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Federal and California State Tax Code Changes for 2011

Tell you what, it sure is hard to keep up with the constantly-changing income tax laws and tax year 2011 is no exception to that rule. Tell you what else though, here at Pronto Income Tax of California, Inc., we try to do our best. In fact, we study the new tax laws months in advance just to be prepared to do your taxes during tax season.

But of course it is important not only for your tax preparer to know the tax law changes for 2011, it is also important for you, as a taxpayer, to know what is going on with tax changes for 2011. After all, it is your money that is at stake!

With that in mind, we want to share with you our Pronto Income Tax list of the most important tax changes for tax year 2011. You will notice that many of the changes revolve around one common theme: the IRS is tightening up the tax collection system.

But there is some good news for 2011 tax changes, too, so just keep reading this article to discover the most critical income tax changes for tax year 2011.

Federal Income Tax Changes for 2011 Tax Year

Payroll Tax Cut Extended for Two Months

There is no more $400 Single / $800 Married “Making Work Pay Credit” for 2011. For this reason, many tax refunds will be smaller for tax year 2011 than they were for tax year 2010.

However, the payroll tax was reduced for 2011, but instead of giving a credit at the end of the year, less tax was taken out during the year.

This payroll tax cut was in place for 2011, and decreased the "employee side" of the Social Security Tax from 6.2 percent of wages to 4.2 percent of wages. Self-employed people also enjoy a cut in the Self-Employment Tax from 15.3 to 13.3 percent of net business income for tax year 2011.

It's all part of the "put money in people's paychecks" strategy and this strategy will continue…at least for another two months. Congress extended the payroll tax cut until the end of February 2012.

Stay tuned! It's estimated that 160 million Americans benefit from this tax cut. If it is not extended at the end of February, paychecks will get smaller by 2 percent.

How Fast Can You Get Your Tax Refund?

The bad news for taxpayers who want their tax refunds as fast as possible is that the 24-48 hour Refund Anticipation Loan (RAL) product appears to be almost completely dead.

H&R Block is not doing 24-48 hour RALs this tax season, neither is Pronto Income Tax, and even tax prep companies who are doing RALs can expect extremely low loan approval rates due to the IRS removing the "debt indicator" used by RAL banks to determine whether or not taxpayer will receive the refund and thus pay back the loan. Without the ability to know whether or not the taxpayer’s refund could be held by IRS due to issues such as back taxes or unpaid child support, banks have not been extending loans anymore based on the tax refunds.

Moreover, there have been several successful multi-million dollar class action lawsuits against RAL lenders and tax preparation companies due to the high interest rates and questionable ethics involved with the RAL program as a whole.

At the same time, beginning this tax season, IRS is implementing its vaunted "CADE" program whereby taxpayers with straightforward tax returns should be able to receive their federal tax refunds within 3-5 days via direct deposit rather than the usual 8-14 days.

IRS reports that up to 75 percent of all taxpayers will qualify to have their refunds accelerated through the CADE program; Earned Income Credit recipients are not likely to qualify for accelerated refunds, though, so if you receive EIC, your refund probably won’t arrive as fast as 3-5 days.

However, mere weeks after announcing that tax refunds would come faster this year, IRS experienced a nationwide computer problem that delayed the first round of tax refunds expected to be delivered January 25th. Therefore, it remains to be seen whether IRS will be able to deliver on its promise to deposit most federal tax refunds within 3-5 days for tax year 2011.

But that is what they IRS is saying should happen!

E-Filing Now Mandatory for Professional Tax Preparers

Beginning this tax season, every tax preparer who anticipates filing more than 10 tax returns is required to e-file all federal tax returns.

However, just as California allows an opt-out, the IRS will also allow tax preparers to opt-out of electronic filing in some cases. If the taxpayer does not want to e-file, Form 8948 can be filled out by the tax preparer and the tax return can be sent by mail.

Otherwise, though, tax preparers are now required to file electronically on both the federal and the state.

New Mileage Deduction Rates for 2011

For the first six months of 2011, business mileage can be deducted at a rate of 51 cents per mile, and Moving and Medical mileage deductions are 19 cents per mile.

For the last six months of 2011, business travel goes up to 55.5 cents per mile, and Moving and Medical miles go up to 23.5 cents.

Charitable mileage deduction remains at 14 cents for whole year.

In order to claim business mileage deduction, taxpayer is required to keep a mileage log documenting business miles claimed—another thing that IRS has been getting stricter about.

American Opportunity Credit Still Around

American Opportunity Tax Credit is available for 2011 and has been extended through tax year 2012. Credit applies to first four years of post-high school education, at a maximum of $2,500 per year.

Make sure to claim this credit if you attended college or certain trade schools in 2011!

Refundable 2011 Federal Adoption Credit of up to $13,360

As part of Healthcare Reform Law, the federal Adoption Credit is now refundable for tax year 2010 and 2011. Prior to tax year 2010, Adoption credit was a non-refundable tax credit.

Without bogging you too deep down in the details of why a refundable tax credit is better than a non-refundable tax credit, this is a HUGE change for taxpayers who adopt children in 2011 and can result in gigantic tax refunds, as the maximum Adoption Credit for 2011 is $13,360.

Additionally, there is a special tax loophole with the Adoption Credit for taxpayer(s) who adopt special needs child to be able to claim the maximum credit even if no expenses were incurred by the taxpayer in the adoption process.

However, extra paperwork is required to claim this credit, and all taxpayers who claim this credit will undergo a special audit process before being given the Adoption Credit.  Pronto Income Tax preparers are experienced in processing the Adoption Credit, make sure your tax preparer knows how this credit works before submitting your tax return.

Teachers $250 Above-the-Line Deduction for Classroom / Teaching Supplies

The $250 deduction for teacher expenses has been extended through 2011. Claim this deduction if you are a teacher who pays for classroom supplies, you can claim this deduction even if you do not itemize deductions.

IRS Has Loosened Tax Treatment of Cell Phones Used for Business Purpose

Business owner documentation requirements for business cell phone use have been reduced.

Child Tax Credit and Additional Child Tax Credit Stay the Same

Child Tax Credit has been extended in its present form ($1,000 per child) through 2012.

The Additional Child Tax Credit is the refundable portion of the Child Tax Credit and has also been extended in its current form giving taxpayers with zero tax liability the chance to receive a portion of the Child Tax Credit as a payment in their tax refunds.

IRS Letters and Visits to Tax Preparers on the Rise

The IRS has changed strategy over the past year in terms of taxpayer compliance, and is starting to put much more onus on the tax preparer to ensure that taxpayers are not overstating deductions, claiming the Earned Income Credit incorrectly, and so forth.

IRS has sent out thousands of letters to "at-risk" tax preparers and is actively putting crooked tax preparation places out of business.

As a taxpayer, you should realize how this affects you: if you are going to a cheating tax preparer to do your taxes, you are exposing yourself to tremendous risk, as the IRS has been raiding the offices of shady tax preparers with increased regularity.

Using a reputable tax preparer is more important than ever to protect yourself from IRS audits.

Also keep in mind that once you sign the tax return, it is YOUR responsibility as a taxpayer to make sure the information on that tax return is correct. Tax preparers have limited liability, it is your tax return and you, not the tax preparer, are responsible for its contents—that is the law.

Earned Income Credit under the IRS Microscope

The Earned Income Credit is an anti-poverty program tax credit that helps low and middle income taxpayers with children. For tax year 2011, the Earned Income Credit can be worth up to $5,751, so it is quite a bit of money we are talking about here.

Incorrect and/or fraudulent claims for the Earned Income Credit are common and IRS is getting serious about putting a stop to false Earned Income Credit claims.

If you are claiming the Earned Income Credit, your tax preparer is required to exercise due diligence to make sure that you qualify for this credit and you as a taxpayer are also responsible for making sure you qualify to claim EIC.

Form 8867 is an EIC Checklist that shows you what the requirements are to claim EIC.

When claiming the EIC for qualifying children, the “qualifying child” must meet three main criteria:

1. Age: must be age 0-18, or 19-23 if full-time student

2. Residency: must live with taxpayer for more than half the year

3. Relationship: must be closely-related to taxpayer, cannot be cousin for example

Remember, again, that you as a taxpayer are responsible for the accuracy of your tax return. If you are claiming Earned Income Credit, make sure you qualify.

IRS Now Receives Information about the Basis of Stock Sales

IRS is now requiring stock brokers, mutual funds, etc. to report the basis of capital assets "when feasible" on Form 1099-B.

Previously, only the sales proceeds were reported to IRS by stock broker, allowing taxpayers and tax preparers to report the basis of each asset without third party verification from the broker transacting the asset sale. Going forward, IRS requires that the stock broker provide third party verification of the basis of the asset.

This may seem like complete tax jargon gibberish, but this 2011 stock basis reporting change matters a lot for taxpayers who gain income from stock sales.

In short, the basis of a stock is usually the purchase price. Because taxpayers only pay tax on the profit from a stock sale, not the total sales proceeds, the temptation for many taxpayers has been to inflate the basis of the stock, thus decreasing the profit and therefore the tax on the profit.

With the brokers now reporting basis information to the IRS, inflating the basis of stock to avoid tax will become much more difficult.

Bottom line, the IRS is now unwilling to "take the taxpayer's word for it" as to what is the basis of capital assets disposed of. Taxpayer (and tax preparer) must now submit, in addition to Schedule D, anew Form 8949 showing all the details of each asset disposition.

Seeing a trend here? As noted above, the IRS is tightening up the tax collection system in a wide variety of ways after many years of lax enforcement.

IRS Discusses the Creation of a More "Real Time" Tax System

Suffice it to say that the federal income tax system is not always the most efficient system in the world.

For example, the IRS may not identify income omission problems on a taxpayer's tax return for two or three years—even though by the time the taxpayer submits the tax return, IRS already has the third party information in its computer systems. For instance, the IRS may not write the taxpayer a letter stating that a W-2 was left off the tax return until years later, even though the IRS receives that W-2 information directly from the employer during the tax year.

In light of this common problem, IRS is discussing the implementation of a more "real time" tax system in the future. Under such a system, a taxpayer's tax return would be "matched up" with the third party data at the time that the tax return is submitted, rather than two years later. Under such a system, a taxpayer who is not reporting a W-2 would receive a notice from the IRS that the tax return was not accepted through electronic filing because of the income omission.

Nothing is for certain on this yet, but certainly this is something to be aware of going forward, as it is a part of the overall focus by the IRS on using new technology to improve the tax system.

IRS Requires New Form 1099-K Showing Credit / Debit Sales of Each Business

Also new for tax year 2011, IRS will now begin requiring credit card processing companies to report the amount of credit and debit card sales for their business clients directly to the IRS, on Form 1099-K.

This is an attempt to stop business owners from underreporting their cash sales. IRS studies show that underreporting of income by business owners is a major area of tax avoidance, and this new Form 1099-K is an effort to close the business owner “tax gap.”

For example, let us suppose that you are a business owner in a cash-intensive business, such as a restaurant, and your credit / debit card sales are $50,000, and you are reporting a total income of $50,000. This new Form 1099-K would allow the IRS to immediately see that you are only reporting your credit / debit transactions and none of the cash transactions.

All small business owners need to be aware of this tax change and new Form 1099-K!

Tax Preparers Will Need to Pass IRS Competency Exam

Speaking of tightening up requirements, as of November 2011, the IRS has instituted a requirement that all paid tax preparers, nationwide, must pass an IRS Competency Exam by December 31, 2013.

This IRS Competency Test idea was put in place after a study showed that a large percentage of tax preparers were either barely competent or outright incompetent. If tax preparers do not pass this IRS test by December 31, 2013, they will not be allowed to do taxes for pay anymore.

You can read more about the IRS Competency Exam at www.irs.gov.

Pronto Income Tax of California, Inc. offers a 60 hour basic income tax course at www.ProntoTaxClass.com that addresses many of the topics that are on the IRS Competency Exam and can help professional tax preparers get ready for this test.

Additionally, we are currently developing a course specifically for the IRS test.

Tax Preparation Fees Charged by Other Campanies Continue to Increase

According to a report by research firm CPA Trendlines, tax professionals are raising their prices due to the increased cost of doing business as described above.

Pronto Income Tax prices, however, remain the most affordable in the industry, consistently beating the “big guys” on price by $50-$200 per tax return to save Pronto clients money year after year. Sorry for the shameless plug but you know we gotta do it! :)

New Exemption and Standard Deduction Amounts for 2011

The federal Exemption Allowance for 2011 is $3,700.

There is no exemption phase-out for 2011. High-earning taxpayers can keep the entire amount of their exemptions for tax year 2011, regardless of how much income they earn.

Standard Deduction Amounts for 2011

            Joint & Surviving Spouse           11,600

            Head of Household                       8,500

            Single & Married Separate           5,800

In 2013 Hospital Insurance Rate (Medicare) Will Increase for High Earners

Higher income taxpayers will be forced to pay an extra .9 percent of Medicare tax beginning in 2013. The normal Medicare tax rate is 1.45 percent of earned income for the employee, plus 1.45 percent of earned income for the employer.

(Self-employed taxpayers pay both sides of this tax, for a total Medicare tax rate of 2.9 percent).

Individual taxpayers whose income exceed a certain amount (Single, $200,000; married filing joint, $250,000; married filing separate, $ 125,000) will need to pay this extra .9 percent tax.

Medicare tax is assessed on all earned income unlike Social Security tax which has a maximum. In short, this is a tax increase for high earners.

Medical Care Reimbursements from Employer-Provided Health Insurance

As part of the Health Care Reform Act, taxpayer are now (generally speaking) able to obtain medical insurance reimbursements from employer health care plans for children of employees who have not yet reached the age of 27, i.e. are age 26 or under.

This 2011 change also applies to self-employed individuals whose dependents are covered by health insurance. The child no longer has to qualify as a dependent in order to be covered by the parent’s health insurance plan.

Self-Employed Health Insurance Deductible against Income Tax But Not Self-Employment Tax

For tax year 2011, self-employed taxpayers are still able to use health insurance premiums paid for themselves, spouse, and/or dependents as a tax deduction to reduce income tax, but not to reduce the Self-Employment Tax.

For tax year 2010, self-employed taxpayers were able to use health insurance premiums to reduce both income tax and Self-Employment Tax.

Capital Gain Tax Rates Stay Low for 2011

Current capital gains tax rates, including 15 percent on long-term capital gains and 0 percent long-term capital gains rate for certain low and middle income taxpayers, have been extended through the end of 2012.

After 2012, with the expiration of the “Bush Tax Cuts,” it is uncertain what will be done with a wide variety of tax rates including cap gain rates.

Foreign Account Reporting Requirements (FBAR)

As you may have heard in the news regarding Swiss bank account scandals, IRS is cracking down on unreported income from overseas bank accounts. IRS now requiring foreign banks to report directly to IRS regarding the bank accounts of U.S. citizens, through Foreign Account Reporting Requirements or FBAR.

FBAR applies to any United States person who has a financial interest in or signature or other authority over any foreign financial accounts if the aggregate amount in these accounts exceeds $10,000 at any time during the calendar year.

Penalties for non-compliance are severe.

2011 Bonus Depreciation for Purchase of Business Equipment

Congress has increased the bonus depreciation limit from 50% to 100%(subject to limitations) for the period of Sept. 9, 2010 through Dec. 31, 2011.

Amount reverts to 50% after 2011.

$500,000 Section 179 Expense Limit for 2011

Section 179 allows business owner taxpayers to write off (i.e. deduct) more of the cost of business equipment in the year of purchase, rather than depreciating the equipment and taking the deduction over a number of years.

In 2011, the Section 179 limit is $500,000. Limit is supposed to revert to $125,000 beginning in 2012, but Congress is discussing expanding that amount.

Business owners should be strategic about when to use deductions for purchase of large business equipment. It is not always best to expense everything in the year of purchase, especially if the business income (and thus the tax rate) is low for that year.

Roth IRA AGI Conversion Options for 2011

Beginning in 2010, the $100,000 modified AGI limit on conversions of traditional IRAs to Roth IRAs is eliminated, and married taxpayers who file separate are now allowed to convert traditional IRA funds into a Roth IRA.

For conversions made in 2010 taxpayer can elect to choose between:

  1. 1.Including income from Roth conversion on 2010 return; or
  2. 2.Including one-half the conversion income in 2011 and one-half in 2012.

First-Time Homebuyer Credit Recapture

Reminder: taxpayers who received the $7,500 Homebuyer credit in 2008 must generally recapture credit over a period of fifteen years beginning in tax year 2010. For 2011, there is no longer a First-Time Homebuyer Credit, neither on the Federal side nor the California state side.

Homeowner Energy Credit Reduced to 10 Percent with Lifetime Limit of $500

The Homeowner Energy Efficiency Credit, which used to be 30 percent of qualified expenses, has now been reduced to generally a 10 percent credit of eligible energy-saving improvements, up to a maximum lifetime credit of $500.

Eligible energy-saving improvements include EnergyStar windows, doors, and certain types of insulation and roofs. To claim the tax credit for energy efficient home improvements, taxpayers must have a certificate from the manufacturer of the item showing that the item qualifies.

This 10 percent / $500 limit for the energy efficient home credits is a significant decrease both in terms of percentage and dollar maximum relative to the 30 percent / $1,500 limit for tax year 2010.

Estate Tax Limit for 2011 at $5 Million

Estate tax may apply when someone dies and is leaving behind substantial property to heirs. This tax is sometimes called the “death tax.”

For 2011 and 2012, there is a $5 million per person estate tax exemption with a top tax rate of 35 percent applying to any excess estate beyond the $5 million limit.

The above exemption applies to estate, gift and generation skipping taxes.

There is also a provision through 2012 that permits the executor of a deceased spouse’s estate to transfer any unused personal exemption to the surviving spouse.

Advance Earned Income Credit No More for 2011

Advance Earned Income Credit was when the employer would give the employee who is eligible for Earned Income Credit an advance of the EIC in the employee’s paychecks during the year.

This credit is not available for 2011.

1099 Rule Revision

IRS, for 2011, is NOT requiring recipients of rental income or those individuals or businesses making payments over $600 to a corporation to report those payments to the IRS on Form 1099.

This rule was supposed to go into effect as part of the Health Care Reform Act, but ultimately was dismissed by Congress after an uproar about all the new paperwork that would be required to comply with this rule.

Innocent Spouse Ruling

IRS is no longer holding to their previous position that innocent spouses must apply for relief within a two year period beginning with the date the IRS started collection action.

For innocent spouse taxpayers who were late in reporting their innocence, then, this represents a loosening of the normal rules that state that both spouses are jointly responsible for all of the tax due on a jointly-filed tax return. Taxpayers who are being pursued for a tax debt related to the tax problems of an ex-spouse may be able to get out this tax debt more easily than before.

Did you know that Pronto Income Tax offers tax debt resolution services to solve all kinds of tax problems? Well if you didn’t know, now you do!

California Tax Changes Update for 2011

California Tax Numbers to Know for Tax Year 2011

California Dependent Exemption Credit for 2011 is $315.00. For tax year 2010, the dependent exemption credit for CA was reduced to $99. So this "re-increase" of the dependent exemption credit will be a welcome tax cut for taxpayers with dependents.

Personal Exemption Credit for Single, Married Filing Separately, and Head of Household is $102.00.

Personal Exemption Credit for Married Filing Jointly, Qualifying Widow(er) is $204.00

Blind? Add an extra $102. Age 65 or over? Add an extra $102.

State Disability Insurance (SDI) Rate for 2011 is 1.2% up to a maximum wage base amount of $93,316.

California Tax Treatment of Canceled Debt

FTB began mailing letters in January of 2011 to pre-selected individuals who received a Form 1099-C for tax years 2007 and 2008 to check their qualification for exemption of Cancellation of Debt income.

It remains to be seen how this will play out for canceled debt from short sales, foreclosures, et

California Child & Dependent Care Credit Still in Effect But No Longer Refundable

As a result, lower income taxpayers who claim the California Child and Dependent Care Credit may see their state income tax refunds come in lower this year than last year, due to this change from a refundable to a non-refundable credit.

California New Jobs Credit: Form 3527

This credit actually became effective at the beginning of 2009 but has been somewhat overlooked. California has allocated $400 million dollars but as of 8/6/2011 only approximately $61 million has been used. Here are the details to know on the CA New Jobs Credit:

Provisions:

  • Up to $3,000 for each additional full-time employee hired;
  • For small businesses with less than 20 employees at the end of the preceding year;
  • Credit is prorated on an annual full-time equivalent basis for employees employed less than a year;
  • Credit must be claimed by individual or business on a timely filed return before the credit has been used up.

Qualifications:

  • Each qualified full-time hourly employee is paid wages for not less than an average of 35 hours per week
  • There is a net increase in qualified full-time employees compared to the number of full-time employees employed in the preceding taxable year.

Employees who are not eligible would be those who are:

  • Certified as a qualified employee in an enterprise zone or targeted tax area;
  • Certified as a qualified disadvantaged individual in a manufacturing enhancement area;
  • Certified as a qualified disadvantaged individual or qualified displaced employee in a local agency military base recovery area.
  • An employee whose wages are included in calculating any other credit allowed.

California "Carrover" of New Home and First-Time Buyer Credit

Taxpayers receiving either of the California homebuyer tax credits must allocate the credit amount over three year period beginning in 2010, meaning taxpayers get 1/3 of the credit each year.

Be careful not to miss credit in 2011 and 2012. Tax software (or inexperienced tax preparers) may not automatically pick up this "carryover" credit, so make sure to check and see if there is more credit to be used! However, for tax year 2011 itself, there is no homebuyer credit for either