

2012 Tax Year | Small Business Quickfinder® Handbook H-3Replacement Page 01/2013

Income and Expense Chart for a Decedent (Continued)—Cash Method of Accounting—

Category Where to Report ExplanationMedical Expenses Final Form 1040, Schedule A Medical expenses paid before death. Can elect to deduct medical expenses incurred before death but paid from the

estate within one year of the day following death [Reg. §1.213-1(d)]. Election does not apply to medical expenses for dependents of the decedent. To elect, attach a statement to Form 1040 stating the estate has waived the right to claim medical expense for estate tax. With the election, deduction is taken on Form 1040, Schedule A in year costs were incurred (a Form 1040X may be needed).

Form 706, Schedule K Unpaid medical expenses at death are reported on Form 706 as a claim against the estate, unless an election is made to report on decedent’s final Form 1040. Amounts deducted on Form 706 are not subject to the 7.5% AGI limitation. If deduction taken on Form 1040, amount not allowed due to 7.5% AGI limitation cannot be claimed on Form 706.

Form 1041 Any insurance reimbursements after death of amounts previously deducted on Form 1040. Report as IRD. Miscellaneous

Itemized DeductionsFinal Form 1040 Miscellaneous itemized deductions paid before death.Form 706, Schedule J or Form 1041

Unpaid miscellaneous itemized deductions at date of death are reported on Form 706. When paid, deduct on Form 1041 as DRD.

Form 1041 Incurred and paid after death: may be subject to 2% AGI limit. See Deductions on Page G-5.

Partnership Income (Loss)

Final Form 1040, Schedule E Income (or loss) up to date of death using any reasonable method of allocating income (loss). Allocation is often based on pro rata amount for year or interim closing of books.

Form 1041 (or beneficiary’s return)

Income (or loss) after death not included on final Form 1040.

Passive Losses Final Form 1040 Losses are allowed to extent of passive income, plus accumulated unused losses to extent they exceed any increase in basis allocated to the activity. For example, if a passive activity’s basis is increased $6,000 upon taxpayer’s death, and unused passive activity losses as of date of death are $8,000, decedent’s deduction is $2,000 ($8,000 – $6,000).

Form 1041 Estates are subject to the same passive loss limitation rules as individuals. The fiduciary’s level of participation determines the classification. If decedent actively participated in a rental real estate activity before death, the estate will be allowed the special $25,000 rental real estate exemption for up to two years after decedent’s death.

Personal Residence Form 1041 The Section 121 exclusion of gain from sale of personal residence does not apply to estates. If personal residence is a capital asset to the estate (either held for investment or rental purposes), estate can deduct loss on sale. If property is used by estate beneficiaries for personal purposes, loss on sale is not deductible. If home was not subject to probate and passed directly to heirs, sale of home is reported on beneficiaries’ Form 1040.

Real Estate, State and Local Income Taxes

Final Form 1040, Schedule A Paid before death. General sales taxes deductible if state and local income taxes not deducted. [IRC §164(b)(5)] Expired Provision Alert: The election to deduct state and local sales tax expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.

Form 706, Schedule K and Form 1041 (or beneficiary’s return)

Real estate taxes accrued before death but paid after death.

Form 1041 (or beneficiary’s return) Accrued and paid after death. Rental Income and Expenses

Final Form 1040, Schedule E Income and expenses received or paid before death.Form 706 and Form 1041 (or beneficiary’s return)

Income and expenses accrued before death but not actually received or paid until after death (IRD and DRD). Passive activity loss rules apply to estates (for Form 1041 reporting).

Form 1041 (use Schedule E of Form 1040)

Income and expenses accrued and received or paid after death. Passive loss rules apply to estates.

S Corporation Income (Loss)

Final Form 1040, Schedule E Pro rata share of income (or loss) up to death. Generally, amount of income (or loss) is computed as follows: S corporation income or loss for the year, divided by number of days in S corporation’s year, multiplied by number of days shareholder was alive. Can elect under Section 1377(a)(2) to close S corporation books on day of death.

Form 1041 (or beneficiary’s return) Income (or loss) after date of death and not included on final Form 1040.

U.S. Savings Bond Interest (Decedent did

not elect to report interest annually)

Final Form 1040 or Form 1041 Two options: (Rev. Rul. 68-145)1) Executor elects to report interest accrued before death on final Form 1040. Interest accrued after death is

reported on Form 1041 (or beneficiary’s return) in year bond is redeemed or matures.2) All interest (both before and after death) is reported on Form 1041 (or beneficiary’s return) in year bond

is redeemed, matures or an election is made to report income. Interest accrued before death is IRD. Alternatively, recipient of an inherited bond can elect to report interest annually. (Rev. Rul. 64-104)

Form 706, Schedule B FMV of bonds, including interest accrued up to date of death, which may be IRD.U.S. Savings Bond Interest (Decedent

elected to report interest annually)

Final Form 1040 Interest accrued up to date of death.Form 1041 (or beneficiary’s return)

Interest accrued after death. Note that the last Series E bonds matured in 2010 and the last Series H bonds matured in 2009. These bonds stopped paying interest at that time and any deferred interest should have been recognized on the 1040 in the year the bond matured.

Form 706, Schedule B FMV of bonds as of date of death. No IRD.Social Security Final Form 1040 Payments cease at death; therefore, subject to reporting on final Form 1040.

Standard Deduction Final Form 1040 Full amount allowed. No proration required.Wages Final Form 1040 Wages received before death.

Form 706, Schedule F and Form 1041 (or beneficiary’s return)

Wages earned before death but received after death (IRD).

has been extended through 2013.

2012 Tax Year | Small Business Quickfinder® Handbook J-3Replacement Page 01/2013

Qualifying property threshold. Only 50% of the cost of qualified zone property placed in service is counted when determining whether the qualifying property threshold ($2,000,000 for 2011) has been exceeded.Increased limits also apply to certain qualified Section 179 disaster assistance property. See Disaster Assistance Property in Tab 5 of the Depreciation Quickfinder® Handbook.

Business Income LimitationThe Section 179 deduction cannot cause a business loss [IRC §179(b)(3)]. The expense deduction is lim-ited to taxable income computed as follows.Partnerships. The income limitation is the aggregate of the partnership’s items of income and expense from any trade or business the partnership actively conducted without regard to credits, tax-exempt income, the Section 179 deduction and guaranteed payments.S corporations. The income limitation is the aggregate of the corporation’s items of income and expense from any trade or busi-ness the corporation actively conducted without regard to credits, tax-exempt income, the Section 179 deduction and the deduction for shareholder-employee compensation.C corporations. The income limitation is the corporation’s tax-able income before the Section 179 deduction, net operating loss deduction and special deductions, excluding items not derived from a trade or business actively conducted by the corporation.

ElectionThe Section 179 election is made on an item-by-item basis for qualifying property. The election is made by completing Part I of Form 4562. Section 179 elections made in any tax year beginning after 2002 and before 2013 can be revoked without the consent of the IRS, including the election to treat real property as Section 179 property. [IRC §179(c)(2)]A taxpayer is allowed to make or revoke the expensing election on an amended return (Rev. Proc. 2008-54). Once the election is revoked, however, it cannot be reinstated.

Partnerships and S CorporationsPartnerships and S corporations must apply the annual deduction limit, qualifying property limit and business taxable income limit before passing through any Section 179 expense. The limits then apply separately to each individual partner or shareholder [Reg. §1.179-2(b) and (c)]. However, an owner does not include his allocable share of the pass-through entity’s cost of qualifying property in determining whether his qualifying property additions exceed the threshold ($560,000 for 2012). The cost of property that is not deductible under Section 179 because of the business taxable income limitation may be carried over to the next tax year and added to the cost of qualifying property placed in service in that tax year. Amounts carried over must be applied on a first-in first-out (FIFO) basis. If costs from more than one year are carried forward to a subsequent year in which only part of the total carryover can be deducted, the costs being carried forward from the earliest year must be deducted first.However, a partner or S shareholder who is passed through more Section 179 deduction in a single tax year than what is allowed on his return (after considering all his sources of the Section 179 deduction) cannot carry over the excess deduction. Instead, it is lost even though the partner or S shareholder must reduce his basis in the pass-through entity by the lost deduction. (Rev. Rul. 89-7)

Section 179 deductionSee Tab 10 in the 1040 Quickfinder® Handbook for Section 179 rules concerning:•Qualifyingandnon-qualifyingproperty.•LimitationsforusingtheSection179deduction.•MaximizingbenefitsofSection179—planning.•Section179recapture.See Tab 11 in the 1040 Quickfinder® Handbook for limits on Sec-tion 179 deductions for certain heavy vehicles, including SUVs.

Section 179 Expense LimitsOverall expense limit. For tax years beginning in 2012, the an-nual deduction limit is $139,000 ($500,000 for tax years beginning in 2010 and 2011). A special $25,000 per vehicle limit applies to certain heavy vehicles (including SUVs).Exception: The Section 179 expensing limit was increased for property placed in service in certain locations or businesses. See Increased limits below.Qualified real property limit. For purposes of the $500,000 limit for tax years beginning in 2010 and 2011, qualified real property up to but not exceeding $250,000, could be treated as Section 179 property if the taxpayer elected. Expired Provision Alert: For 2011, qualified real property was assigned a 15-year recovery period (SL depreciation required) and was eligible for Section 179 expensing. It’s possible Congress will extend these rules to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.Qualified real property is limited to qualified:1) Leasehold improvement property,2) Restaurant property and3) Retail improvement property.In addition, the property must be depreciable, acquired for use in an active trade or business and not ineligible. Ineligible real property includes property that is:1) Used predominantly to furnish lodging or in connection with

furnishing lodging. 2) Used outside of the U.S.3) Used by certain tax-exempt organizations.4) Used by certain governmental units, foreign persons or entities.5) An air-conditioning or heating unit.No unused amounts of the $250,000 real property limit may be carried over to tax years after 2011. Amounts that cannot be carried over beyond that year will be treated as placed in service in 2011.

Qualifying Property LimitationThe Section 179 deduction limit is reduced dollar-for-dollar to the extent the amount of qualifying Section 179 property placed in service during the year exceeds $560,000 (for 2012). Thus, the Section 179 deduction is completely phased out when the amount of Section 179 property placed in service during the year exceeds $699,000.Increased limits for qualified zone property. An enterprise zone business that places qualified zone property in service in an empowerment zone [IRC §1391(b)(2)] before 2012 can increase its Section 179 deduction and qualified property limits. (See IRS Pub. 946.) Expired Provision Alert: The increased limit for qualified zone property expired at the end of 2011. It’s possible Congress will ex-tend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.Annual deduction limit. The annual Section 179 deduction limit is increased by the smaller of:•$35,000or•thecostofSection179propertythatisalsoqualifiedzoneprop-

erty placed in service during the year). [IRC §1397A(a)]

2010–2013

500,000

2010–2013

so elects

can

2012 and 2013

2012 and 2013

is

is

2013

$2,000,000

has been extended to 2013

2,500,000 2,000,000

2014

2014

J-4 2012 Tax Year | Small Business Quickfinder® Handbook Replacement Page 01/2013

Example: Martha is a 50% partner in Better Living Partnership. The partnership netted $100,000 in profits in 2012 without regard to any Section 179 deduction. The partnership elects to expense $139,000 under Section 179. The partner-ship is only permitted to pass through $100,000 to its partners because of the income limit. The $39,000 excess Section 179 deduction is carried over to 2013 to be added to the 2013 partnership Section 179 deduction. Martha receives a 2012 Schedule K-1 from the partnership reporting a $50,000 Section 179 deduction (50% of $100,000).Martha is also a 100% shareholder of Insider Magazine, an S corporation. The S corporation passes through $96,000 of Section 179 expense on her 2012 Schedule K-1. The $7,000 of excess Section 179 deductions passed through to Martha ($250,000 + $296,000 – $139,000) is not deductible on her Form 1040, nor can it be carried over to her 2013 Form 1040. In addition, Martha must reduce her basis in her partnership interest and S corporation stock by the $7,000 unused Section 179 expense.

UNICAP RulesAmounts allowed as a Section 179 deduction are not subject to Section 263A uniform capitalization. [Reg. §1.179-1(j)]

Advantages of Electing Section 179•Mayreducebusinessowner’sadjustedgrossincome(AGI),which

could increase deductions subject to limitations and phase-outs based on AGI.

•May claima full $139,000 Section 179 deduction even if the qualifying property is placed in service on last day of tax year.

•Mayavoidtheshort-yeardepreciationrules.•Mayavoidthemid-quarterconventiondepreciationrule.•MayavoidUNICAPrules.•MayavoidanAMTdepreciationadjustment.

recapture—Section 179 and liSted property

Section 179 RecaptureThe Section 179 deduction must be recaptured as ordinary income if business use of the property falls to 50% or less during its regular MACRS recovery period. [Reg. §1.179-1(e)]The amount originally deducted as Section 179 expense is reduced by the depreciation on the same amount that would have been allowed under regular MACRS, using the same property class and recovery period as the underlying property. The excess is recap-tured as ordinary income. The basis of the underlying property is then increased by the recaptured amount.

Recapture Rule for Listed PropertyIf listed property (for example, autos, computers and entertainment property) business use falls to 50% or less for any year during its alternate MACRS recovery period, the excess depreciation must be recaptured. (The recapture rule applies to listed property regardless of whether a Section 179 deduction was claimed.) [IRC §280F(b)]Excess depreciation is (1) the amount of depreciation (including any Section 179 deduction) actually claimed in prior years, minus (2) the amount of depreciation that would have been allowed using straight-line depreciation under ADS.

Where to ReportWhen the qualified business use of an asset decreases to 50% or less, the recapture amount is first entered on Part IV, Form 4797. This amount is then reported as income on the form where the deductions were originally claimed.

•IftheformisScheduleCorF,therecapturedamountissubjectto self-employment (SE) tax.

•RecaptureonPartIVofForm4797thatissubjecttoSEtaxfora sole proprietor or a partner only applies when business use drops to 50% or less. Section 179 property disposed of before the end of its MACRS recovery period is not subject to Section 179 recapture if Section 1245(a) applies [Reg. §1.179-1(e)(3)]. Although Section 1245 recapture produces ordinary income, it is not subject to SE tax. [Reg. §1.1402(a)-6]

Example #1: Apple Partnership bought office equipment on January 1, 2011, for $10,000. The full $10,000 was deducted under Section 179 (which was passed through to each partner on the partnership tax return). Each partner was able to reduce his or her SE income by the amount of his or her distribu-tive share of the Section 179 deduction. On January 2, 2012, the partnership sold the office equipment for $10,000.Total gain from the sale is determined by Section 1245(a) [see IRC §1245(a)(2)(C)]. It is therefore not considered Section 179 recapture, but it is subject to Section 1245 ordinary income recapture.Example #2: Assume the same facts as Example #1, except that instead of selling the office equipment, it was distributed to the partners, who in turn used the equipment for personal purposes.The partnership must now recapture the portion of the Section 179 deduction that exceeds SL depreciation as income subject to SE tax. Note: In the examples above, the income related to the sale or reduction in business use is not included in the partnership’s ordinary income but instead passes through to the partners as a separately stated income item, the tax consequences of which depend on how much of the original Section 179 deduction the partner actually claimed on his or her return.

Note: See Depreciation Recapture on Page J-6 for a discus-sion of the general depreciation recapture rules.

Short tax year—macrSA short tax year is any tax year with less than 12 full months. How a short tax year affects MACRS computations depends on the nature of the property and the applicable convention. The half-year, mid-quarter and mid-month conventions establish the date property is treated as placed in service. Since a property’s recovery period begins on the placed-in-service date, depreciation is allowed only for that part of the tax year the property is treated as in service. (Rev. Proc. 89-15)A taxpayer may have a short tax year in these situations:•The first or last year that a partnership, corporation or an estate

is in existence.•Thefirstyearofasoleproprietorship,employee’stradeorbusi-

ness or individual’s rental activity.•Thefinalreturnofanindividual.•Ayearinwhichataxpayerchangesfromacalendaryeartoa

fiscal year or vice versa. Note: In a short tax year, MACRS percentage tables cannot be used except for property subject to mid-month convention (see below).

Mid-Month ConventionProperty subject to the mid-month convention (271/2-year residen-tial property and 311/2-year or 39-year nonresidential real property) is treated as placed in service or disposed of on the midpoint of the month it is placed in service or disposed of, regardless of whether the tax year is a short one [IRC §168(d)(4)(B)]. (See IRS Pub. 946.)

Half-Year ConventionUnder the half-year convention, treat property placed in service or disposed of in a short tax year as placed in service or disposed of on the midpoint of that year, which always falls on either the first day or the midpoint of a month.

500,000

500,000

50,000 457,000 457,000

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Section 1245 Depreciation RecaptureSection 1245 property is personal property (either tangible or intangible) that is (or has been) subject to depreciation or amorti-zation. Examples include machinery, furniture, vehicles, livestock, franchises, covenants not to compete and Section 197 goodwill. When Section 1245 property is disposed of (whether by sale, exchange or involuntary conversion) at a gain, the gain is treated as ordinary income up to the lesser of: [IRC §1245(a)]•Thesumofalldepreciationoramortizationdeductionsallowed

or allowable (see Allowed or Allowable Depreciation on Page J-6) or

•Gainrealizedonthedisposition.Any gain recognized that is more than the ordinary income from depreciation recapture is a Section 1231 gain.

Section 1250 Depreciation RecaptureSection 1250 property is any depreciable real property that is not and never has been Section 1245 property [Reg. §1.1250-1(e)]. Section 1250 property includes a depreciable leasehold of land or of Section 1250 property. However, a fee simple interest in land is not included because it is not depreciable.Gain on the disposition of Section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable on the property.

Additional DepreciationSection 1250 Property

Held one year or less Held longer than one yearAll the depreciation allowed or allowable is additional depreciation.

Excess of the depreciation allowed or allowable over the amount that would have been allowed using the SL method.

Unrecaptured Section 1250 GainThe term unrecaptured Section 1250 gain generally refers to gain attributable to SL depreciation on real property. For noncorporate taxpayers, this gain is treated as a capital gain subject to the maxi-mum 25% rate [IRC §1(h)(1)(D)]. For how to calculate unrecaptured Section 1250 gain, see Tab 7 in the 1040 Quickfinder® Handbook.

Depreciation Recapture—C CorporationsSection 1245 recapture is computed the same way for corporations and individuals. However, Section 1250 recapture is different for C corporations [and S corporations that were C corporations in the last three years—IRC §1363(b)(4)].Under Section 291(a)(1) for a sale of depreciable real estate that is Section 1250 property, 20% of the excess of any amount that would be treated as ordinary income under Section 1245, over the amount treated as ordinary income under Section 1250, is additional ordinary income.

Example: AT Inc., a C corporation, purchased a warehouse in 20X1 and sold it in 20X5. The original cost was $327,000 and the property was sold for $500,000. None of the gain is subject to regular Section 1250 recapture since it was depreciated under MACRS (straight-line). However, a portion of the gain is subject to ordinary income recapture under Section 291.

Sales price .......................................................................... $ 500,000Cost ................................................................ $ 327,000Accumulated depreciation .............................. < 27,949> < 299,051>Gain .................................................................................... $ 200,949Ordinary income recapture if property were Section 1245 property ...................................................... $ 27,949Portion of gain subject to Section 1250 recapture .............. 0Excess ................................................................................ 27,949Multiply by Section 291 percentage .................................... × 20%Additional Section 1250 ordinary income recapture ........... $ 5,590

Note: For simplicity, the example above did not allocate an amount for land.

general aSSet account (gaa) depreciation

A group of similar assets may be combined in one account and depreciated as a single item [IRC §168(i)(4); Temp. Reg. §1.168(i)-1T(c)(2), effective January 1, 2012]. Depreciation is based on the total combined basis of assets in the account. A Section 179 deduction does not prevent including the remaining basis of an asset in a GAA. Assets can be grouped into one or more GAAs. Assets that are eligible to be grouped into a single GAA may be divided into more than one GAA.

Grouping AssetsAssets that are subject to the Section 168(a) gen-eral depreciation system or the Section 168(g) alternative depreciation system can be combined in GAAs. An asset is included in the GAA only to the extent of its unadjusted depreciable ba-sis. See Tab 2 in the Depreciation Quickfinder®

Handbook for more information on depreciating assets in GAAs.Qualifying assets. To group depreciable assets into one or more GAAs, they must have the following attributes in common: [Temp. Reg. §1.168(i)-1T(c)(2)]1) Depreciation method,2) Recovery period,3) Convention and4) Tax year in which they were placed in service.Prior to 2012, under the former regulations, assets had to be in the same asset class in order to be grouped into a single GAA.Election. To elect GAA treatment under Section 168(i)(4), check the box on line 18 of Form 4562. The election is available each year that new assets are placed in service.Recordkeeping. Taxpayers must maintain records that:1) Identify the assets included in each GAA,2) Establish the unadjusted depreciable basis and depreciation

reserve of the GAA and3) Reflect the amount realized on dispositions from each GAA.

Dispositions from a GAAUnder the temporary regulations, a disposi-tion of an asset is deemed to occur when (1) ownership of the asset is transferred or (2) when the asset is permanently withdrawn from use in the taxpayer’s trade or business or from use in the production of income. A disposition includes the sale, exchange, retirement, physical abandonment or destruction of an asset; the transfer of an asset to a supplies or scrap account; and the retirement of a structural component of a building. [Temp. Reg. §1.168(i)-1T(e)(1)]Disposition of a single asset from the account is treated as if the asset has a zero basis. Thus, all sale proceeds are treated as ordinary income.

Gain is recognized as ordinary income up to: The total beginning basis of the account+ Any expensed amounts subject to recapture as depreciation.– Amounts previously recognized as ordinary income from

the sale of other property from the account.Depreciation continues until the final asset in the GAA is disposed.Any sale proceeds in excess of the original depreciable basis are generally Section 1231 capital gains.

2014, but may be applied to tax years beginning after 2011

2014 (2012 if the taxpayer so elects)

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Example: Hitek Corporation purchases 10 computers with a total depreciable basis of $20,000. Hitek elects to group the computers into one GAA, which will be depreciated under MACRS using 200% DB over five years.First Year: GAA depreciation is $4,000.Second Year: Hitek sells two computers for $5,000. The $5,000 amount real-ized is reported as ordinary income (on Part II of Form 4797) because it is not more than the $20,000 total beginning basis of the account. Second-year GAA depreciation is $6,400.Third Year: Hitek sells seven computers for $16,000. Hitek reports $15,000 as ordinary income ($20,000 total beginning basis of the account minus $5,000 previously recognized as ordinary income). The remaining $1,000 amount realized is a capital gain under Section 1231. Third-year GAA depreciation is $3,840.Fourth Year: Hitek sells the last computer for $2,000. Fourth-year GAA depreciation in the year of disposition is $1,152.The disposition of the GAA results in a Section 1231 loss of $2,608 [$2,000 amount realized from sale of final asset minus adjusted basis of $4,608 ($20,000 original cost less $15,392 depreciation claimed)].

expenSing policyIn general, depreciation rules apply to assets that have a useful life of more than one year. There is no minimum dollar amount in the Code that provides an exception to this rule. A screwdriver, for example, that costs $10 must be depreciated if its useful life is more than one year.Generally, no deduction is allowed for expenditures for (1) new buildings or permanent improvements or betterments made to in-crease the value of any property or estate or (2) restoring property or making good the exhaustion thereof for which an allowance has been made [IRC §263(a)]. There are exceptions to this general rule in Section 263 and elsewhere. A widely applicable exception has long provided that amounts paid or incurred for incidental repairs and maintenance of property are currently deductible, not capital expenditures.The Supreme Court has recognized the highly factual nature of determining if expenditures are for capital improvements or de-ductible repairs. Following its lead, other courts have articulated a number of ways to distinguish between deductible repairs and capitalizable improvements. Despite the court-developed guid-ance and IRS regulations and rulings on the capitalization versus deduction issue, whether a cost is an ordinary repair or should be capitalized has continued to be a source of much controversy and uncertainty. In December 2011, the IRS issued a third set of proposed regulations, along with a matching set of temporary regulations. The temporary regulations are effective for tax years beginning in 2012. See Tab 1 in the Depreciation Quickfinder®

Handbook for more detailed coverage of the new temporary regulations.

Capital Improvements vs. Deductible RepairsWhat can be expensed currently? Taxpayers generally may deduct amounts paid for repairs and maintenance to tangible property if the amounts paid are not otherwise required to be capitalized under Section 263(a) or any other provision of the Code or regulations. [Temp. Reg. §1.162-4T(a)]Repairs undertaken contemporaneously with im-provements that do not directly benefit or are not incurred because of the improvement do not have to be capitalized. [Temp. Reg. §1.263(a)-3T(f)(3)]

What must be capitalized? Expenditures that result in any of the following with respect to a unit of property [as defined in Temp. Reg. §1.263(a)-3T(e) and discussed in Tab 1 of the De-preciation Quickfinder® Handbook] must be capitalized: [Temp. Reg. §1.263(a)-3T(d)]1) A betterment,2) A restoration or 3) An adaptation to a new or different use.If used for business or the production of income, these assets may be depreciated.Betterment. There is a betterment to a unit of property only if an ex-penditure results in any of the following: [Temp. Reg. §1.263(a)-3T(h)]1) Amelioration of a material condition or defect that either existed

before the taxpayer’s acquisition of the unit of property or arose during the production of the property.

2) A material addition to the unit of property. 3) A material increase in capacity, productivity, efficiency, strength,

quality or output of the unit of property.Restoration. An amount is paid to restore a unit of property only when it: [Temp. Reg. §1.263(a)-3T(i)]1) Is to replace a component of a unit of property and the taxpayer

has properly deducted a loss for that component (other than a casualty loss under Reg. §1.165-7).

2) Is to replace a component of a unit of property and the taxpayer has properly taken into account the adjusted basis of the com-ponent in realizing gain or loss from the component’s sale or exchange.

3) Is to repair damage to a unit of property for which the taxpayer has properly taken a basis adjustment due to a casualty loss (or relating to a casualty event) described in Section 165.

4) Returns the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use.

5) Results in the rebuilding of the unit of property to a like-new condition after the end of its class life.

6) Is for the replacement of a part or a combination of parts that comprises a major component or a substantial structural part of a unit of property.

Adaptation to a new or different use. Amounts paid to adapt a unit of property to a new or different use must be capitalized. Adapting a unit of property to a new or different use generally occurs when an adaptation is not consistent with the property’s intended ordinary use when it was originally placed in service. [Temp. Reg. §1.263(a)-3T(j)]

Materials and SuppliesMaterials and supplies used to improve tangible property must generally be capitalized. [Temp. Reg. §1.263(a)-3T(c)(2)]Other materials and supplies are treated as follows: [Temp. Reg. §1.162-3T]•Thecostofincidentalmaterialsandsuppliesisdeductedinthe

year paid (or accrued if accrual-method taxpayer), provided in-come is clearly reflected. Materials and supplies are incidental if carried on hand, and no record of consumption is kept or physical inventory taken.

•Thecostofnon-incidentalmaterialsandsuppliesisdeductedinthe year the item is used or consumed in the taxpayer’s business.

For more information see Materials and Supplies on Page O-3.

De Minimis RuleTaxpayers are not required to capitalize items that would be capitalized under the general rules if the de minimis rule applies. Taxpayers can apply the de minimis rule to any tangible property regardless of its cost, plus materials and supplies that the taxpayer

2014, but may be applied to tax years beginning after 2011

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The percentage depletion rate for oil and gas properties is 15% of gross income (22% for natural gas sold under a fixed contract in effect on February 1, 1975 and at all times thereafter). (IRC §613A)A taxpayer’s depletable oil quantity is limited to average daily production of 1,000 barrels [IRC §613A(c)]. For natural gas, the average daily depletable quantity is 6,000 cubic feet times the depletable oil quantity (1,000 barrels). If depletion is claimed on both oil and gas production, the depletable oil quantity must be reduced by the number of barrels (equivalent) used to figure the depletable natural gas quantity.See Depletion on Page J-9 for more information on depletion, including cost depletion.Marginal production properties. Producers of so-called marginal production properties are eligible for a higher depletion rate when the reference price of crude oil for the preceding calendar year is below $20 a barrel [IRC §613A(c)(6)]. For 2012, however, there was no adjustment, so the depletion rate on marginal production was also 15%. (IRS Notice 2012-50)Limits on depletion deduction. The oil and gas depletion de-duction for independent producers and royalty owners is limited to the lesser of: •100% of taxable income from the property figured without the

depletion deduction and the Section 199 producer’s deduction [IRC §613(a)] or

•65%ofthetaxpayer’staxableincomefromallsources,computedwithout the depletion deduction, the Section 199 producer’s de-duction, any net operating loss carryback and any capital loss carryback. [IRC §613A(d)(1)]

Any depletion not deductible because of the 65% of taxable income limit can be carried over to the next tax year.The 100% of taxable income limit for marginal production proper-ties was temporarily suspended, effective for tax years beginning in 2009, 2010 or 2011. [IRC §613A(c)(6)(H)] Expired Provision Alert: The temporary suspension of the net income limitation expired at the end of 2011. It’s possible that Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.

Lease Bonuses and Advanced RoyaltiesLease bonuses and advanced royalties are payments a lessee makes, before production begins, to a lessor for the grant of rights in a lease to extract oil and gas from leased property. A depletion deduction is not allowed on income from oil and gas lease bonuses and advanced royalties. [IRC §613A(d)(5)]

Geological and Geophysical (G&G) CostsOil and gas G&G costs are amortizable over 24 months using the SL method and the half-year convention. For major integrated oil companies, a seven-year amortization period is used. [IRC §167(h)]

Partnership and S Corporation PropertiesThe depletion allowance for partnership oil and gas property, whether cost or percentage, must be figured separately by each partner and not by the partnership. Only the partner will have the necessary information to determine the 65% of taxable income limitation. Each partner must also keep track of his proportionate share of the adjusted basis of the partnership oil or gas property as determined by the partnership agreement. Therefore, the partner must reduce the share of adjusted basis of each property by the depletion deduction each year.Where to report. The oil and gas partner reports and deducts depletion on Schedule E (Form 1040). The partner’s share of the net income or loss from the partnership is also reported on Schedule E as either passive or nonpassive.The depletion allowance is figured separately by each S corpora-tion shareholder in the same way as a partner in a partnership.

without the depletion deduction and without the manufacturing deduction under Section 199. [IRC §613(a)]The selected depletion percentages for the more common minerals are listed in the table below.

Deposits PercentSulfur and uranium; and, if from deposits in the United States, asbestos, lead, zinc, nickel, mica and certain other ores and minerals

22.0%

Gold, silver, copper, iron ore and oil shale, if from deposits in the United States

15.0%

Coal, lignite, sodium chloride and certain asbestos 10.0%Clay and shale used in making sewer pipe or bricks or used as sintered or burned lightweight aggregates

7.5%

Clay (used or sold in manufacture of drainage and roofing tile, flower pots and kindred products), gravel, sand and stone

5.0%

Most other minerals and metallic ores 14.0% Notes:• For a complete list of minerals and their depletion rates see Code Section 613.• Natural resources that do not qualify for percentage depletion include timber,

soil, sod, dirt, turf, water or similar inexhaustible sources.

Depletion allowed or allowable each year is the greater of percent-age depletion or cost depletion. Also, depletion, whether cost or percentage, is figured separately for each property.

Basis LimitationCost depletion deduction cannot exceed property’s basis. (IRC §612)Percentage depletion reduces basis, but continues to be (1) com-puted (as long as there is gross income from the property) and (2) deductible (as long as there is taxable income from the property), even after the basis has been reduced to zero. [IRC §613(a)]This means that a taxpayer could be entitled to neither percentage depletion (if barred because of the lack of taxable income) nor cost depletion (if barred because the mineral property’s adjusted basis is zero).

Percentage Depletion Reduction—CorporationsThe percentage depletion deduction of a corporation for iron ore and coal (including lignite) is reduced (that is, cut back) by 20% of the excess of:1) Amount of the percentage depletion deduction for the tax year

over2) Adjusted basis of the property at the close of the tax year

(determined without the depletion deduction for the tax year). [IRC §291(a)(2)]

Note: The above cutback applies to an S corporation only if it was formerly a C corporation and only for the first three tax years it is an S corporation after a C tax year. [IRC §1363(b)(4)]

Form T (Timber)—Forest Activities ScheduleThe cost depletion method must be used for timber depletion [IRC §611(a)]. The depletion deduction is based on the taxpayer’s cost or other basis in the timber, not including the cost of land.Generally, Form T should be filed with the income tax return when standing timber is sold or cut or when there are other timber transactions.Form T must be completed to claim a deduction for depletion of timber or for depreciation of plant and other improvements that are timber related, or to elect to treat the cutting of timber as a sale or exchange under Section 631(a).

oil and gaS

Percentage DepletionPercentage depletion with respect to oil and gas properties is available only to independent producers (generally working inter-est owners who are not retailers or refiners) and royalty owners.

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2012 Fringe Benefits Comparison ChartEmployee Benefits Who Is Considered an Employee?

Benefit Description Provision Non-Owner Employee

Self-Employed Individual 1 Partner 2 >2% S Corp.

Shareholder 3C Corporation Shareholder 3

Accident and Health Insurance

Cost of accident and health insurance provided to employee.

Tax free to the employee, subject to certain restrictions.

Adoption Assistance

Expenses connected with the legal adoption of an eligible person.

Employer-paid expenses are tax free to the employee, within certain dollar limits and an AGI phase-out range.

4

Cafeteria Plans Two or more benefits consisting of cash and qualified benefits that the employee can select.

Tax free or tax deferred to the employee.

Deferred Compensation

Employee agrees to work now and defer receipt of salary until a future date.

May be tax deferred or taxable to the employee depending on conditions.

Dependent Care Assistance

Expenses for the care of a dependent while the employee is at work.

Employees can pay for day care costs with pre-tax earnings or employer contributions.

De Minimis Fringe

Minimal benefits, such as occasional personal use of office equipment by employee.

Tax free to the employee. 5

5

5

5

5

Educational Assistance

Educational costs, such as tuition, fees, books, supplies, etc. Education does not have to be job related.

Employer assistance payments of up to $5,250 are excluded from the employee’s gross income.

4, 6

4

4

4

4

Employee Achievement

Awards

Tangible personal property, such as a watch, given to an employee for length of service or safety achievement.

Tax free to the employee up to a specified dollar limit.

7

Employer- Provided Vehicle

Cost of vehicle used by the employee for business or personal purposes.

May be taxable or tax free to the employee depending on conditions.

Group Term-Life Insurance

Cost of term life insurance provided to the employee.

Up to $50,000 of coverage tax free to the employee.

Job Placement Assistance

(Work. Cond.)

Cost of providing counseling on interviewing skills, resume preparation, secretarial services, etc.

Tax free to the employee unless the benefit is conditional or received in lieu of some other taxable benefit.

8

Meals and Lodging

Meals and lodging provided to the employee on the employer’s business premises.

Tax free to the employee if furnished on the business premises, furnished for the employer’s convenience and—for lodging only—as a condition of employment.

No-Additional-Cost Service

Hotel accommodations, telephone services, and transportation by aircraft, train, bus, subway and cruise liner.

Value excluded from the employee’s gross income if service is offered to public and employer incurs no additional cost by offering the service to the employee.

9, 10

11

On-Premises Athletic

Facilities

Athletic facilities on the employer’s business premises.

Tax free to the employee if the facility is generally only used by employees, their spouses, children, etc.

9

11

Qualified Employee Discounts

Goods and services the employer generally offers to the public.

The value of discounted price offered to the employee is tax free to the employee when certain conditions are met.

9

11

Qualified Moving Expense Reimbursement

Amount received as payment or reimbursement for expenses that would be deductible under Section 217 if paid by the individual employee.

Tax free to the employee.

Qualified Retirement Plans

Employer and/or employee contributions to an employer-sponsored retirement plan.

Tax deferred to the employee until funds are withdrawn.

12

Qualified Transportation

Fringe

Employer-provided commuter vehicle transportation between the employee’s residence and place of employment, transit passes and qualified parking.

Exclude $125 per month for 2012 for the combined value of transit passes and employer-provided transportation; $240 per month in 2012 for qualified parking. (Rev. Proc 2011-52)

Retirement Planning Services

Retirement planning advice to the employee and/or spouse.

Tax free to the employee. 13 13 13

Working Condition Fringe

Property and services the employer provides to employees to perform their jobs.

Tax free to employee if it would have been deductible as a business expense had the employee paid for the goods or services.

8

5

5

5

5

1 An independent contractor who performs services for another company. 2 A partner who provides services for the partnership. 3 Assumes S and C corporation shareholders are providing services as employees. 4 Not more than 5% of amounts paid by the employer during the year may be provided to

more-than-5% owners (including their spouses and children). 5 See Reg. §1.132-1(b)(2) and (4). 6 Includes any currently employed person, retired, disabled or laid-off employee and any

employee presently on leave (for example, armed forces). 7 Safety achievement awards cannot go to managerial, administrative, clerical or other

professional employees.

8 Includes currently employed employee, and any director of the employer. 9 Includes any individual currently employed by the employer, the spouse and dependent

children of the employee, any individual who was formerly employed by the employer and separated due to retirement or disability, and the surviving spouse of an employee who died while employed or after separation due to retirement or disability.

10 Special rule for parents in the case of air transportation. 11 Includes the spouse and children of the partner. 12 An independent contractor can participate in his or her own plan, but cannot participate in

another company’s plan as an independent contractor of that company. 13 The IRS has not comprehensively defined “employee” under Section 132(m) for this benefit.

Note: The cost of employee fringe benefits is generally tax deductible to the employer, and tax free or tax deferred to the employee when certain requirements are met.

240

; IRC §132

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tax-Free Fringe BeneFitSIRC §132

No-Additional-Cost ServicesAn employer may exclude the value of a no-additional-cost service from an employee’s gross income if: [IRC §132(b)]1) The service is offered for sale to customers in the ordinary

course of the line of business in which the employee is perform-ing services and

2) The employer does not incur any substantial additional cost (including foregone income and labor costs) in providing the service to an employee.

Examples of no-additional-cost services: Excess capacity services such as hotel accommodations, telephone services and transportation by aircraft, train, bus, subway and cruise line.

Qualified Employee DiscountsEmployees may exclude from gross income certain discounts on the purchase of their employer’s goods or services if: [IRC §132(c)]1) The discount received on property is not greater than the gross

profit percentage of the price at which the property is offered for sale to the public.

2) The discount received on services is not greater than 20% of the price at which the services are offered to the public.

To qualify for the tax-free benefit, the goods or services must be of-fered for sale to customers in the ordinary course of the employer’s business. Furthermore, the discounts must be made available to all employees, not just to officers, owners or highly compensated employees [Reg. §1.132-8(a)]. However, the tax-free discount rule does not extend to real property of any kind or personal property held for investment (such as stocks or bonds).Discounts may also be extended to retired or disabled former em-ployees, surviving spouses and dependent children of employees.

Working Condition Fringe BenefitsAn employer-provided service or property is tax free to an em-ployee if it would have been deductible as a business expense by the employee if paid out of his or her own pocket. [IRC §132(d)]

Job placement assistance (Rev. Rul. 92-69). Job placement services offered by employers are treated as a working condition fringe as long as the services are geared to assisting employees obtaining employment in the same line of work. The employer must also have a business purpose for providing the assistance, such as maintaining employee morale, promoting a positive public image, avoiding wrongful termination suits or fostering a positive work atmosphere. The tax-free benefits include the value of counseling on interviewing skills, resume preparation, and providing office space and secretarial services.

De Minimis Fringe BenefitsThese minimal benefits are so small that it would be unreasonable or administratively impractical for an employer to account for the benefits. [IRC §132(e); Reg. §1.132-6(a)]Examples:•Occasionaltypingofpersonallettersbyasecretary.•Occasionalpersonaluseofofficeequipment.•Holidaygiftsoflow-valuenoncashproperty,suchasaturkey.•Occasionalsportsortheatertickets,employeeparties,picnics.•Coffeeanddonuts.•Flowers,fruitorsimilaritemsgivenonaccountofanillness.•Groupterm-lifeinsurancepayableonthedeathofanemployee’s

spouse or dependent if $2,000 or less. (IRS Notice 89-110)

Little value and frequency. The question of whether or not a de minimis fringe benefit is of little value was addressed in Chief Counsel Advice 200108042. A nonmonetary recognition award having a fair market value (FMV) of $100 did not qualify as a de minimis fringe benefit. (Informally, the IRS has indicated that this does not mean that noncash awards with a FMV of less than $100 are de minimis.) Other examples of de minimis fringe benefits in Regulation Section 1.132-6(e)(1) include theater and sporting event tickets, which often exceed $100 in value. In Field Service Advice 200219005, where meals and sporting event tickets were determined to not qualify as de minimis fringe benefits, the FSA stated in part: “The smaller in value and less frequently a particular benefit is provided, the more likely that such a benefit is properly characterized as a de minimis fringe benefit.”Meal furnished for the convenience of the employer. Meals provided under the convenience of the employer rules are a de minimis fringe benefit excludable by the employee and fully de-ductible by the employer. See Meals and Lodging on Page K-9.

On-Premises Athletic FacilitiesThe value of athletic facilities provided by an employer to its em-ployees is excluded from an employee’s income [IRC §132(j)(4)]. The facility must be located on premises owned or leased by the employer, and substantially all of its use must be by employees, their spouses and dependent children. The facility can be a tennis court, gym, pool or golf course. This exclusion does not apply if the facility is made accessible to the general public. The exclusion does not apply to any residential use facility. For example, a resort with athletic facilities does not qualify. [Reg. §1.132-1(e)]

Qualified Transportation BenefitsEmployer-provided qualified transportation fringe benefits are excludable from the employee’s income, up to certain limits. Public transportation. Employers can provide up to $125 per month in 2012 (Rev. Proc. 2011-52) to help employees defray the costs of commuting. Employers can:1) Give tokens or transit passes each month to an employee for

the monthly limit,2) Sell tokens or transit passes to employees at a discount for the

monthly limit or3) Reimburse employees up to the monthly limit for public com-

muting expenses.U Caution: A cash reimbursement arrangement for transit passes is allowed as a qualified transportation fringe only if no vouchers or transit passes are readily available for direct distribution by the employer to employees. [Reg. §1.132-9(b), Q/A-16(b)(1)]Commuter transportation. An employer may provide a commuter highway vehicle (van pool) for transportation of employees to and from work. The combined value of employer-provided commuter transportation and transit passes excludable from income is limited to $125 per month for 2012. (Rev. Proc. 2011-52) To qualify, these requirements must be met: [IRC §132(f)(5)]1) Vehicle must seat at least seven adults, including driver,2) 80% of van use must be for transporting employees to and from

work and3) At least half of the seating capacity must be used by employees

(excluding the driver).Under the commuting valuation rule, each one-way trip is valued at a flat rate of $1.50 ($3.00 per round trip) (Notice 94-3). Workers do not have to include either type of assistance in gross income, as long as the statutory monthly limit is not exceeded. Amounts over the monthly limit are included in income and subject to federal income tax, federal withholding, FICA and FUTA.

240

240

; IRC §132

; IRC §132

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Special rules for qualified conservation contributions: Expired Provision Alert: Certain provisions of the qualified conservation contribution deduction expired at the end of 2011. It’s possible Congress will extend them to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.Before 2012, qualified conservation contributions that were not deductible in the year made because of the applicable percentage-of-income limitation on total contribution deductions had a 15-year carryover period (rather than the usual five-year carryover period). For individual taxpayers, a conservation contribution was taken into account for purposes of the 50%-of-AGI-limitation base (100% in the case of farmers and ranchers) only after taking into account all other contributions (which are subject to the five-year carryover period), saving this contribution for deduction in later years (Notice 2007-50). The special 100% limit also applied to corporate farmers and ranch-ers for whom it is especially beneficial, as deductibility of donations by corporations is generally limited to 10% of taxable income. [IRC §170(b)(1)(E) and (b)(2)(B)]

Abandonment or Worthlessness of Investment Property—Ordinary vs. Capital LossSale of investment property at a loss is generally subject to capi-tal loss limits. However, if nondepreciable investment property is abandoned or becomes worthless, the transaction may be eligible for deduction as an ordinary loss. (Reg. §1.165-2)Under the Regulations, ordinary loss treatment for worthless or abandoned property applies to transactions that do not constitute a sale or exchange, even if the property is a capital asset.Establishing abandonment. A taxpayer must show intent to aban-don an asset and must overtly act to abandon it. Under Regulation Section 1.165-1(b), the loss must be “evidenced by closed and completed transactions, fixed by identifiable events, and, ... actu-ally sustained during the taxable year.” For example, a taxpayer who deeded property to the taxing authorities was found to have abandoned the property. [Jamison, 8 TC 173 (1947)]Dispositions must be carefully structured to achieve the desired tax effects. For example, a loss on investment property that is properly abandoned is treated as an ordinary loss. However, if the same property is sold for $1, the loss is subject to capital loss limits.Where to report. An individual’s deduction for abandonment or worthlessness of investment property is taken as a miscellaneous itemized deduction on Schedule A of Form 1040, subject to the 2%-of-adjusted gross income (AGI) floor. The loss is reported on Schedule A rather than another form (such as, Form 4797) because it is a Section 165(a) deduction. That Code section falls under Part VI of Subchapter B of the Code, which covers itemized deductions for individuals and corporations. Such deductions (unless another Code section, regulation or ruling, etc., requires they be reported elsewhere on the return) are reported on Schedule A.Abandoned/worthless securities. While losses under Section 165 generally are ordinary, Section 165(g) provides that a capital loss results when a security that is a capital asset becomes worthless during the tax year. The worthless security is treated as if it was sold on the last day of the tax year. Some taxpayers have claimed ordinary losses under Section 165(a) for abandoned securities, arguing that Section 165(g) applies only when a security becomes worthless, not when it is abandoned. However, the IRS position is that, if the abandoned security is a capital asset, the loss is treated as a capital (not ordinary) loss on the last day of the tax year—the same as a worthless security. To abandon a security, a taxpayer must perma-nently surrender and relinquish all rights in the security and receive no consideration in exchange for the security. [Reg. §1.165-5(i)] Note: See Revenue Ruling 93-80 for information about worth-lessness or abandonment of partnership interests with liabilities versus without liabilities.

Costs of abandoned business restructuring. Generally, costs incurred in investigating and pursuing mutually exclusive business restructurings (recapitalization, divestiture of business divisions, etc.) must be capitalized as part of the cost of the completed transaction. However, if such costs relate to a transaction that is not completed, they can be deducted under Section 165 at the time the transaction is abandoned.

aSSet acquiSitionSForm 8594; see also IRC §1060

Form 8594, Asset Acquisition Statement Under Section 1060, is filed by both the seller and the buyer of a group of assets that constitutes an applicable asset acquisition. An applicable asset acquisition is any direct or indirect transfer of a group of assets that constitutes a trade or business in the hands of either the seller or the buyer, and the pur-chaser’s basis in the assets is determined wholly by the amount paid for the assets. The purpose is to identify goodwill or going-concern value that could be attached to the sale price of the business. Differences in the buyer and seller amounts on Form 8594 can give the IRS incentive to examine the transaction and make its own allocations. To avoid drawing attention to the transaction, the buyer and the seller can agree in writing to specific allocations and prepare the Forms 8594 according to those allocations.The allocation is generally done under the rules of Section 338 and Regulation Section 1.338-6 and is referred to as the residual method (discussed below). Further guidance on the Section 338 rules is provided in Tab 9 of the Tax Planning for Businesses Quickfinder® Handbook. If a written agreement is entered into and that agreement differs from the residual method figures reported on Form 8594, the written purchase agreement will take precedence (Peco Foods, Inc., TC Memo 2012-18). As a practical matter, any taxpayer involved in an asset acquisition who has a cost segregation study done on cost allocation should do it before entering into a written agreement. The written agreement should match that cost segregation, and those figures should be used for Form 8594 reporting to avoid unwanted IRS questions.The taxpayer should be very careful in assigning allocations, as the amounts agreed to become the tax bases of assets; changing allocations (for example, to assign more to a depreciable asset and less to land) could result in an accounting method change. Accounting method changes are discussed in Tab L.Form 8594 is not required to be filed if:1) The acquisition is not an applicable asset acquisition (as defined

above),2) The group of assets that constitutes a trade or business is ex-

changed for like-kind property in a transaction to which Section 1031 applies (however, if Section 1031 does not apply to all the assets transferred, Form 8594 is required for the group of assets to which Section 1031 does not apply) or

3) A partnership interest is transferred.The buyer’s and seller’s Forms 8594 are filed with their tax returns for the year of the sale. If the amount allocated to any asset is increased or decreased after Form 8594 is filed, a new Form 8594 must be filed (by attaching it to the tax return for the year of the increase or decrease) reporting the adjustment.

Allocation Using the Residual MethodAllocation of purchase price must be made to determine the buyer’s basis in each acquired asset and the seller’s gain or loss on the transfer of each asset. The amount allocated to an asset, other than intangible assets (goodwill and going-concern), cannot exceed its FMV on the purchase date.Allocate the sale price in the following order (commonly referred to as the residual method):Class I assets are cash and general deposit accounts (including sav-ings and checking accounts) other than certificates of deposit held in banks, savings and loan associations and other depository institutions.

applies

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Strategy: A representative for the acquiring company who is fa-miliar with IRS procedures should obtain a power of attorney from the company being acquired. Copies of tax records can then be obtained and examined for back taxes, interest, penalties or possible audit items.U Caution: Liabilities assumed by a purchaser are not neces-sarily limited to the amount of liabilities that are known at the time. Strategy: To diminish risks created by the successor liability laws, the acquiring company should acquire the target company with an asset purchase rather than a stock purchase, if possible.

Installment Sales (Form 6252)The installment method allows a taxpayer selling a business in exchange for a note to defer the recognition of gain until payment is actually received (IRC §453). The buyer would like the seller to finance the sale rather than obtain financing through a bank or other lending institution, which generally means strict loan qualification procedures and credit checks. The seller may want to spread the gain out over a number of years to minimize the effect of subjecting other income to higher ordinary income tax rates, such as Social Security benefits, investment income and retirement plan distribu-tions. However, the seller takes on all the risk. Repossession. If the seller has to repossess the business, the seller will recognize gain to the extent payments received prior to the repossession exceed gain already reported under the install-ment method, limited to the initial gain on the sale minus the sum of (1) repossession costs and (2) gain on the sale reported as income before the repossession. The seller also could lose a substantial amount of the value of goodwill due to the buyer’s negligence in operating the business. Such a risk should influence the negotia-tions between the buyer and seller in valuing the various assets in the original sales contract.The installment method does not apply to assets that produce ordinary income when sold. Only capital gains may be reported under the installment method. Any ordinary income as a result of the sale of a business asset must be reported as income in the year of sale, regardless of when payment is actually received.

Ordinary income in a sales contract may be produced by:•Inventory.•Accountsreceivable.•Depreciationrecapture. Strategy: The seller should obtain a sufficient down payment from the buyer to cover the tax liability on ordinary income in the year of the sale.Sale of business. If multiple assets are sold in a single sale (such as the sale of an entire business), the seller must determine whether the installment method can be used to report the sale of each asset. The buyer and seller must use the residual method to allocate the sale price. See Allocation using the Residual Method on Page N-15.Installment method reporting. Income from an installment sale is reported on Form 6252, Installment Sale Income. Dispositions of eligible property by an installment sale must be reported using the installment method unless the taxpayer makes an election not to use installment method reporting [IRC §453(d)]. Generally, such an election is irrevocable, but exceptions do exist. The IRS allowed a taxpayer to revoke the election out when the taxpayer acted as soon as he became aware that his accountant had mistakenly elected out of installment method reporting. The request was granted because the reason for revoking the election was not a desire to avoid tax but was based on the accountant’s mistake. (Ltr. Rul. 200813019)

Reporting Requirements for Certain AcquisitionsCertain domestic corporations involved in an acquisition of control or a substantial change in capital structure must file Form 8806, Information Return for Acquisition of Control or Substantial Change in Capital Structure (Reg. §1.6043-4). This reporting requirement applies to acquisitions involving acquired stock with a FMV of $100 million or more and changes in which the shareholders receive cash or property (including stock) of $100 million or more.

Tax Treatment of Assets Included in Sale of a BusinessAsset Buyer’s Tax Treatment Seller’s Tax Treatment

Buildings and building components

Depreciable over 39 years. Long-term gain attributed to depreciation is unrecaptured Section 1250 gain. Maximum individual capital gain rate on unrecaptured Section 1250 gain is 25% for 2012.Long-term gain in excess of depreciation is a capital gain under Section 1231. Maximum individual capital gain rate on Section 1231 property is 15% for 2012.

Land Nondeductible—cost is capitalized and recovered when sold.

Long-term gain is Section 1231 gain. Maximum individual capital gain rate on Section 1231 property is 15% for 2012.

Equipment and vehicles

Depreciable—generally over five or seven years unless other class life applies. For 2012, up to $139,000 may qualify for current expense deduction under Section 179.

Gain attributed to depreciation is ordinary income under Section 1245. Maximum individual ordinary income tax rate is 35% for 2012.Long-term gain in excess of depreciation is a capital gain under Section 1231. Maximum individual capital gain rate on Section 1231 property is 15% for 2012.

Inventory Added to cost of goods—deductible when sold to customers. Gain is ordinary income. Maximum individual ordinary income tax rate is 35% for 2012.Intangible assets such as goodwill, covenant not to compete, copyright, patent, customer list, employee contract, franchise, trademark or trade name

Amortizable over 15 years as Section 197 intangibles. Long-term gains on self-created intangibles are generally considered capital gains. Top individual capital gain rate is 15% (for 2012). Exception: Income from a covenant not to compete is generally ordinary income, not subject to SE tax, maximum rate of 35%. [Barrett, 58 TC 284 (1972), acq. 1974-2 CB 1]. However, if a noncompete agreement cannot be clearly distinguished from a consulting agreement or other agreement entered into at the same time, payments under the noncompete agreement could be subject to SE tax.Gain on acquired intangibles attributed to amortization is ordinary income under Section 1245. Maximum individual ordinary income tax rate is 35% for 2012.Long-term gain on acquired intangibles in excess of amortization is a capital gain under Section 1231. Maximum capital gain rate on Section 1231 property is 15% for 2012.

Notes:• A loss on the sale of any business asset is an ordinary loss under Section 1231. Ordinary losses are deductible against other ordinary income.• A loss is not allowed on the disposition of a Section 197 intangible asset that was acquired in a transaction with other Section 197 intangibles that the taxpayer retains.

The basis of the retained Section 197 intangibles are increased by the unrecognized loss.• A short-term gain on the disposition of any business asset is subject to ordinary income tax rates.• If a building component is portable and removable, it may be considered separate and qualify as equipment rather than as a part of the building. Examples include

window air conditioners, movable partitions, movable shelving, window blinds, etc. Buyer should consider a cost segregation study to identify components.• If the seller is a C corporation, capital gains and ordinary income are taxed at the same rate. A net capital loss is nondeductible and must be carried back three years

and forward five years. [IRC §1212(a)(1)]

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Deductions, Credits and Books vs. Tax

BuSineSS tax deductionSAccountable plan. Employer reimbursements for an employee’s business expenses are deductible by the employer and not includ-ed in the employee’s income. The expenses must have a business purpose and be substantiated by the employee, and the employee must return any excess reimbursements within a reasonable period of time. See Tab 9 of the 1040 Quickfinder® Handbook for more information. If the expenses are not substantiated or excess expenses are not returned within the required period of time, the expenses are treated as paid under a nonaccountable plan. See Nonaccountable plan on Page O-3.Advertising. Advertising costs that relate to business activities are deductible as current operating expenses. Advertising is not capitalized under UNICAP. Advertising to influence legislation is not deductible. Prepaid advertising costs are deductible in the year to which they apply.Amortization. See Tab J. Attorneys, etc. See Lawyers’ costs incurred on behalf of clients and Legal and professional fees on Page O-3.Auto expenses. Passenger automobiles rated at or below an unloaded gross vehicle weight of 6,000 pounds are listed property [IRC §280F(d)(5)]. Deduction limits and substantiation require-ments apply.The value of an employer-provided vehicle must generally be included in the employee’s wages. See Employer-Provided Autos on Page K-14 for more information.Self-employed individuals, including partners in a partnership, and employees who do not use more than four vehicles at a time for business are allowed to compute their deduction using the standard mileage rate. The 2012 standard mileage rate is 55.5¢ per mile (Rev. Proc. 2010-51 and Notice 2012-1). The IRS no longer updates mileage rates each year in a revenue procedure. Therefore, the rules in Rev. Proc. 2010-51 remain in effect until superseded, and the IRS publishes subsequent notifications as needed. Generally, a corporation can deduct 100% of the costs associated with an auto. The business portion of the employee’s use is deductible as a transportation expense while the personal use is deductible either as additional compensation or as a taxable fringe benefit.Awards and bonuses. Bonuses paid to employees are deductible if intended as additional pay for services. Gifts to employees or customers are limited to $25 per year, per individual [IRC §274(b)]. Cash or gift certificates given to employees must be treated as tax-able wages. Also see Employee Achievement Awards on Page K-9.Bad debts—business. See Business Bad Debts on Page O-12.Barrier removal for disabled or elderly. Up to $15,000 of the cost of removing barriers to make a facility more accessible for disabled or elderly individuals may qualify for a current deduction (IRC §190). Some barrier removal costs may also qualify for the

disabled access credit (Form 8826). See General Business Tax Credit Summary on Page O-9.Bribes or kickbacks. Payments made directly or indirectly to a government official or employee are not deductible if made in violation of the law. Payments are not deductible if made to any person in violation of a federal or state law that provides a criminal penalty for loss of license or privilege to engage in a trade or business.Capital expenses. Capitalizable expenditures typically are per-manent improvements or betterments that increase the value of property, restore its value or use, substantially prolong its useful life or adapt it to a new or different use [IRC §168 and 263(a)]. Incidental expenses that do not materially add to the value of a property or appreciably prolong its useful life are deductible as incurred. Materials and supplies are typically deductible in the year consumed. See Improvements and repairs on Page O-2 and Materials and supplies on Page O-3.The IRS issued temporary regulations (effective January 1, 2012) to help taxpayers determine whether an expense must be capital-ized. Temp. Reg. §1.263(a)-3T(d) dictates that expenditures are typically capitalized if they result in:•Abetterment,•Arestorationor•Anadaptationtoanewordifferentuse.The temporary regulations state that, for property other than build-ings, all functionally interdependent components of a property comprise a single unit of property if placing one component in service depends on placing the other component in service. [Temp. Reg. §1.263(a)-3T(e)(3)]For buildings, expenditures are capitalized if they result in an im-provement to the building (including its structural components) or any of the following building systems: [Temp. Reg. §1.263(a)-3T(e)(2)]1) Heating, ventilation and air conditioning (HVAC).2) Plumbing systems (including pipes, drains, valves, sinks, bath-

tubs and toilets).3) Electrical systems (including wiring outlets, junction boxes and

lighting fixtures).4) Escalators.5) Elevators.6) Fire protection and alarm systems.7) Security systems.8) Gas distribution systems.Repairs that are subject to capitalization under the UNICAP rules or any other provision of the Code or regulations cannot be deducted. (Temp. Reg. §1.162-4T)æ Practice Tip: The IRS has indicated that the temporary regula-tions could be finalized, with some further changes, in early 2013. See Expensing Policy on Page J-8 for more information.Cell phones. Cell phones and similar telecommunications equip-ment are no longer included in the definition of listed property (to which strict substantiation rules and deduction limits apply). [IRC §280F(d)(4)(A)]. See Employer Provided Cell Phones on Page K-8 for guidelines on their proper tax treatment.Charitable contributions. See Charitable Contributions on Page O-14. For C corporations, see Charitable Contributions and Chari-table Contributions of Inventory on Page C-14. See also Tab 5 of the 1040 Quickfinder® Handbook and Tab 12 of the Tax Planning for Businesses Quickfinder® Handbook.

Tab O TopicsBusiness Tax Deductions ....................................... Page O-1U.S. Production Deduction..................................... Page O-4Tax Credits ............................................................. Page O-7Selected Energy Tax Incentives for Businesses .... Page O-7Net Income per Books vs. Taxable Income ...........Page O-11

2014, but may be applied to tax years beginning after 2011

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Circulation expenses. The cost of increasing circulation of a newspaper, magazine or other periodical is deductible as a cur-rent operating expense, or may be capitalized and amortized as a deferred expense. (IRC §173)Club dues are generally nondeductible if the club has a principal purpose of providing access to or conducting entertainment activi-ties for members or their guests. Out-of-pocket business meals and entertainment expenses incurred at a club are deductible, subject to limits. See Tab 9 in the 1040 Quickfinder® Handbook. Computer software. See Computer Software on Page O-14.Cost of goods sold. See Cost of Goods Sold (COGS) on Page O-15.Demolition expenses. Costs incurred to demolish a structure are added to basis of the land where the demolished structure was located. (IRC §280B)Depletion. See Tab J.Depreciation. See Tab J.Development costs. Costs of developing a mine or other natural deposit (other than an oil or gas well) may be deducted. The costs must be paid after the discovery of ores or minerals in commercially marketable quantities [IRC §616(a)]. An election can be made to treat the costs as deferred expenses deducted ratably as the ores/minerals are sold [IRC §616(b) or to amortize the costs over ten years. [IRC §59(e)]Disaster losses. A taxpayer that sustains a loss occurring in a disaster area can elect to deduct the loss in the tax year before the year the loss occurred. The taxpayer thus has the option of selecting either the year of the loss or the prior year in which to claim the deduction (Reg. §1.165-11). See also Qualified disaster expenses on Page O-4.Donations of patents, etc. A deduction for a contribution of a patent or certain other items of intellectual property to charity is limited to the lesser of (1) the taxpayer’s basis in the property or (2) the FMV. Taxpayers may deduct certain additional amounts in later years, based on a specified percentage of qualified income received by the charitable organization from the contributed prop-erty. No deduction is permitted for income received by the charity after the expiration of the legal life of the patent or other intellectual property. [IRC §170(e) and (m)]Education expenses. An employer can deduct the following employee education expenses:•Educational Assistance Program. Up to $5,250 of qualified edu-

cational assistance can be excluded from an employee’s income (IRC §127). See Tab K for more information about educational assistance programs.

•Working Condition Fringe Benefit [IRC §132(d)]. Employer-provided education is excludable from an employee’s income if the expense would have been deductible as a business expense if paid out of the employee’s pocket. An individual is generally not allowed to deduct education expenses if (1) the education is required to meet minimum requirements of the individual’s em-ployment or trade, or (2) the education will qualify the individual for a new trade or business. See Work-Related Education Costs in Tab 5 of the 1040 Quickfinder® Handbook for more information about deducting education expenses for individuals.

Employee awards. See Awards and bonuses on Page O-1.Employee benefit programs. See Tab K.Entertainment. See Meals and entertainment on Page O-3. See Tab 9 in the 1040 Quickfinder® Handbook and Tab 7 in the Tax Plan-ning for Businesses Quickfinder® Handbook for more information on travel, meal and entertainment tax issues.Entertainment expenses included in W-2 wages. When an employer adds the personal value of a benefit to a “specified indi-vidual’s” taxable W-2 wages, the employer’s deduction is limited to

the lesser of the actual cost of the benefit or the amount included in the employee’s taxable wages. This rule applies to expenses for activities generally considered to be entertainment, amusement or recreation and facilities used in connection with such activities, such as a company airplane. Specified individuals generally include officers, directors and 10% or greater owners of private and publicly held companies. [IRC §274(a) and (e)]Environmental clean-up costs. Revenue Ruling 94-38 held that costs incurred to construct groundwater treatment facilities were capital expenses. Other costs incurred to clean up land and to treat groundwater contaminated with hazardous waste resulting from business operations were deductible as business expenses. However, Revenue Ruling 2004-18 issued a clarification of the prior ruling, stating that otherwise deductible costs incurred by a manufacturing operation must be included in inventory under the uniform capitalization rules of Section 263A.Newly issued temporary regulations require that for tax years beginning on or after January 1, 2012, taxpayers must capitalize amounts paid to improve or better a material condition or defect that existed prior to a taxpayer’s acquisition of property, whether or not the taxpayer was aware of the defect at the time of acquisition [Temp. Reg. §1.263(a)-3T(h)]. Therefore, if a taxpayer purchases land contaminated prior to acquisition, the clean-up cost is capital-ized. However, environmental remediation costs paid or incurred to clean up a state designated qualified contaminated site may qualify for deduction. The deduction applies for expenditures incurred through December 31, 2011. (IRC §198) Expired Provision Alert: The expensing of environmental remediation costs expired at the end of 2011. It’s possible Con-gress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.The IRS has privately applied rules similar to those for soil re-mediation costs to a taxpayer removing mold from a building. A deduction was allowed for the cost of removing mold from a nursing home where the facility was not contaminated at acquisition and the mold removal did not prolong the building’s life or increase its value. (Letter Rul. 200607003)Environmental remediation costs incurred to clean up land contami-nated with a taxpayer’s hazardous waste during operation of the taxpayer’s manufacturing activities are allocable to the inventory produced under Section 263A during the year costs are incurred. (Rev. Rul. 2005-42)Fines. See Penalties and Fines on Page O-20.Franchise. See Intangible Assets on Page O-17.Fringe benefits. See Tab K.Gifts. See Awards and bonuses on Page O-1.Goodwill. See Intangible Assets on Page O-17.Impact fees on real estate development (Rev. Rul. 2002-9). Impact fees are one-time charges imposed by a state or local government for offsite capital improvements necessitated by a new or expanded development. The Revenue Ruling treats impact fees as capital expenses that are added to the basis of the buildings. This allows developers to depreciate impact fees over the life of constructed buildings, rather than adding the fees to the basis of nondepreciable land. Impact fees may also be considered for purposes of computing the low-income housing credit.Impairment losses. See Impairment Losses on Page O-16.

Improvements and repairs. Taxpayers may deduct amounts paid for repairs or maintenance of tangible property provided the amounts are not otherwise required to be capitalized (Temp. Reg. §1.162-4T). Also see Capital expenses on Page O-1 and Expens-ing Policy on Page J-8.

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In the U.S. RequirementU.S.

Defined• The 50 states, District of Columbia, U.S. territorial waters and the

seabeds and subsoils of any waters adjacent to U.S. territorial waters that the U.S. has exclusive exploration and exploitation rights over. [Reg. §1.199-3(h)]

• Taxpayers with foreign activities must allocate gross receipts. Imports • Some taxpayers import partially manufactured items and then finish

the process in the U.S.• To the extent that the taxpayer’s actions, given all of the facts and

circumstances, are substantial, the gross receipts from the activity will qualify as DPGR.

Exports • If the taxpayer manufactures a product in the U.S. and then exports it, all of the gross receipts will be DPGR, regardless of whether the taxpayer imports the property back into the U.S. for final disposition. [Reg. §1.199-3(g)(5), Ex. 5]

Note: The DPD was available for certain Puerto Rico activities between Decem-ber 31, 2005 and January 1, 2012.

Expired Provision Alert: The DPD allowable for income at-tributable to production activities in Puerto Rico expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.

What Is QPAI?Qualified production activities income (QPAI) is the taxpayer’s domestic production gross receipts (DPGR) reduced by:1) The cost of goods sold allocable to those receipts and2) Other expenses, losses or deductions (other than the DPD

itself) that are properly allocable to those receipts.Determining DPGR. DPGR is the taxpayer’s gross receipts from the lease, rental, license, sale, exchange or other disposition of QPP that was manufactured, produced, grown or extracted in whole or in significant part within the U.S.Additional activities producing DPGR include: •Qualifiedfilmproduction;•Electricity,naturalgasorpotablewaterproducedintheU.S.;•Farmingandprocessingofagriculturalproductsandfood;•ConstructionperformedintheU.S.and•EngineeringorarchitecturalservicesperformedintheU.S.for

U.S. construction projects. Gross receipts from a related party rental, lease or license are excluded. [IRC §199(c)(7)]Computing gross receipts. Gross receipts are computed us-ing the taxpayer’s normal accounting method. Therefore, the taxpayer could potentially recognize gross receipts (for example, advance payments) in a different tax year than when the costs are recognized.Gross receipts include: [Reg. §1.199-3(c)]•Totalsales,netofreturnsandallowances;•Serviceincome;•Investmentincomeand•Anyotherincomefromincidentaloroutsidesources.Gross receipts also include interest, gains from the sale of prop-erty, dividends, rents, royalties, annuities and tax-exempt income (although these items will reduce the amount of the deduction because such income is not DPGR.)Exclusions from gross receipts computation:•Salestaxif thetaxis imposedonthebuyerandthetaxpayer

merely collects the tax and pays it over to the taxing authority. •Costofsalesisnotdeducted,noristhebasisofpropertysoldif

the property is not a capital asset. Therefore, there is no basis reduction for property that is inventory, or that is held for sale to customers in the ordinary course of business.

Gross receipts allocation. Taxpayers with both DPGR and non-DPGR must use a reasonable method to identify gross receipts that constitute DPGR. [Reg. §1.199-1(d)(2)]

Exceptions for allocating gross receipts between DPGR and non-DPGR:•Iflessthan5%oftotalgrossreceiptsarenon-DPGR(suchas

interest income, gains from the sale of property and dividends), then the taxpayer can classify 100% of its gross receipts as DPGR. [Reg. §1.199-1(d)(3)]

•Taxpayerswithade minimis amount of gross receipts (less than 5%) from embedded services may include the embedded service income as DPGR. [Reg. §1.199-3(i)(4)]

Allocating costs to gross receipts. Classifying receipts as DPGR is only the first step. The next step is to allocate the appropriate costs against the DPGR to determine the QPAI.•TaxpayersmustsubtractfromDPGRthecostofgoodssoldal-

locable to DPGR, as well as other expenses, losses or deductions (other than the DPD itself) that are properly allocable to such receipts. [Reg. §1.199-4(a)]

•RegulationSection1.199-4(a)providesthreemethodsforallocatingand apportioning deductions (the Section 861 method, the simplified deduction method and the small business simplified overall method). Taxpayers can change the allocation method from year to year.

•TherearerulesfordeterminingcostofgoodssoldallocabletoDPGR [Reg. §1.199-4(b)] and for determining deductions prop-erly allocable to DPGR. [Reg. §1.199-4(c)]

•Certain taxpayers ($100millionor lessaverageannualgrossreceipts or tax year end total assets of $10 million or less) can apportion deductions to DPGR using the simplified deduction method. [Reg. §1.199-4(e)]

•Smaller taxpayers ($5million or less average annual grossreceipts, cash method farmers, or $10 million or less average annual gross receipts and using the cash method under Revenue Procedure 2002-28) are allowed to use the small business sim-plified overall method to apportion cost of goods sold and other deductions to DPGR. [Reg. §1.199-4(f)]  U Caution: While using the simplified methods significantly

reduces the complexity of the calculations, the allocation may not be as accurate as one made under the Section 861 rules. Using one of the simplified methods could cause the taxpayer to allocate too much cost to DPGR, which would reduce QPAI and, thus, reduce the DPD.

Calculating the DPDSee Filled-in Sample Form 8903 on Page O-6.A taxpayer calculates the DPD after determining its QPAI.•QPAIequalsthetaxpayer’sDPGRless COGS and other deduc-

tions, expenses and losses allocable to DPGR.•ForataxpayerwithonlyDPGRfromqualifiedproductionprop-

erty manufactured in the U.S., QPAI will essentially equal the taxpayer’s taxable income (AGI for an individual taxpayer) before the DPD, with exceptions for Section 165 losses and Section 172 net operating losses (see Losses affect the DPD computation as follows on Page O-6).

Determining W-2 wages. The DPD is driven by the taxpayer’s DPGR, but is limited to 50% of the W-2 wages properly allocable to DPGR paid by the taxpayer during the year.æ Practice Tip: Because of the limitation of W-2 wages to those allocable to DPGR, taxpayers will have to design and implement recordkeeping systems to capture the portion of employees’ time, and thus employees’ pay, devoted to qualifying Section 199 activi-ties (for example, by establishing separate general ledger accounts for DPGR-related wages and other wages). Strategy: Since payments to independent contractors are not W-2 wages for the DPD, taxpayers may want to bring qualifying activities in-house that previously have been sub-contracted out. However, before doing so they should determine whether the de-duction gained from including the workers’ W-2 wages in the DPD computation outweighs the additional expense and administrative burden of carrying these workers on the payroll.

in tax years beginning after

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before January 1, 2014.

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the partners or shareholders. If a partnership or S corporation does so, each partner or shareholder combines its QPAI and W-2 wages from the entity with its QPAI and W-2 wages from other sources.

tax creditSUnlike deductions—which reduce a taxpayer’s tax liability by the marginal tax rate times the deduction amount (cents on the dol-lar)—tax credits reduce the tax liability on a dollar for dollar basis. See the General Business Tax Credit Summary table on Page O-9 for more information on the component credits of the general business credit.

Personal Tax CreditsSee Tab 12 in the 1040 Quickfinder® Handbook for information on personal tax credits claimed by individuals on Form 1040.

General Business CreditA taxpayer must file Form 3800 to claim any of the general busi-ness credits.U Caution: The IRS has not released a draft or final 2012 Form 3800 as of the date of this publication. Therefore, this publication references information found in the 2011 form. Readers should re-main alert for possible changes in the 2012 Form 3800.Compute each component credit separately on its applicable form. After each component credit is separately computed on its applicable form, it is then carried to Form 3800, where the com-ponent credits are separately listed and then combined into one general business credit (GBC). The combined credit is subject to a limitation based on tax liability. Follow the line-by-line steps of Part II of Form 3800 to figure the limitation. Attach to the return Form 3800 and the separate forms for each credit claimed.Exception: Taxpayers whose only source of credits listed on Form 3800, Part III, is from pass-through entities may not be required to complete and file separate credit forms to claim the general business credit—see the Form 3800 instructions. If a credit is being reported from a pass-through entity, that entity’s employer identification number must be entered in Part III.Form 3800, Part III includes eight different check boxes for the specific categories of GBC being reported. A taxpayer must com-plete a separate Part III for each box checked, and an additional consolidated Part III if certain conditions are met. See the Form 3800 instructions for details.Carryback/carryforward of unused credits. The passive activ-ity limit and carryover amounts for all GBCs are also reported on Form 3800. The general business credit is limited to net income tax reduced by the greater of: [IRC §38(c)(1)]•Tentativeminimumtaxor•25%oftheamountbywhichthenetregulartaxliabilityexceeds

$25,000.If the full general business credit may not be claimed because of the limitation, unused credits are carried back one year and forward 20 years (IRC §39). However, no part of any unused current year business credit attributable to a component credit may be carried back to tax years before the first tax year that the component credit was allowable.Unused credits. Credits as defined in Section 196(c) that remain unused after the 20-year carryforward period may be taken as a deduction in the first tax year following the expiration of the 20-year period. Unused credits may also be taken as a deduction if a taxpayer dies or goes out of business. See the instructions for Form 3800 for more information about deducting carryovers.

Other Tax Credits for BusinessesIn addition to the various components of the general business credit, several other tax credits are available to business taxpay-ers, including those shown in the following table.

Other Tax Credits for Business Taxpayers Summary

Tax Credit IRC § TaxForms

Federal Fuels Tax1 Various 4136

Foreign and U.S. Possessions Tax 901 11161118

Prior-Year Minimum Tax 53 88018827

Qualified Tax Credit Bonds, Clean Renewable Energy Bonds and Gulf Tax Credit Bonds2

54A, 54 and1400N(l) 8912

Undistributed Capital Gains of REITs and RICs 852(b)(3)(D)857(b)(3)(D) 2439

1 See following discussion.2 Gulf tax credit bonds must be issued during 2006, but the tax credit for

bondholders continues to be available in later years.

Federal fuels tax. Taxpayers may be eligible to claim a refund or credit for federal and state excise taxes paid for motor fuels for vehicles and equipment. These excise taxes are collected for highway and road construction and maintenance. Therefore, if the equipment or vehicle is used off-road, typically in a trade or business, the excise taxes are refundable. The federal refund can be claimed on Form 4136, Credit for Federal Tax Paid on Fuels. Expired Provision Alert: The credits expired for alcohol fuel mixtures, biodiesel mixtures, renewable diesel mixtures, alternative fuels and alternative fuel mixtures (except liquefied hydrogen), at the end of 2011. It’s possible Congress will extend them to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information. Note: For 2012, credits are available for liquefied hydrogen.

Selected energy tax incentiveS For BuSineSSeS

There are many incentives (deductions or credits) for both energy production and conservation by businesses and individuals. Here’s a list of recent significant provisions for businesses:•Alternative Motor Vehicle Credit below.•Appliance Manufacturer’s Credit on Page O-10.•Commercial Buildings Deduction on Page O-10.•Energy Efficient Home Builders Credit on Page O-10.•Low-speed and 2- and 3- Wheeled Vehicles on Page O-10.•Plug-in Electric Drive Motor Vehicle Credit on Page O-8.•Vehicle Refueling Property Credit on Page O-8.

Alternative Motor Vehicle CreditForm 8910; see also IRC §30BThe alternative motor vehicle credit is determined under a com-plicated set of rules. For vehicles purchased after 2010, only the following components of the credit are allowed for the following types of vehicles.

Alternative Motor Vehicle CreditType of Vehicle New or Used

Qualified fuel cell NewPlug-in conversion1 New or Used1 Expired at the end of 2011. See Plug-in conversion credit on Page O-8.

The credit is allowed for both personal and business vehicles. If claimed for a business vehicle, the credit becomes part of the taxpayer’s general business credits so any credit not used in the

credit

many types of fuels and uses listed on Form 4136, including the credits previously scheduled to expire for biodiesel mixtures, renewable diesel mixtures, alternative fuels and alternative fuel mixtures. Credits also continue to be available for

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of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.Note: For 2012, the credit for hydrogen-related property has not expired. It applies through 2014.Taxpayers may claim a 30% credit for the cost of installing clean-fuel vehicle refueling property to be used in a trade or business or installed at the taxpayer’s principal residence. The credit generally applies to property placed in service after 2005 and before 2012 (before 2015 for hydrogen-related property).The maximum allowable credit is:•$30,000forbusinessproperty.•$1,000forpropertyinstalledataprincipalresidence.Qualified alternative fuel vehicle refueling (QAFVR) property is any property, not including a building and its structural components, whose original use begins with the taxpayer, that is depreciable (not required for the $1,000 credit) and that:1) Stores or dispenses a clean-burning fuel into the fuel tank of a

vehicle propelled by that fuel, but only if the storage or dispens-ing of the fuel is at the point where the fuel is delivered into the fuel tank of the vehicle or

2) Recharges vehicles propelled by electricity, but only if the prop-erty is located at the point where the vehicles are recharged.

Clean-burning fuels include:•Any fuel at least 85% of which consists of one or a mixture of

ethanol, natural gas, compressed natural gas, liquefied natural gas, liquefied petroleum gas or hydrogen.

•Any fuel that is a mixture of diesel fuel and biodiesel determined without regard to any use of kerosene and containing at least 20% biodiesel.

•Electricity.The tax basis of QAFVR property is reduced by the portion of the property’s cost allowed as a credit. Notice 2007-43 provides interim guidance on the credit pending issuance of regulations.

Plug-In Electric Drive Motor Vehicle Credit Form 8936, IRC §30DTaxpayers can claim a credit for each new qualifying vehicle purchased for use or for lease, but not for resale. The credit amount ranges from $2,500 to $7,500. The portion of the credit attributable to the vehicle’s business-use percentage is treated as part of the taxpayer’s general business credit. The remainder is a nonrefundable personal credit that can offset both regular tax and AMT. (IRC §30D)Qualifying vehicles. These are new four-wheeled plug-in electric vehicles manufactured primarily for use on public streets, roads and highways that meet certain technical requirements. However, the following do not qualify:1) Vehicles manufactured primarily for off-road use (such as golf carts).2) Vehicles weighing 14,000 pounds or more.3) Low-speed vehicles (but see Low-Speed and 2- and 3-Wheeled

Vehicles on Page O-10).Manufacturer’s certification. The IRS will acknowledge a manufacturer’s (or in the case of a foreign vehicle manufacturer, its domestic distributor’s) certifications that a vehicle meets the standards to qualify for the credit. Taxpayers may rely on such a certification. (Notice 2009-89)

The credit begins to phase out for a manufacturer’s vehicles when at least 200,000 qualifying vehicles manufactured by that manufac-turer have been sold for use in the U.S. (determined cumulatively for sales after 2009). As of publication date, no manufacturers had reached that threshold.

current year is available for carryback (but not to years before 2006) and carryover under the rules for general business credits. (See Carryback/carryforward of unused credits on Page O-7.)Qualified fuel cell vehicle credit. A qualified fuel cell vehicle is a motor vehicle that is propelled by power derived from one or more cells that convert chemical energy directly into electricity by combining oxygen with hydrogen fuel that is stored on board the vehicle and may or may not require reformation prior to use. [IRC §30B(b)]The fuel cell credit has two parts: (1) a flat amount based on the vehicle’s weight and (2) an additional amount based on fuel ef-ficiency improvements compared to 2002 models. To be eligible for this credit, fuel cell vehicles must also meet certain federal emission standards.

Qualified Fuel Cell Vehicle Credit—Base Credit AmountsCredit Amount Gross Vehicle Weight Rating (GVWR) in Pounds

$ 8,0001 Vehicle ≤ 8,500

10,000 8,500 < vehicle ≤ 14,00020,000 14,000 < vehicle ≤ 26,00040,000 26,000 < vehicle

1 $4,000 for vehicles placed in service after 2009.

Qualified fuel cell motor vehicles include, for example, vehicles that run on hydrogen power cells. Only new vehicles purchased after 2005 and before 2015 qualify for the credit. The IRS will certify the credit amount for qualifying vehicles. Tax-payers can rely on this certification. (Notice 2006-9)

Certified Fuel Cell Motor VehiclesMake Year Model Credit Amount

Honda 2010–2012 FCX Clarity Fuel Cell $ 8,000

Honda 2008–2009 FCX Clarity Fuel Cell 12,000

Note: Current as of publication date. To check for updates, search www.irs.gov for “Qualified Fuel Cell Vehicles.”

Plug-in conversion credit. A tax credit is allowed for plug-in electric drive conversion kits. The credit equals 10% of the cost of converting a vehicle to a Section 30D qualified plug-in electric drive motor vehicle that is placed in service after February 17, 2009 and before 2012. The maximum amount of the credit is $4,000. Taxpayers may claim this credit even if they claimed a hybrid vehicle credit for the same vehicle in an earlier year.

Expired Provision Alert: The plug-in conversion credit expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information. Reporting. Form 8910, Alternative Motor Vehicle Credit, is used to claim the alternative motor vehicle credits. The business/investment-use percentage of the credit is then transferred to Form 3800, General Business Credit.The personal-use portion of the credit is transferred to the “Other Credits” line of Form 1040 (check box c and write “8910” in the space next to that box). Any part of the personal-use portion of the credit that can’t be used in the current year is lost. It cannot be carried over to other years.

Vehicle Refueling Property CreditForm 8911; see also IRC §30C Expired Provision Alert: The alternative fuel refueling prop-erty (non-hydrogen refueling property) credit expired at the end Continued on Page O-10

2014

has been extended

through 2013

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General Business Tax Credit Summary1

Credit Name IRC § For Rate Tax Forms

Employment CreditsDifferential Wage Payment 45P Small business employers paying differential wage payments to

qualified employees that are active duty uniformed service members. 2012 = 0%.2 2011 = 20% of eligible differential wage payments; $20,000 maximum wage payments per year per employee.

8932

Disabled Access 44 Expenses to make business accessible to or usable by disabled. 50%; $5,000 maximum credit. 8826Employer-Paid FICA on Tips 45B Amount paid on tips above minimum wage. 100% of eligible amounts. 8846Employer-Provided Child Care 45F Employers who provide child care and related services to

employees.25% of qualified child care facility plus 10% of resource and referral costs.

8882

Empowerment Zone Employment 1396 Wages paid to employees working in selected geographic areas. Empowerment zone: 20% of wages up to $15,000. 8844Indian Employment 45A Wages and health insurance costs paid to members of an Indian tribe

or spouse for services performed on a reservation. 2012 = 0%.2 2011 = 20% of increase over amount paid in 1993.

8845

Pension Plan Start-Up Costs 45E Credit for start-up costs of new employer retirement plans. Employer cannot have more than 100 employees

50% of eligible costs up to a maximum credit of $500, for first 3 years of plan.

8881

Small Employer Health Insurance Premiums

45R Qualified small employers that pay at least 50% of a qualified health arrangement for their employees.

Up to 35% (25% for tax-exempt organizations) of the lesser of: (1) the amount contributed or (2) the small business benchmark premium.

8941 990-T

Work Opportunity 51 Effective for work begun by certain qualified veterans before 1/1/13. Rates vary for certain targeted groups. Maximum credit per qualified veteran is $9,600 if employed by a for-profit entity and $6,240 if employed by a qualified tax-exempt organization.

58848850

Other CreditsAgricultural Chemicals Security 45O Retailers, distributors, formulators, aerial applicators and

manufacturers of specified agricultural chemicals.30% of qualified expenditures subject to facility and annual limitations.

8931

Alcohol Fuels 40(e) Sale of straight alcohol or mixture as fuel at retail or use in business. 2012 = 0%.2 2011 = Rate varies depending on mixture. 6478Biodiesel and Renewable Diesel Fuels

40A Use in the production of biodiesel mixture; use of biodiesel in a trade or business or sale at retail; production of qualified agri-biodiesel. For biodiesel mixture and biodiesel components, $1 rate applies if agri-biodiesel or renewable diesel (may include certain aviation fuel) is used.

2012 = 0%.2 2011 = Biodiesel mixture: $1 per gallon used. Biodiesel: $1 per gallon used or sold at retail. Agri-biodiesel: 10¢ for each gallon produced.

8864

Carbon Dioxide Sequestration 45Q The capture of carbon dioxide from an industrial source that would otherwise be released into the atmosphere as greenhouse gas.

2012 = $20.88 per metric ton of qualified carbon dioxide from a qualified facility ($10.44 per metric ton for tertiary injectant in oil/gas recovery).

8933

Cellulosic Biofuel Producer 40(b)(6) Producers of cellulosic biofuel. Generally, $1.01 for each gallon produced. 6478Distilled Spirits 5011 Wholesalers and warehousers of distilled spirits. 2012 = 10.575¢ per case of distilled spirits purchased

or stored.8906

Energy Credits Var. See Selected Energy Tax Incentives for Businesses on Page O-7. Varies Var.Investment Credit:• Rehabilitation Property• Energy Credit

• Qualifying Advanced Coal • Qualifying Gasification • Qualified Advanced Energy • Therapeutic Discovery

4748

48A48B

48C(d)48D

• Pre-1936 nonresidential buildings/certified historic structures.• Equipment that uses solar energy to generate electricity, to heat

or cool or provide hot water for use in a structure, or to provide solar process heat. Also, equipment used to produce or use energy derived from a geothermal deposit.

• Investment in qualifying advanced coal project.• Investment in qualifying gasification project.• Investment in qualifying advanced energy project. • Investment in qualifying therapeutic discovery project.

• 10% for pre-1936 buildings; 20% for historic structures.

• 10%; 30% for qualified fuel cell and certain equipment that uses solar energy property to produce electricity.

• 15% or 20% of qualified investment (QI).• 20% of QI.• 2012 = 0%.2 2011 = Up to 30% of QI.• 2012 = 0%.2 2011 = Up to 50% of QI from pass-throughs.

3468

Low-Income Housing 42 Owners of residential rental buildings providing qualified low-income housing.

70% (or 30%) of qualified building basis over 10 years. 85868609-

ALow-Sulfur Diesel Fuel 45H Production of low-sulfur diesel fuel by a small business refiner. 5¢ for each gallon produced. 8896Mine Rescue Team Training 45N Training program costs for qualified employees. 2012 = 0%.2 2011 = 20% of up to $50,000/employee. 8923New Markets 45D Investment in community development entities. 2012 = 0%.2 2011 = 5% – 6% per year over seven years. 8874Nonconventional Source Fuel 45K Production of fuel from a nonconventional source. $3 per barrel-of-oil equivalent sold, subject to inflation

adjustment and phase out.38907

Nuclear Power Facility 45J Production of electricity at an advanced nuclear power facility. 1.8¢ per kwh of electricity sold. NAOrphan Drug 45C Expenses in testing certain drugs for rare diseases or conditions. 50% of qualified clinical testing costs. 8820Railroad Track Maintenance 45G Costs to maintain certain railroad track, roadbed, bridges, etc. 2012 = 0%.2 2011 = 50%; not over $3,500 × track miles. 8900Renewable Electricity, Refined Coal and Indian Coal Production

45 • Electricity sold that was produced using wind, closed-loop biomass, geothermal, and solar sources or marine and hydrokinetic renewables.

• Steel industry fuel produced at a qualified refined coal facility.• Refined coal or Indian coal produced at qualified facilities.

• 2.2¢ per kwh of electricity sold (wind, etc.) or 1.1¢ per kwh (marine, etc.).

• $6.475 (refined) or $2.267 (Indian) per ton of coal sold.4• $2.96 per barrel-of-oil equivalent produced and sold.4• Refined coal 2012 = 0%.2 2011 = Phaseout rules apply

to electricity and refined coal.

8835

Research Activities 41 Business research and experimental expenditures. 2012 = 0%.2 2011 = 20% of expenses over base amount. 67651 At the time of publication, the 2012 Form 3800 was not yet available. See the final version of Form 3800, the other referenced forms and their instructions for details of

these credits and others that may be required 2012 Form 3800 entries.2 See Expired Tax Provisions on Page Q-1.3 Notice 2012-30 contains the 2011 amounts—$95.73 reference price; $3.51 credit amount for coke or coke gas only. The IRS will publish the 2012 amounts by April 2013 in a Notice.4 Notice 2012-35 contains the 2012 amounts.See Tab 12 in the 1040 Quickfinder® Handbook for information on personal tax credits.

or 30%

,

or 30%

(steel industry fuel)

(including steel industry fuel)

targeted groups before 1/1/14.

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U Caution: Certain low-speed vehi-cles acquired before 2010 could qualify for the Section 30D plug-in electric drive motor vehicle credit (Notice 2009-54). After 2009, such vehicles can only qualify for the credit for low-speed and 2- and 3-wheeled vehicles under Section 30. Note: A vehicle is considered acquired on the date when title to that vehicle passes under state law. (Notice 2009-89)For more information on plug-in electric drive motor vehicles, see Tab 6 of the Depreciation Quickfinder® Handbook.

Low-Speed and 2- and 3-Wheeled VehiclesForm 8834; IRC §30 and §30D(g) Expired Provision Alert: The low-speed and 2- and 3-wheeled vehicle credit expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information. For vehicles bought after February 17, 2009 and before 2012, a nonrefundable credit is available to purchasers of the following plug-in electric vehicles, if they meet certain technical require-ments: (IRC §30)1) Low-speed vehicles [four-wheeled vehicles that can obtain a

speed of 20 (but not more than 25) miles per hour and a gross vehicle weight rating of 3,000 pounds or less].

2) Motorcycles.3) Three-wheeled vehicles.The credit is 10% of the cost (less any Section 179 deduction, if used in business), capped at $2,500. The vehicles must be new (not used). Taxpayers can rely on a manufacturer’s certification that the vehicle qualifies for the credit. (Notice 2009-58)The IRS has certified several manufacturer’s vehicles as qualify-ing for the credit. Go to the IRS website and search for “Plug-In Electric Vehicle Credit” for the most recent list. Reporting. The credit for plug-in electric drive motor vehicles is claimed on Form 8936. The credit for low-speed and 2- and 3-wheeled vehicles is claimed on Form 8834. For both credits, the portion of the credit attributable to business/investment use of the vehicle is part of the general business credit and the remainder is a personal nonrefundable credit that can offset regular tax and AMT.

Energy Efficient Home Builders CreditForm 8908; see also IRC §45L Expired Provision Alert: The energy efficient home builders credit expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.Contractors that build new energy efficient homes in the U.S. may claim a tax credit of $2,000 per dwelling unit for homes sold after 2005 and before 2012. To qualify, the unit must be certified to have annual energy con-sumption for heating and cooling that is at least 50% less than comparable units and meet certain other requirements. The credit can also apply to a substantial re-construction and rehabilitation of an existing dwelling unit because that counts as new construction for this purpose. A manufactured home that meets a 30% reduced energy consumption standard can generate a $1,000 credit. These credits only apply to homes sold by contractors for use as personal residences. The contrac-tor’s tax basis in the home is reduced by the amount of the credit. The credit applies through 2011.The IRS has guidance on the certification process that builders must complete to qualify for the credit. See Notice 2008-35 for standard homes rules. Notice 2008-36 covers manufactured homes.

Commercial Buildings DeductionSection 179D allows businesses to deduct, rather than capitalize and depreciate, all or part of the cost of energy efficient commer-cial building property. The deduction is allowed only for qualifying property placed in service in 2006 through 2013. IRS guidance in Notices 2006-52, 2008-40 and 2012-26 is summarized below.Qualifying property. Energy efficient commercial building property is depreciable property that is:•InstalledonorinabuildinglocatedintheU.S.thatisnotasingle-

family house, a multi-family structure of three stories or fewer above grade, a mobile home or a manufactured house.

•Partofthe(1)interiorlightingsystem,(2)heating,cooling,ven-tilation and hot water systems or (3) the building envelope.

•Certifiedthatitwillreduceorispartofaplantoreducetheoverallenergy costs of these systems by 50% or more.

Deduction limits. There are several deduction limits to consider:•Qualifying property. For any one building, the total deduction for

property meeting the 50% or more energy reduction requirement is limited to $1.80 times the building square footage.

•Partially qualifying property. A summary of energy savings percentages necessary to qualify for a partial deduction under Section 179D is available in Notice 2012-26.

Energy Savings Required to Qualify for Reduced Deduction1

Notice 2006-52 Notice 2008-40 Notice 2012-26Interior Lighting Systems 162/3% 20% 25%

Heating, Cooling, Ventilation and Hot Water Systems

162/3% 20% 15%

Building Envelope 162/3% 10% 10%Property Placed in Service 1/1/06–12/31/08 1/1/06–12/31/13 3/28/12–12/31/131 Property described in the Notices above is eligible for a reduced deduction limited

to 60¢ times the building’s square footage.

Certification. Before claiming the deduction, the property must be certified as meeting the requirements by an unrelated qualified and licensed engineer or contractor. Taxpayers must retain these certifications in their tax records.Software programs. The Department of Energy maintains a public list of software that may be used to calculate energy and power consumption and costs as part of the certification process. The list appears at www1.eere.energy.gov/buildings/qualified_software.html.

Appliance Manufacturers CreditForm 8909; see also IRC §45M Expired Provision Alert: The appliance manufacturers credit expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information.A business tax credit is available for the manufacture of qualifying energy efficient dishwashers, clothes washers and refrigerators in the U.S. The per-appliance credit amount depends on the type of appliance. For 2011, the maximum overall credit for all qualified appliances is the smaller of 4% of the manufacturer’s average annual gross receipts for the three prior tax years or $25 million. The $25 million limit does not apply to certain types of clothes washers and refrig-erators—see the Form 8909 instructions for more information. This credit will benefit consumers to the extent appliance manufacturers pass along their tax savings.

Section 30

had to

met

pre-2012

was

was

For 2012 and 2013, a credit equal to the lesser of 10% of the vehicle’s cost or $2,500 is available for purchasing certain 2- and 3-wheeled plug-in electric vehicles that (1) are manufactured primarily for on-road use, (2) are capable of a speed of at least 45

miles per hour and (3) meet several other requirements of Section 30D. [IRC §30D(g)]

d

could

2013

has been extended through 2013

has been extended, with modifications, through 2013

pre-2012

The

2014

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Accounting for Bookkeeping Accounting for Income TaxCost of

Goods Sold (COGS)

Revenue is recognized at the point of sale. The cost of a product is not deductible until it is sold. GAAP requires the accrual accounting method so that revenues and related expenses are reported in the same accounting period.In determining the cost of goods sold (COGS), an inventory account is maintained to keep track of the tangible personal property on hand that may be classified as raw materials, work in process and finished goods. Long-term assets subject to depreciation and selling expenses are not included in inventory. GAAP requires certain overhead expenses to be included in inventory.Under the periodic system, a physical count of inventory on hand is taken as of a specific date. The net change between the beginning and ending inventories determines the COGS amount. Various COGS expense accounts are used to record daily transactions such as purchases, purchase returns and allowances, purchase discounts and freight-in. At the end of the period, inventory is debited or credited to its actual balance, the expense accounts are debited or credited to eliminate existing balances, and a COGS account is debited to balance the entry.Under the perpetual system, inventory records are maintained and updated continuously as items are purchased and sold. The inventory account is debited when an item is purchased. The COGS account is debited and inventory is credited when the item is sold. At the end of the accounting period, inventory is adjusted to the actual physical count.

The cost of an item that is produced or purchased for sale to customers is deductible. An inventory account must be kept when the production, purchase or sale of merchandise is an income-producing factor. The accrual accounting method must generally be used for inventory transactions, even though the cash method may be used for service-related transactions. (Reg. §1.446-1)Example: An auto repair shop reports the purchase and sale of parts on the accrual basis while using the cash method to report labor charges and general operating expenses. See Inventory Methods on Page L-7.UNICAP. Under Section 263A, an allocable portion of most indirect costs must be included in inventory and expensed under the cost of goods sold rules. See Uniform Capitalization Rules on Page L-8 for more information.Exception [Rev. Procs. 2001-10 and 2008-52 (as modified by Rev. Procs. 2011-14 and 2011-43)]: An exception to the accrual requirement for inventory applies for taxpayers with average annual gross receipts of $1 million or less. Under this exception, the taxpayer can use the cash method of accounting even though the production, purchase or sale of merchandise is an income-producing factor. However, the taxpayer must still account for the purchase of inventory in the same manner as non-incidental materials and supplies. Non-incidental materials and supplies cannot be deducted until they are used. (Temp. Reg. §1.162-3T)Another exception to the accrual requirement applies when gross receipts are $10 million or less. However, this exception generally excludes manufacturers, wholesalers, retailers, miners, certain publishers and certain information industries unless they are principally a service business or perform certain kinds of custom manufacturing. [Rev. Proc. 2002-28 (as modified by Rev. Procs. 2011-14 and 2011-43)]See Accounting Methods on Page L-1, for more details.

Demolition Expenses or

Losses

Although there is no direct guidance in the current FASB Codification, a practical method of accounting for demolition is to add costs less salvage value to the basis of the land. Costs added would include the adjusted basis of any demolished structure and the cost of demolition. This treatment is supported by a former AICPA Statement of Position, Accounting for Certain Costs Related to Property, Plant, and Equipment, which was discontinued in 2004. GAAP for the types of assets that might be susceptible to demolition is now provided in FASB ASC 360, Property, Plant, and Equipment.

Costs incurred to demolish a structure must be added to the basis of the land where the demolished structure was located. [IRC §280B(2)]

Depletion Cost depletion is the basic method of computing a depletion deduction. An estimate is made of the amount of natural resources to be extracted in units, tons, barrels or any other measurement. The estimate of total recoverable units is divided into the total cost of the depletable asset to arrive at a depletion rate per unit. The annual depletion expense is the rate per unit times the number of units extracted during the year.If there is a revision of the estimated number of units that are expected to be extracted, a new unit rate is computed. The cost of the natural resource property is reduced each year by the amount of the depletion expense for the year.

A depletion deduction is allowed only if a taxpayer has an economic interest (generally an owner or operator) in mineral property, an oil, gas or geothermal well, or standing timber. See Depletion on Page J-9 for more information.

With respect to each property, the excess of the depletion deduction for regular tax purposes over the adjusted basis in the property (determined without regard to the depletion deduction for the tax year) is added back into income for AMT purposes. Exception: Depletion taken by independent oil and gas producers and royalty owners. [IRC §57(a)(1)]

Depreciation The cost of an asset minus its salvage value (if any) is depreciated over the estimated useful life of the asset. The useful life is the period for which services are expected to be rendered by the asset, and it can vary from company to company. GAAP allows several depreciation methods including straight-line (SL), units-of-production, sum-of-the-years’-digits and DB.All normal expenditures to put an asset in service for use by the business are added to the basis of the asset. Expenditures that do not improve the asset or prolong the asset’s useful life should be deducted as a current expense.Example: A repair to a piece of equipment damaged during shipment should be expensed rather than added to basis.

Assets are depreciated using SL depreciation over the alternative depreciation system (ADS) life listed in Tab J. If the Section 179 deduction was used for tax purposes, the life is five years for E&P purposes. [IRC §312(k)(3)]

Assets are depreciated under the modified accelerated cost recovery system (MACRS). Three-year, five-year, seven-year and 10-year properties are depreciated using the 200% DB method. Fifteen-year and 20-year properties are depreciated using the 150% DB method. Real property is depreciated using the SL method. Elections are available to use less accelerated methods of depreciation.In 2012, up to $125,000 ($139,000 inflation-adjusted) of the cost of tangible property may be expensed under Section 179.See Tab J for more information on tax depreciation, including the special (bonus) depreciation allowance for qualified new property acquired in 2012.

If the 200% DB method was used for tax purposes, the 150% DB method must be used for AMT purposes. The MACRS recovery periods are used for both regular tax and AMT purposes [IRC §56(a)(1)]. No AMT adjustment is made on property expensed under Section 179. Also, no AMT adjustment results from bonus depreciation.

Table continued on the next page

500,000

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Accounting for Bookkeeping Accounting for Income TaxDividend

Distributions Cash dividends:

• To record a dividend declaration: Debit: Retained Earnings Credit: Dividends Payable• To record the payment to stockholders: Debit: Dividends Payable Credit: CashStock dividends:• To record a dividend declaration: Debit: Retained Earnings Credit: Stock Dividend to be Distributed• To record the stock distribution to stockholders: Debit: Stock Dividend to be Distributed Credit: Common Stock Credit: Additional Paid-in Capital

Distributions to shareholders from C corporations first reduce current E&P and then reduce any accumulated E&P.The amount by which E&P is reduced depends on what is distributed to the shareholder(s):• Cash distributions decrease E&P by the amount distributed, but not

below zero.• Property distributions decrease E&P by the adjusted basis of that

property, but not below zero.• Appreciated property distributions increase E&P by the excess of the

FMV over the adjusted basis of the property, and then reduce E&P by the FMV of the property distributed, but not below zero.

See Tab C for more information on distributions from E&P.

Distributions to shareholders have no effect on taxable income of the corporation, except when a corporation distributes appreciated property (other than its own securities or stock). Taxable gain equals the FMV of the distributed property minus the adjusted basis of the property. [IRC §311(b)]The FMV of the property is the greater of: (1) the actual FMV or (2) the amount of any liabilities the shareholder assumed in connection with the distribution of the property. If the property was depreciable, any depreciation recapture will be subject to treatment as ordinary income. A corporation can accumulate its earnings for a possible expansion or other bona fide business reasons. If a corporation accumulates its earnings beyond the reasonable needs of the business, it may be subject to an accumulated earnings tax at a 15% rate in 2012, but scheduled to increase to the highest individual tax rate for tax years beginning after 12/31/12 (IRC §531). See Accumulated Earnings Tax on Page C-12 for more details.

Dividends- Received Deduction

Not a deduction for GAAP reporting purposes.

Deduction is not allowed for E&P purposes.

C corporations may deduct 70% of the dividends received from a less-than-20%-owned distributing corporation, or 80% of the dividends received from a 20%-or-more-owned distributing corporation. Certain limitations and exceptions apply. See Dividends-Received Deduction on Page C-13.

Impairment Losses

An asset is impaired when the FMV of the asset is lower than the amount at which the asset is carried on the balance sheet (cost of the asset minus accumulated depreciation). This occurs when the value of an asset unexpectedly declines a significant amount. If the carrying amount of the asset is greater than the sum of expected undiscounted cash flow from the asset’s use and disposition, the value should be written down for book purposes. The resulting impairment loss is expensed.

Rules governing accounting for impaired assets do not affect tax treatment of the item. Cost recovery for tax purposes is determined by the basis of the item. Any increase or decrease in value of the asset is not recognized for tax purposes until the asset is sold or exchanged.

Installment Sales

The installment sales method of accounting is generally not allowed except under unusual circumstances where receivables are collectible over an extended period of time and collectibility cannot be reasonably estimated.

Deferral of gain is not allowed for E&P purposes. [IRC §312(n)(5)]

Capital gain on the sale of property is reported under the installment method of accounting if any principal payment is received after the tax year in which the sale occurred. The taxpayer may make an election to report the entire gain in the year of sale. (IRC §453)

Corporations must add back deferred installment gains in computing the year of sale adjusted current earnings (ACE) adjustment [IRC §56(g)(4)(D)]. This add back is not required if interest is charged on the deferred installment gains under Section 453A. A C corporation (1) in its first tax year of existence or (2) with three-year average gross receipts of $5 million or less for its first tax year beginning after 1996 and $7.5 million or less each year thereafter, is not subject to AMT. [IRC §55(e)]

(20%)

2012 Tax Year | Small Business Quickfinder® Handbook O-21Replacement Page 01/2013

Accounting for Bookkeeping Accounting for Income TaxResearch

and Development

Costs

Research and development (R&D) costs should generally be expensed in the period incurred (FASB ASC 730-10-25, Research and Development—Recognition). Some costs related to R&D activities are capitalized if they have alternative future uses.Costs incurred in establishing the technological feasibility of a computer software product that is sold, leased or otherwise marketed are expensed in the period incurred (FASB ASC 985-20, Costs of Software to Be Sold, Leased, or Marketed). However, the cost of purchased software having an alternative future use should be capitalized and accounted for according to its use. Once the technological feasibility of a software program is established, costs for coding and testing are capitalized and (1) amortized over the product’s economic life and (2) reported at the lower of unamortized cost or net realizable value.The capitalization of costs ends when the product is available to be sold, leased or marketed.

Reasonable research and experimental costs may qualify for one of the following methods of recovery: (1) deduction as a current expense [IRC §174(a)(1)], (2) amortization over 60 months [IRC §174(b)(1)] or (3) amortization over a 10-year period. [IRC §174(f)(2) and §59(e)]Research and experimental costs include expenses incurred to provide information that would eliminate uncertainty about development or improvement of a product. The term product for this purpose includes a formula, invention, patent, pilot model, process, technique or similar property. For example, costs of obtaining and perfecting a patent application are research and experimental costs, but costs to obtain another’s patent are not. Research and experimental costs do not include costs for market research, management surveys or normal product testing. (Reg. §1.174-2)Credit for increasing research activities (Form 6765):Costs of qualified research undertaken for discovering information that is technological in nature qualify for a credit under Section 41. The application must be intended for use in developing a new or improved business component of the taxpayer. The expenses must qualify under Section 174, and substantially all of the activities of the research must be elements of a process of experimentation relating to a new or improved function, performance, reliability or quality. [IRC §41(d)]Expired Provision Alert: The research credit expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page Q-1 for more information. Note: See Reg. §1.41-9 relating to the election and calculation of the alternative simplified credit under Section 41(c)(5).

Salariesand

Wages

Wages are generally deductible as incurred, unless they are required to be capitalized or added to inventory based on the services performed. An adjusting entry is usually made at the end of the accounting period to accrue wages for services performed by employees who have not yet been paid.Example: The last pay day during a calendar year falls on Friday, December 31, and covers work performed through Wednesday, December 29. An adjusting entry is made to accrue wages that will be paid next year for work performed on December 30 and 31.

Wages, salaries, commissions, etc., are deductible if they meet the tests below. Wages are capitalized when they are incurred to produce capital assets. Wages are included in inventory and deducted as part of COGS when they are incurred to produce merchandise sold to customers.Deductibility tests:• The wages must be an ordinary and necessary expense directly connected

with carrying on a trade or business. Wages paid in connection with the start up or organizing of a business are deductible as a current business expense up to $5,000. The $5,000 deduction is reduced for expenditures exceeding $50,000. Any remaining costs are amortized over 180 months.

• The wage must be paid for services actually performed by the employee, and it must actually be paid or incurred during the tax year. For example, token wages paid to family members who do not work for the business are not deductible. Likewise, a sole proprietor cannot treat joint personal expenses paid as wages to a spouse who performs services for the business.

• Reasonable compensation for shareholders. C corporations have incentive to pay high wages to shareholders because wages are deductible by the corporation, and therefore double taxation on the amount is avoided. However, S corporations have incentive to pay low wages to shareholders, and pass through remaining income to avoid FICA tax. The IRS frequently challenges whether wages paid to shareholders are reasonable, and the issue often results in litigation. See Wages for Shareholders on Page C-8 and Reasonable Wages on Page D-8.

Public companies. Wages paid to certain employees of publicly held corporations are not deductible if they exceed $1 million per employee [IRC §162(m)]. This rule applies to any employee of the taxpayer if, at the close of the tax year, (1) the employee is the principal executive officer or acts in such capacity or (2) total compensation of that employee for the tax year is required to be reported to shareholders under SEC rules because the employee is among the three highest compensated officers for that year other than the principal executive or financial officer. Compensation of the principal financial officer for whom SEC reporting is also required is not subject to the Section 162(m) limitation. (Notice 2007-49)For purposes of the $1 million limit, compensation does not include qualified retirement plan contributions, tax-free fringe benefits, performance-based compensation meeting certain requirements or compensation paid on a commission basis. Compensation paid to an executive is not considered qualified performance-based compensation if the agreement/contract provides for payment of that compensation to employees for meeting performance goals if they are terminated without cause or for good reason or voluntarily retire (Rev. Rul. 2008-13). Compensation paid to an executive under an incentive plan on the attainment of performance goals under any performance share/unit awards is not considered Section 162(m)(4)(C) performance based compensation. (Ltr. Rul. 200804004)Executives of companies participating in the troubled assets relief program. The deduction for compensation paid to certain top executives of publicly traded companies selling more than $300 million of troubled assets to the federal government in the bailout program is capped at $500,000 (instead of $1 million) for each such employee per year [IRC §162(m)(5)]. See IRS Notice 2008-94 for more information.

Table continued on the next page

has been extended through 2013.

P-10 2012 Tax Year | Small Business Quickfinder® Handbook Replacement Page 01/2013

When the payments are reclassified as constructive dividends, Nora must pay $3,300 tax on the distributions from the corporation ($22,000 × 15%, the 2012 tax rate on dividends). The corporation also loses the interest deduction, costing the corporation $680. Nora’s basis in stock is increased by $20,000. Caution: Closely held corporations are particularly susceptible to having distributions reclassified as constructive dividends. Transactions with their shareholders must be carefully structured in an arm’s-length manner to avoid unwanted tax consequences.N Observation: Qualified dividends are taxed through 2012 at a 15% or lower rate, whereas interest is taxed at the regular rates. This, along with possible upcoming rate changes, might influence the tax planning involved in raising capital.

Shareholder loan to S corporation

Problem: Securing a loan for an S corporation often requires a shareholder guarantee. If the loan is not properly structured, the shareholder’s ability to deduct losses may be limited.Applicable Rules: The amount of losses an S corporation share-holder can take is limited to the adjusted basis of the shareholder’s stock, plus any direct loans the shareholder makes to the corpo-ration [IRC §1367(b)(2)]. If a shareholder merely guarantees a loan from a lender to the S corporation, there is no effect on the shareholder’s ability to deduct losses.Solution: If a loan is needed to provide capital for an S corporation, the shareholder should take out a personal loan for the amount needed and make a direct shareholder-to-corporation loan (a back-to-back loan). With a back-to-back loan, the shareholder’s allowable deduction for losses increases.

Example: Buzz is sole shareholder in an S corporation. His beginning basis in stock is $10,000. Buzz needs to provide an additional $20,000 in funds to keep the S corporation operating. By year-end, it has a loss of $28,000.Direct Loan From Shareholder. Buzz takes out a personal loan from his bank in the amount of $20,000. He then makes a direct loan of $20,000 to the S corporation. Buzz’s limit for deduction of S corporation losses is now $30,000 ($10,000 initial contribution + $20,000 direct loan). Buzz can deduct the S corporation loss of $28,000 on his individual tax return because the loss does not exceed his basis plus the amounts loaned directly to the S corporation.Loan Guarantee. Assume the facts shown above with this exception: Instead of making a personal loan directly to the corporation, Buzz has the bank loan funds directly to the S corporation. In order to approve the loan, the bank requires Buzz’s signature as guarantor. Although he is liable for repayment of the loan, Buzz’s basis for deducting losses remains at $10,000 because he did not loan the funds directly to the corporation. Buzz’s deduction for the S corporation loss is limited to $10,000. The remaining $18,000 loss is suspended until his basis increases. Note: The same result would occur if Buzz had loaned the S corporation $20,000 from a second S corporation solely owned by Buzz. To avoid this situation, Buzz should distribute the $20,000 from the second S corporation and then loan the $20,000 directly to the S corporation requiring the funds. Caution: An S corporation can have only one class of stock (IRC §1361). For S corporations with more than one shareholder, a loan must be structured so that a second class of stock is not created. If debt is convertible to equity, or if loan terms are contingent on profits or dependent on the borrower’s discretion, the loan may be considered a purchase of a second class of stock, which will disqualify a corporation’s S status.

S corporation Built-in gainS taxProblem: In a cash basis corporation, basis in accounts receivable is zero. If the corporation elects S status, any accounts receivable will be subject to built-in gains tax when collected. The revenue from the accounts receivable will be subject to double taxation (as in a C corporation). Note: The following principles also apply to built-in gains from assets other than accounts receivable.

Applicable Rules:1) When an S corporation holds assets with built-in gains, income

from the sale of those assets is subject to built-in gains tax at a rate of 35% (IRC §1374). Net built-in gain cannot be greater than taxable income computed as if the corporation was a C corporation.

2) An S corporation can retain E&P from C corporation years. Shareholders are not taxed on E&P until it is distributed. S corporation earnings are distributed before E&P. Therefore, as long as S corporation distributions do not exceed earnings, there will be no distributions or tax from the E&P account.

3) Built-in gains tax applies to assets sold within 10 years from the date of the S corporation election. [IRC §1374(d)(7)]

Note: Special rules exist for built-in gains occurring in tax years beginning in 2009 through 2011. See Temporary suspension on Page D-7 for more information. The examples below illustrate the general rule and are not year specific.See also Built-In Gains (BIG) Tax (IRC §1374) on Page D-7.Solution 1: Sell assets with built-in gains before converting to an S corporation. This increases the C corporation E&P that will be carried to the S corporation but not taxed until distributed. This avoids transfer of built-in gains property to the S corporation.

Example #1: Rightbrain, Inc., has $30,000 accounts receivable outstanding when it elects S status. It will collect the receivables in its first S tax year. The built-in gains will be taxed at the rate of 35% and the tax is not reduced by income limits. All shareholders have an individual marginal rate of 28%.The $30,000 is first reduced by $10,500 (35% built-in gains tax). The remaining $19,500 passes through as S corporation income to shareholders, subject to tax of $5,460 (28%). Therefore, after-tax income on the $30,000 is $14,040.

Solution 2: Pay an accrued bonus before converting to S corpo-ration status. This will reduce built-in gains of C corporation assets.Applicable Rules:1) For computing built-in gains, income and deductions are ac-

counted for under the accrual method regardless of which ac-counting method is used for tax and books. [Reg. §1.1374-4(b)]

2) For 5%-or-greater shareholders, the accrued bonus must be paid within the first 2½ months of the first S corporation year. All events must have occurred that establish the fact of the liability and its exact amount must be determinable [Reg. §1.1374-4(c)]. In addition, the bonus can only be deducted if it is reasonable in view of the services rendered by the shareholder-employee. [IRC §162(a)]

Example #2: Randy is a 40% shareholder in Rightbrain, Inc. The C corpora-tion accrues a bonus to Randy in the amount of $30,000 before converting to S corporation status. For built-in gains purposes, the bonus is allowed as a deduction against built-in gain assets and reduces net built-in gains from the corporation to zero as long as the bonus is paid within 2½ months of the start of the S corporation tax year. Note: Randy is a cash basis taxpayer. The deduction for the accrued bonus only applies for built-in gains tax. An accrued bonus paid to a cash basis taxpayer is not allowed as a deduction on the corporation’s tax return until the amount is reported as income to the recipient.If the corporation does not have enough cash to pay the bonus, the cost of securing a loan may be worthwhile compared to the built-in gains tax.

S corporation election to cloSe BookS on termination oF

Shareholder’S intereStProblem: When an S corporation shareholder’s interest is terminat-ed during the year, the shareholder’s allocation of income, losses and deductions is generally computed by applying a percentage to the full-year activity of the corporation. [See Item 1) on page P-11.] This can produce inequity, because the departing shareholder is

2013

Q-2 2012 Tax Year | Small Business Quickfinder® Handbook Replacement Page 01/2013

BuSineSS tax FormS

Form 1099-KFor 2011 and later, payment settlement entities are required to report all payments made in settlement of payment card (for example, credit and debit card) transactions on Form 1099-K. Payment settlement entities are generally banks or other organizations contrac-tually obligated to make payments in settlement of payment card transactions. It’s likely that businesses that accept debit or credit cards will receive a 2012 Form 1099-K. For 2011, it appeared that the IRS intended to require taxpayers to separately report Form 1099-K payments on their tax returns. In an FAQ posted to its website, the IRS states that there will be no reconciliation required on the 2012 Form 1099-K amounts, nor does it intend to require reconciliation in future years.

æ Practice Tip: The amount reported on Form 1099-K is the gross dollar amount of total reportable payment transactions with no adjustment for credits, discounts, fees or refunded amounts. Thus, the amount reported on Form 1099-K is often not the amount that should be reported as income. However, even without a reconciliation requirement, a business would be well advised to contact the Form 1099-K provider concerning reported amounts that significantly exceed those reflected in the business’s books and records. Moreover, when gross receipts reported by a taxpayer

are significantly less than gross payments shown on Forms 1099-K, return preparers should consider, as part of their due diligence, asking the taxpayer for an explanation.

inFlation-adjuSted amountS

For a summary of inflation-adjusted amounts for 2012 (plus 2013, 2011 and prior years), see the Business Quick Facts Data Sheet on Page A-1.

SelF-employed health inSurance deduction For medicare premiumS

The IRS has clarified that premiums paid for all parts of Medicare count as insurance for the health insurance deduction for self-employed individuals. In the past, it was unclear whether premiums paid for parts other than Part B could be counted. Furthermore, the IRS said that Medicare premiums paid for the taxpayer, his spouse, dependents and other children under age 27 at the end of the year also count as self-employed health insurance. Amended returns can be filed if Medicare premiums were not deducted in an earlier year (assuming the statute of limitations is still open and that all the other rules for deducting health insurance for a self-employed person are met). See Self-Employed Health Insurance Deduction on Pages B-6, D-15 and K-10.

Notes Additional IRS guidance. The IRS is apparently starting to use the information reported on Form 1099-K. In a late-2012 posting to its website, the IRS

discusses the new notices related to Form 1099-K that it

is sending to taxpayers. Search for “New Notices Related to

Form 1099-K” at www.irs.gov for tips on how to respond to these notices and information on how

the IRS is going to use Form 1099-K data.

2012 Tax Year | Small Business Quickfinder® Handbook Q-3Replacement Page 01/2013

What’s New for 2012This table summarizes selected tax law changes affecting businesses first effective in 2012 or enacted since last year’s Handbook was published. See the Business Quick Facts Data Sheet on Page A-1 for the inflation-adjusted amounts for various 2012 tax items.

Item Effective Date QF Page

New Law Prior Law

Business Property—Depreciation and Section 179 ExpensingSection 179—Election Can Be Revoked

Tax years beginning

before 2013

J-3 Generally, a Section 179 election can only be revoked with IRS consent. However, the ability to irrevocably revoke a Section 179 election without IRS consent for any property is extended for one year, to tax years beginning after 2002 and before 2013. [IRC §179(c)(2)]

The one-time ability to revoke a Section 179 election applied to years beginning after 2002 and before 2012.

Section 179—Expensing for Off-the-Shelf Software Extended

Software placed in service in a year beginning

before 2013

— 5-5,1

11-41

Off-the-shelf computer software qualifies for Section 179 expensing for an additional year. Off-the-shelf software is eligible for the Section 179 election if it is placed in service in a year beginning after 2002 and before 2013. [IRC §179(d)(1)(A)(ii)]

Off-the-shelf computer software was Section 179 property if placed in service in a year beginning after 2002 and before 2012.

Section 179—Expensing Limit

Property placed in service in

2012

J-3 The Section 179 deduction and qualifying property limits are $139,000 and $560,000. In addition, off-the-shelf computer software continues to qualify for Section 179 expensing and taxpayers can amend or irrevocably revoke a Section 179 election. [IRC §179(b), (c) and (d)]

The limits would have fallen to $25,000 and $200,000 for property placed in service in a tax year beginning after 2011. Also, off-the-shelf software would not qualify for Section 179 expensing and the election could only be amended or revoked with IRS consent.

Special (Bonus) Depreciation—Allowance

Property acquired and

placed in service before

2013

J-6 For 2012, the special depreciation allowance is 50%. For long-production-period property and certain aircraft, the placed-in-service dates are extended one year.

50% special depreciation was due to expire for property placed in service after 2010.

Special (Bonus) Depreciation—Corporate Election to Accelerate Certain Credits in Lieu of Claiming

Property placed in service in

2012

2-111 The election to forego the special depreciation allowance and instead increase the limit on certain credits is available for assets placed in service in 2012 (2013 for long-production-period property and certain aircraft) [IRC §168(k)(4)(D)]. The election (available only to corporations) can be made for Round Two property, which is property eligible for the special depreciation allowance solely because it meets the requirements under the extension of the special depreciation allowance deduction for certain property placed in service after 2010. However, corporations that have already made this election for an earlier year can elect to not apply the election to Round Two property. Also, for Round Two property, the limit on unused research credits cannot be increased by making this election.

Expired for property placed in service after 2009 (2010 for long-production-period property and certain aircraft).

1 Reference is to the 2012 Depreciation Quickfinder® Handbook.

500,000

2,000,000

or Round Three

or Round Three

and 2013

and 2013

and 2013

(Round Two) or 2012 (Round Three)

2014

2014

2014

2014

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Table continued on the next page

Tax Provisions That Expired December 31, 2011Not Available in 2012 (Unless Extended by Legislation)

Note: This table summarizes significant tax provisions that affect businesses and expired on December 31, 2011. It’s possible that Congress will extend some or all of them to 2012, but had not done so at the date of this publication. Quickfinder will post an update at www.quickfinder.com if any of these provisions are extended to 2012.

Description IRC § QF Page

Provision in Effect for 2012 Provision in Effect for 2011 2011 Law Extended to 2012?1

Business Property—Depreciation and Section 179 ExpensingQualified Real Property Assigned a 15-Year Recovery Period

168(e)(3) J-3,10-132

No special provisions for qualified leasehold improvements, qualified restaurant property and qualified retail improvement property placed in service in 2012. These are nonresidential real property with a 39-year (40 for ADS) recovery period.

Qualified leasehold improvements, qualified restaurant property and qualified retail improvements placed in service in 2011 were assigned a 15-year recovery period (39 years for ADS).

Yes

Qualified Real Property Eligible for Section 179

179(f) J-3,10-102

Qualified leasehold improvements, qualified restaurant property and qualified retail improvements placed in service in a tax year beginning in 2012 are not eligible for Section 179 expensing.

Qualified leasehold improvements, qualified restaurant property and qualified retail improvements placed in service in a tax year beginning in 2011 were eligible for Section 179 expensing.

Yes

Section 179—Expensing Limit

179(b) J-3,10-102

Expensing limit and qualifying property threshold are $139,000 and $560,000, respectively, for tax years beginning in 2012.

Expensing limit and qualifying property threshold were $500,000 and $2,000,000, respectively, for tax years beginning in 2011.

Yes

Special Depreciation Allowance

168(k)(5) J-6,10-82

For qualified property placed in service in 2012, the special depreciation rate is 50% (100% for certain long-production property and noncommercial aircraft).

The special depreciation allowance equaled 100% of the adjusted basis of qualified property placed in service in 2011.

No

Charitable ContributionsBook Inventory by Corporations

170(e)(3) C-14 None. Deduction not available after 2011.

C corporations could take an above-basis deduction for charitable donations of book inventories to public schools.

No

Computer Inventory by Corporations

170(e)(6) C-14 None. Deduction not available after 2011.

C corporations could take an above-basis deduction for charitable donations of computer technology and equipment for educational purposes.

No

Food Inventory 170(e)(3) C-14 Special provision for contributions of food inventory not available after 2011 for taxpayers other than C corporations. Deduction amount for contributed inventory is generally equal to taxpayer’s basis.

Taxpayers in a trade or business could take an above-basis deduction for donations of apparently wholesome food inventory.

Yes

Qualified Conservation Contributions

170(b) N-15, 5-132

Qualified conservation contributions are subject to the 30%-of-AGI limit and are carried forward for five years.

Qualified conservation contributions were subject to the 50%-of-AGI limit (100% for farmers and ranchers) and can be carried forward for 15 years.

Yes

S Corporations—Basis Reduction for Property Donations

1367(a) — S corporation shareholders reduce their stock basis by the pro rata share of any charitable deduction claimed for a donation of S corporation property.

S corporation shareholders reduced their stock basis by the pro rata share of the corporation’s adjusted basis in any property donated by the corporation to charity.

Yes

1 Use this column to indicate whether a provision is extended to 2012 or not. 2 Reference is to the 2012 1040 Quickfinder® Handbook.

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Table continued on the next page

Tax Provisions That Expired December 31, 2011 (Continued)Not Available in 2012 (Unless Extended by Legislation)

Note: This table summarizes significant tax provisions that affect businesses and expired on December 31, 2011. It’s possible that Congress will extend some or all of them to 2012, but had not done so at the date of this publication. Quickfinder will post an update at www.quickfinder.com if any of these provisions are extended to 2012.

Description IRC § QF Page

Provision in Effect for 2012 Provision in Effect for 2011 2011 Law Extended to 2012?1

Credits—Employment TaxEmpowerment Zone Employment

1396 O-9 None. Credit not available after 2011.

A credit was available for certain wages paid to employees in selected geographic areas.

Yes

Indian Employment

45A O-9 None. Credit not available after 2011.

A credit was available to employers who made qualifying payments to certain Indian tribe members.

Yes

Military Wage Differential

45P O-9 None. Credit not available after 2011.

A credit was available for certain payments to activated military reservists.

Yes

Work Opportunity 51(c) O-9 For employees hired in 2012, the credit is only available for wages paid to qualified veterans.

A credit was available for wages paid to employees in several targeted groups.

Yes3

Credits—Energy TaxAlternative Fuel Vehicle Refueling Property

30C(g)(2) O-8 Credit not available (other than for hydrogen refueling property) after 2011.

A credit was available for certain alternative fuel vehicle refueling property.

Yes

Appliance Manufacturers

45M O-10 None. Credit not available after 2011.

A credit was available for the manufacture of qualifying energy efficient dishwashers, clothes washers and refrigerators.

Yes3

Energy Efficient Homes

45L O-10 None. Credit not available after 2011.

Builders of energy-efficient homes were allowed a $2,000 credit per qualifying home.

Yes

Plug-In Electric Vehicles— Low-Speed and 2- and 3-Wheeled Vehicles

30(f) O-10 None. Credit not available after 2011. Note: The Section 30D credit for plug-in electric drive motor vehicles is still available.

A credit was available for purchasing certain low-speed and 2- or 3-wheeled plug-in electric vehicles.

Yes3

Plug-In Vehicle Conversion

30B O-8 None. Credit not available after 2011.

A credit was available for converting a vehicle to a plug-in electric drive motor vehicle.

No

Credits—Other TaxAlcohol Fuels 40(e) O-9 None. Credit not available after

2011. A credit was available for sale of straight alcohol or certain mixtures as fuel or use in business.

No

Biodiesel and Renewable Diesel Fuels

40A O-9 None. Credit not available after 2011.

Credits were available for biodiesel fuel and for biodiesel or renewable diesel used to produce a qualified mixture.

Yes

Mine Rescue Team Training

45N O-9 None. Credit not available after 2011.

A credit was available for training program costs for qualified employees.

Yes

New Markets 45D O-9 None. Credit not available after 2011.

A credit was available for investment in community development entities.

Yes

Railroad Track Maintenance

45G O-9 None. Credit not available after 2011.

A credit was available for costs incurred to maintain certain railroad track, roadbed, bridges, etc.

Yes

1 Use this column to indicate whether a provision is extended to 2012 or not. 2 Reference is to the 2012 1040 Quickfinder® Handbook.

3 With modifications.

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Tax Provisions That Expired December 31, 2011 (Continued)Not Available in 2012 (Unless Extended by Legislation)

Note: This table summarizes significant tax provisions that affect businesses and expired on December 31, 2011. It’s possible that Congress will extend some or all of them to 2012, but that had not done so at the date of this publication. Quickfinder will post an update at www.quickfinder.com if any of these provisions are extended to 2012. Credits—Other Tax (Continued)

Description IRC § QF Page

Provision in Effect for 2012 Provision in Effect for 2011 2011 Law Extended to 2012?1

Refined Coal 45(d)(8) O-9 None. Credit not available after 2011.

A credit was available for refined coal production (other than used to produce steel industry fuel).

Yes

Research and Development

41 O-9 None. Credit not available after 2011.

A credit was available for increasing research activities.

Yes

Other Business ProvisionsDomestic Producers Deduction—Puerto Rican Activities

199(d)(8) O-5, 6-222

None. Provision not available after 2011.

Income attributable to production activities in Puerto Rico was treated as domestic production income.

Yes

Environmental Remediation Costs

198 O-2 None. Provision not available after 2011.

Taxpayers could elect to expense qualified environmental remediation costs, which otherwise would be capitalized.

No

Fringe Benefit—Employer Provided Mass Transit

132(f) K-7,4-32

The exclusion for employer-provided mass transit benefits (transportation in a commuter highway vehicle and any transit pass) is $125 per month.

The exclusion for employer-provided mass transit benefits was $240 per month.

Yes

FUTA Tax—Surtax Imposed

3301(1) I-1 None. Provision expired on 6/30/11. 0.2% surtax was added to the FUTA tax.

No

Percentage Depletion—Suspension of Net Income Limit

613A(c) J-10, 12-242

The 100% of net income limit applies to percentage depletion for oil and gas from marginal wells for tax years beginning in 2012.

The 100% of net income limit on percentage depletion for oil and gas from marginal wells was suspended for tax years beginning in 2011.

No

Qualified Small Business Stock (QSBS)—Increased Exclusion

1202(a)(4) C-7 QSBS acquired in 2012 qualifies for 50% (60% if an empowerment zone business) gain exclusion (if five-year holding period met). A percentage of the excluded sale is an alternative minimum tax (AMT) preference item.

QSBS acquired between 9/28/10 and 12/31/11 qualifies for 100% gain exclusion (if five-year holding period met). Also, the excluded sale is not an AMT preference item.

Yes

S Corporations—Reduced Recognition Period for Built-In Gains Tax

1374(d) D-7 The built-in gains tax applies during the first 10 years following a conversion from a C corporation to an S corporation. A C corporation that elects to be taxed as an S corporation is taxed at the highest corporate rate on all gains that were built-in at the time of the election if the gains are recognized during the recognition period.

The recognition period was reduced from the corporation’s first 10 years as an S corporation to its first five years.

Yes

1 Use this column to indicate whether a provision is extended to 2012 or not. 2 Reference is to the 2012 1040 Quickfinder® Handbook.

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