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MERRICK SHUKAN CPA, MST
SENIOR MANAGER

A number of Federal and State business and individual tax laws have changed, and are summarized in this article. For a more in-depth analysis of the AMT, mortgage debt and mortgage insurance tax law changes, see the article by Jay Graham.

Federal – Individual Taxes

Survivor's Home Sale Exclusion
Effective January 1, 2008, the sale of a residence that had been jointly owned and occupied by the surviving and deceased spouse is entitled to the $500,000 gain exclusion provided the sale occurs no later than two years after the date of death of the individual's spouse.  The old law generally allowed for the full $500,000 tax break only if the house were sold in the very same year in which the spouse died. 

The surviving spouse in the case of a jointly owned residence continues to be allowed a step up in basis in the residence for the deceased spouse's one-half share. The $500,000 exclusion is in addition to that benefit.

Kiddie Tax
Age in determining the kiddie tax for 2007 is under 18 (change from age 14, pre-2006 tax years). For 2007, a child's net unearned income over $1,700 is taxed at parents' effective rate.

Note:  for tax years beginning with 2008 (or post 5/24/07), kiddie tax will apply to kids 18 years old as well as 19-23 year old students who do not provide half of their own support. 

Federal – Business Taxes

Late S-Elections
The IRS has provided simplified methods for obtaining relief for S corporation elections effective for taxable years ending on or after December 31, 2007.  If the entity meets the qualifications provided in the procedure, these simplified methods may be used in lieu of requesting a letter ruling from the IRS. Relief under this procedure requires the filing of a Form 2553, Election by a Small Business Corporation, and a Form 1120S, U.S. Income Tax Return for an S Corporation, for the first tax year the entity intended to be an S corporation. The forms must be filed with a timely filed tax return including the six-month extension.  The Form 2553 must include a statement explaining the reason the entity failed to timely file the elections.

S-Corporation Health Insurance Premiums of Shareholders
There is new guidance issued to clarify when 2% shareholders in an S corporation may deduct accident and health insurance premiums.   The Internal Revenue Bulletin, 2008-2, provides three examples where a 2% shareholder-employee can deduct 100% on line 29 of the 1040 under section 162(l) and one example where a 2% shareholder-employee can only deduct it on Schedule A subject to 7.5% of AGI. 

In order for a 2% shareholder-employee to deduct the amount of the accident and health insurance premiums, the S corporation must report the accident and health insurance premiums paid or reimbursed as wages on the 2% shareholder-employee's Form W-2 in that same year.  In addition, the shareholder must report the premium payments or reimbursements from the S corporation as gross income on his or her Form 1040, U.S. Individual Income Tax Return.

The only time where a 2% shareholder-employee is not eligible for the section 162(l) deduction is when they make the payments and the S corporation does not make any payments or reimbursements with respect to the premiums.

Section 179 Deduction
The maximum deduction has increased to $125,000 with the phase-out starting after $500,000 of qualified property additions.  The phase-out is on a dollar for dollar basis up until $625,000 of qualified additions.

New Jersey – Business Taxes

S-Corporation Tax Sunset
S-Corporation income tax rate drops to 0% for periods ending after June 30, 2007.

Late S-Elections
Proposed New Rule: N.J.A.C. 18:7-20.3 – September 4, 2007
Late S-election relief may be approved in 2008.  The proposed new rule will affect taxpayers who failed to make a timely New Jersey S corporation election but who filed tax returns as though the election had been made and was in force.

To offset administrative costs connected with the program, the Division will impose a fee of $100.00 for each tax year to which taxpayer's late election is applicable.  We will keep you informed if this bill is signed into law.

Economic nexus, not physical presence, is the new threshold in determining corporate business tax.
In Lanco, Inc. v. Director, Division of Taxation (06-1236), decided on June 18, 2007, Petitioner was seeking a reversal of the New Jersey Supreme Court's opinion which affirmed "economic nexus" under the Commerce Clause as a sufficient connection to the State to be subject to corporate income tax.  Lanco's petition for a writ of certiorari was denied by the Supreme Court of the United States.  Please note that the old standard of physical presence within the State as a requisite for being subject to income taxation has generally been replaced by the economic nexus standard.  Simply put, if there is a clear connection with and income is generated from the State then economic nexus is likely to be established and taxpayer will probably be subject to corporate net income tax.

Construction Industry Independent Contractor Act – Effective July 13, 2007
Employers and business owners that employ independent contractors in construction related industries must be aware of the following new rules where:

• Penalties have been established for employers who misclassify workers as contractors instead of employees.

• Violations range from fines to imprisonment.

"Employer" means a partnership, association, joint stock company, trust, corporation, or other legal business entity or successor thereof that is primarily engaged in the business of, or enters into a contract for, making improvements to real property and includes any subcontractor or lower tier contractor.

New York – Business Taxes

Single sales factor allocation
For New York State's Article 9-A business allocation percentage (BAP) has been amended so that corporations will compute their BAP solely with their receipts factor starting with 2007 calendar year. 

Under legislation enacted in 2005, the transition of the BAP from 3-factor apportionment of property, payroll, and receipts, with the receipts factor double weighted, to single receipts factor apportionment was to be phased-in starting in 2006.  The schedule had called for single receipts factor apportionment for tax years beginning on or after January 1, 2008. The schedule was accelerated by one year.

LLC fees – for Single Member LLCs
For tax years beginning after December 31, 2006 SMLLCs that are disregarded for federal income tax purposes no longer are required to file Form IT-204-LL or pay the $100 fee.

Delaware – Corporate Annual Report and Franchise Tax Payments

Beginning with the 2007 Annual Report, due March 1, 2008, the State of Delaware is requiring mandatory electronic filing.

All corporations incorporated in the State of Delaware are required to file an Annual Report and to pay a franchise tax.  Filing electronically will insure compliance with changes to the Delaware Law, which require the adminstrative voiding of corporations that do not file or file an incomplete Annual Report.