Tina R. Green and Christina A. Mondrik 2012-12-26 02:19:52
The year 2012 was another rather uneventful tax law year, except on the Texas margin tax front. The national focus has continued to be on America’s high unemployment, increasing national debt, national security, and the tax implications of the looming fiscal cliff. Bush-Era Tax Cuts Perhaps one of the most relevant tax law developments for 2012 is what has not yet occurred — the extension of the “Bush tax cuts,” which are set to expire at the end of 2012.1 Originally, these tax cuts were set to expire at the end of 2010, but were granted a two-year reprieve by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.2 Expiration of the Bush tax cuts will cause the tax system to revert back to 2001 levels. Some resulting changes if this occurs are: • Income tax brackets would increase from 10 percent– 35 percent to 15 percent–39.6 percent. • Maximum federal long-term capital gains and dividend rates would increase from 15 percent to 20 percent. • The gift and estate tax exemption is currently $5.12 million, with the highest tax rate above this threshold being 35 percent; effective Jan. 1, 2013, the gift and estate tax exemption would decrease to $1 million with a tax rate of 55 percent. Patient Protection and Affordable Care Act On March 23, 2010, President Obama signed comprehensive health reform, the Patient Protection and Affordable Care Act, into law.3 On June 28, 2012, the U.S. Supreme Court announced its decision upholding the law as authorized by Congress’s power to levy taxes. Tax practitioners pretty much ignored the tax impact of the law until the Supreme Court upheld its validity. While many think of the Affordable Care Act as only making significant changes to the U.S. health care system, it also includes a number of tax provisions. For tax years beginning in 2013, the threshold for deducting unreimbursed medical expenses on Schedule A of Form 1040 increases to 10 percent of a taxpayer’s adjusted gross income. For taxpayers older than 65, the threshold remains at 7.5 percent of AGI (through 2016). In addition, highincome earners will see an increase in their Medicare payroll tax beginning in 2013. Taxpayers will pay 2.35 percent of wages over $200,000 for individuals and $250,000 for couples. The current rate of 1.45 percent will still apply to wages below these levels. One of the most significant taxes resulting from the Affordable Care Act is referred to as the 3.8 percent Medicare surtax. Section 1402 of the Health Care and Education Reconciliation Act of 2010,4 which amends the Act, outlines the new unearned income Medicare tax that goes into effect on Jan. 1, 2013. Taxpayers with modified adjustable gross income over $200,000 who file individually ($250,000 for married couples filing jointly) could be subject to the tax. The provision imposes a 3.8 percent tax on income from interest, dividends, annuities, royalties, and rents that are not derived in the ordinary course of a trade or business. Note that this excludes active S corporation or partnership income. The tax is not imposed on the total MAGI, nor is it imposed solely on the investment income. The taxable amount will depend on the operation of a formula, under which the taxpayer determines the lesser of (1) net investment income for the taxable year (i.e., the sum of gross investment income over allocable investment expenses);5 or (2) the excess, if any, of MAGI over the $200,000/$250,000 MAGI thresholds. Therefore, if net investment income is the lesser amount, then the 3.8 percent tax is applied only to the net investment income amount. If the excess over the thresholds is the smaller amount, then the 3.8 percent tax would apply only to the excess amount. The 3.8 percent surtax will be imposed on trusts and estates as well. Texas Franchise Tax In late 2011 and 2012, the Texas Supreme Court heard taxpayers’ first constitutional challenges to the revised Texas franchise tax, which changed the computation method to “margin” in 2008. First, the court determined the tax is imposed at the entity level under the Texas Business Organizations Code, rather than on the individual’s share of the entity’s income. Therefore, the tax did not violate the Texas Constitution’s “Bullock amendment,” which bans net income taxes on an individual’s share of partnership or unincorporated association income without a referendum.6 Then, In re Nestle USA Inc.7 unsuccessfully challenged the application of the 1 percent tax rate applicable to manufacturers, rather than the 0.5 percent tax rate for wholesalers and retailers, on a business with all of its manufacturing operations located outside Texas. The court held the provision violated neither the equal protection provision of the U.S. Constitution nor the equal and uniform taxation requirement of the Texas Constitution. The Texas Comptroller of Public Accounts also announced a major policy change, allowing taxpayers to amend prior year reports to change their deduction elections. The comptroller originally required an entity to elect to deduct compensation, cost of goods sold, or the standard 30 percent deduction by the deadline for filing the original report for a year and did not allow taxpayers to amend reports to change the deduction method.8 The policy change regarding amended reports does not change the eligibility requirements for deducting cost of good sold or compensation. Taxpayers may file refund claims to recover overpaid tax within the statute of limitations, which is generally four years from the date the tax is due and payable.9 Extending the refund claim period requires compliance with prepayment requirements. Texas Sales and Use Tax Texas sales and use tax cases primarily focused on the application of exemptions and procedural issues. Zimmer US Inc. v. Combs10 awarded a refund of use tax paid on surgical instruments purchased out of state and loaned to Texas customers for use in implant procedures, determining they qualified as “orthopedic devices” under the comptroller’s rules.11 Roark Amusement & Vending, L.P. v. Combs,12 which is pending in the Texas Supreme Court, applied the resale exemption to toys purchased for placement into coin-operated amusement crane machines. The 3rd Court of Appeals held the resale exemption does not turn on whether the taxpayer can show that the subject items are actually resold and taxed in Texas.13 Chapal Zenray Inc. v. Combs14 denied a resale exemption for use taxes paid on display cards, jewelry boxes, labels, elastic strings, twist ties, and foam ring pads affixed to jewelry purchased predominately for display and sale at locations outside of Texas. The appellate court determined the materials were used in Texas because the packaging materials had little usefulness to the ultimate customer. In 2011, the Legislature severely restricted the scope of the resale exemption to tangible personal property or taxable services purchased for resale as part of performing a service that is not subject to tax.15 The statute limited the exemption to listed governmental entities. The 3rd Court of Appeals remanded Austin Engineering Co. Inc. v. Combs16 for further consideration of whether erosion control items were completely used or consumed in work on real property owned or controlled by exempt entities. Items purchased for incorporation into real property, including materials and taxable services completely consumed or incorporated into public property of an exempt entity, are exempt from sales and use tax.17 Bell Helicopter Textron Inc. v. Combs18 unsuccessfully challenged the comptroller’s method, which nets state tax deficiencies with refunds for overpayments in connection with a managed audit. Assignees of Best Buy, Office Max and Comp USA v. Combs19 considered whether customers could bring a class action lawsuit for sales tax lost on mail-in rebates that refunded a portion of the purchase price but not the requisite sales tax paid on that portion of the purchase price. The court determined that individual class members failed to exhaust administrative remedies and assignees did not adequately document their rights to the refunds claimed.20 What does the future hold? Unfortunately, what the future holds for federal tax law depends on many moving targets. One certainty is that change will occur. Speculation is that 2013 will bring more federal tax changes than 2012. On the Texas front, the comptroller’s office announced several pending rule amendments that will address issues raised in recent cases.21 The Texas Legislature reconvenes in 2013. In August 2013, taxpayers will be required to prepay many of their state tax payments as a budget-balancing provision from the 2011 legislative session. While no specific major changes to the franchise tax or sales tax are anticipated, budget considerations will likely result in state tax law amendments. Stay tuned for further developments. Notes 1. Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs Growth Tax Relief Reconciliation Act of 2003. 2. P. L. 111-312, passed by Congress on Dec. 16, 2010, and signed into law by President Obama on Dec. 17, 2010. 3. P.L. 111-148 (also known as the Affordable Care Act or “Obamacare”). 4. P.L. 111-152. 5. For purposes of this surtax, investment income includes interest, dividends, capital gains, annuities, rents, and royalties. 6. See In re Allcat Claims Serv., L.P., 356 S.W.3d 455 (Tex. 2011). 7. 359 S.W.3d 207 (Tex. 2012) and 56 Tex. Sup. Ct. J. 36, Tex., Oct. 19, 2012 (NO. 12-0518). Nestle’s first case was dismissed on jurisdictional grounds. 8. Comptroller Rule 3.584 (d)(1). 9. The statute of limitations for collection may be extended if the taxpayer never files a report, if there is fraud, or if there is a substantial understatement. 10. 368 S.W.3d 579 (Tex. App – Austin 2012, reh’g overruled April 25, 2012). 11. See Tex. Tax Code § 151.313 and Comptroller Rule 3.284 exempting health care supplies from sales and use tax. 12. Cause No. 03-10-00105-CV (Tex. App. - Austin 01-26-2011, pet. filed April 11, 2011). 13. See id., citing 7-Eleven, Inc. v. Combs, 311 S.W.3d 676 (Tex. App. - Austin 2010, pet. denied) (original opinion dated Aug. 31, 2009 withdrawn). 14. 357 S.W.3d 751 (Tex. App. – Austin 2011, reh’g overruled Jan. 25, 2012). 15. Tex. Tax Code § 151.006. 16. ___S.W.3d___ Tex. App. – Austin, Aug. 05, 2011, 2011 WL 3371557, Cause No. 03–10–00323–CV. 17. See Tex. Tax Code § 151.311. (The case is pending resetting at the district court.) 18. ___ S.W.3d ___, Cause No. 03-10-00764-CV (Tex. App – Austin 2011). 19. ___S.W.3d ___, Cause No. 03-10-00648-CV (Tex. App. – Austin 2012). 20. In addition, at least some of the class members failed to challenge a plea to the jurisdiction granted in the Comptroller’s favor. 21. Tax Policy News, October 2012, available at http://www.cpa.state.tx.us/ taxinfo/taxpnw/tpn2012/tpn1210.html. TINA R. GREEN is a member of the Capshaw Green, PLLC, in Texarkana. She is Texas Board Certified in Tax Law and Estate Planning and Probate Law, as well as a Fellow of the American College of Trust and Estate Counsel. Green is currently Chair of the Tax Section of the State Bar of Texas. CHRISTINA A. MONDRIK is the founder of Mondrik & Associates in Austin. She represents taxpayers in resolving state and federal tax controversies and litigation. Mondrik is an active member of the State Bar Tax Section, serving on its council and having served as chair and vice chair of its CLE, Tax Controversy, and Solo and Small Firms. She is also active with the Texas Society of CPAs.
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