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The Top Five Corporate Tax Issues of 2007

U.S. Congress, the IRS and the tax courts were all busy with new tax developments in the form of new legislation, interpretation and legal resolution.

January 24, 2008
by Mary Bernard, CPA/MST

In an unusually active year, several groundbreaking tax developments occurred in 2007 with far-reaching effects for corporations. Here, we’ll look at the top five corporate tax developments. A future column will be devoted exclusively to the important IRS tax court losses during 2007 impacting corporate taxpayers.

  1. The Small Business and Work Opportunity Tax Act of 2007. This expansive Small Business Tax Act directed nearly $5 billion in tax incentives primarily to small businesses in an attempt to offset the cost of the increase in federal minimum wage. Unfortunately, the counterbalancing revenue raiser was accomplished by an expansion of the kiddie tax to apply to children who are under age 19, which will affect millions of families.

    The tax incentives included the following:

    • An extension of the small business IRS code section 179 expensing. Without this provision, the deduction for expensing fixed assets acquired in 2007 would have reverted to $25,000. The deduction was increased retroactively to January 1, 2007, and extended through 2010. The dollar limitation, now indexed for inflation, was increased to $125,000 for tax years beginning in 2007 through 2010. In addition, the phase-out of the deduction, formerly beginning with $450,000 invested in qualifying property, was increased to $500,000 for the same time period and is also indexed for inflation.
    • A FICA tip credit calculation not affected by the increased minimum wage. The federal minimum wage is scheduled to increase over the next two years to $7.25 per hour. The FICA tip credit calculation used by the food and beverage industry will not be reduced accordingly with the scheduled increases. The calculation will continue to be based on the former minimum wage of $5.15 per hour. Alternative minimum tax relief is also provided for these employers.
    • An extension of the Work Opportunity Tax Credit. This credit encourages employers to hire individuals from economically challenged populations. Scheduled to expire for employees hired after December 31, 2007, this credit is now extended through August 31, 2011. The credit was also expanded to include more participants from the veterans’ community, high-risk youths and vocational rehabilitation group.

  1. Code Section 199 Domestic Production Activities Deduction finally noticed. After two years of being ignored, the section 199 deduction introduced in the American Jobs Creation Act of 2004, finally gained wider recognition as the three percent credit for qualified domestic production increased to six percent. Good news and bad news arrived in 2007 for taxpayers attempting to qualify for the deduction. Proposed regulations detail major beneficial changes for the film industry including more flexible tests for film-related compensation, taxpayer participation in production, and related safe harbors. Unfortunately for the high tech sector, final regulations denied the deduction for most online or hosted computer software.

  1. The Tax Gap and IRS Enforcement. The IRS estimates the tax gap — the difference between what taxpayers owe and what they actually pay — to be $345 billion! Congressional leaders are outraged at the size of the gap due to lack of enforcement. Consequently, the IRS focused on solutions during 2007. Initial findings of their focused studies will result in an increased number of regular audits of both individuals and businesses. The Large and Mid-Sized Business Division will focus on high-risk tax compliance issues, as identified through field examinations, Schedule M-3 reviews and other sources. Issues will be prioritized based on the level of compliance risk and prevalence across industry lines.

  1. Guidance under the Pension Protection Act of 2006. Many issues requiring guidance under the PPA that were left to the IRS to provide were forthcoming during 2007. The following issues were addressed:

    • Non-qualified deferred compensation under Code Section 409(A). Guidance clarified and finally liberalized rules for deferral elections, timing of payouts, valuation and plan documents. The new rules must be implemented by January 1, 2008, although an additional year is granted to bring all plan documents into compliance.
    • Section 415 limits on contributions and benefits. Comprehensive final rules were issued on limitations on contributions and benefits under qualified retirement plans. Specifically addressed were benefits provided by qualified defined plans and to contributions and additions to qualified defined contribution plans.  
    • Too numerous to discuss. Additional issues addressed during 2007 included distributions from IRA’s to charitable organizations, rollovers for non-spouse beneficiaries, interest rates for defined benefit limits, hardship distributions from certain employee benefit plans, vesting of non-elective contributions, partial retirements and safe harbors.

  1. Last Place Tidbits.

    • FIN 48 continued. Relief was granted to nonpublic companies in the form of a one year extension in effective date.
    • Abusive tax shelters. IRS now has 32 listed transactions, including the first two transactions of interest that will receive increased scrutiny — manipulation of charitable deduction valuations of real property subject to a long-term lease, and transactions that manipulate grantor trusts to reduce tax liabilities.
    • Increased mandatory e-filing. During 2007, mandatory e-filing was required for midsize corporations with assets between $10 million and $50 million.
    • Roth 401(k) becomes popular. With final regulations issued in 2007 addressing the taxation of distributions from Roth 401(k)’s and making the Roth feature permanent, the streamlined implementation led to wider acceptance of the concept.
    • Advisory fee debate continues. Which estate and trust expenses for portfolio advisory fees are subject to the two percent floor for itemized deductions? Stay tuned for the showdown between the IRS and the Supreme Court.

Familiarize yourself with these important corporate tax developments of 2007. More questions, and hopefully answers, will surface in the year ahead for companies of all sizes and structures.

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Mary F. Bernard
, CPA/MST is a Tax Principal and Director of State and Local Tax Services at Kahn, Litwin, Renza & Co., Ltd. in Providence, RI. She has over 20 years of experience with national and local accounting firms working with a variety of individual, partnership and corporate clients, with particular focus on corporate multi-state tax issues. She has also provided advisory and compliance services to extensive nonprofit clients. Bernard is a member of the AICPA, the Massachusetts Society of CPAs and serves as President-elect of the board of directors for the Rhode Island Society of CPAs.