Thanks to a late change in tax laws, tax time could be very confusing. Here are some things you need to know before Uncle Sam comes calling.
In order not to miss out on a number of newly extended and expanded tax benefits, the owners and operators of many dental businesses may want to miss the deadline for filing income tax returns. Other tax breaks that may have been overlooked in the past have now been clarified, thanks to the last-minute passage of a new tax law.
The passage of the Tax Relief and Health Care Act of 2006, late in December, included a number of expired or expiring tax breaks such as a sales tax deduction for people in states without income taxes. Also included were a tax deduction for college tuition, a tax credit for hiring welfare recipients and others facing difficulties finding jobs, tax credits for alternative energy producers, and purchases of solar energy equipment by homeowners and businesses.
All told, the extension of expiring and expired tax breaks, along with several new tax provisions, are expected to save taxpayers $38 billion over the next five years. While there is nothing earth-shattering in the new legislation, the fact that it was passed so late in the year has thrown both the Internal Revenue Service and tax professionals into a “tizzy.”
Every dental business and its owners, regardless of whether the annual tax returns have already been filed, whether they took advantage of the automatic extension of time to file those tax returns, or whether they - or their tax advisors - are in the process of preparing those income tax returns - should review these tax breaks. Among those likely to be of most interest to owners and operators of dental businesses are such tax breaks as:
Research tax credits
This last-minute legislation extended and modified the popular research tax credit. In general, our tax laws currently provide a research tax credit equal to 20 percent of the amount by which a taxpayer’s qualified research expenses for a taxable year exceed its base amount of research expenditures for that year.
Unfortunately for many dental businesses, R&D costs are limited to research in the laboratory or experimental purposes. Market research and normal product testing costs are not considered research expenditures by our lawmakers.
In addition to extending the R&D credit, the new law also created an Alternative Simplified Credit for 2007. Under the simplified method, the credit is 12 percent of the qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding tax years.
Improving leased property
Those dental businesses that lease property - any business property, not merely the showroom -- will find that the new law extends the 15-year recovery/write-off period for certain leasehold improvements through 2007. Unless a leasehold improvement qualifies as “15-year leasehold improvement property,” its cost must generally be written off or depreciated over the life of the property which it improves. For example, the cost of installing permanent walls in a commercial building (structural components) would be separately depreciated over a 39-year period.
Incorporated dental businesses will benefit from the extended and enhanced rules for deducting donations of property, computer equipment, and technology to schools and public libraries. The new law extends a provision that encourages businesses to contribute computer equipment and software to elementary, secondary, and post-secondary schools by allowing an enhanced deduction for such contributions. For contributions made after 2005, the new law expands the deduction to allow equipment “assembled by” the donor to qualify for the deduction.
Health savings accounts
Many business owners have, in recent years, discovered the cost-effectiveness of so-called “health savings accounts” or HSAs. Similar to an Individual Retirement Account (IRA), but earmarked for health-related expenses, the HSA has caught on among dental equipment dealers and manufacturers as an excellent, tax-favored fringe benefit for themselves as well as employees. Contributions to HSAs are tax-deductible, whether made by the individual or a business.
HSAs enable anyone with high-deductible health insurance to make pre-tax contributions equal to the lesser of the annual deductible or $2,700 for self-coverage ($5,460 for families) in 2006 to cover health care costs. Unlike an IRA, amounts paid or distributed out of an HSA used exclusively to pay qualified medical expenses are not includable in gross income.
As part of the new law, Title III, the Health Opportunity Patient Empowerment Act of 2006, HSAs are now more attractive then ever. The newly eased rules are expected to have a major impact on employer-sponsored health care decisions. Unlike many of the extended provisions, the HSA enhancements have been made permanent, with most taking effect for tax years beginning after 2006.
Employees, even employees of their own dental business, with a health flexible spending account (FSA) or a health reimbursement account (HRA) will be allowed to make a one-time transfer of the balance of their FSA or HRA to an HSA. The maximum amount that may be transferred, tax-free, is the lesser of the balance on the date of transfer or on Sept. 21, 2006. The transfer must be made before Jan. 1, 2012.
What’s more, those with tax favored IRAs are allowed a one-time, once-in-a-lifetime rollover of funds from their IRAs into an HSA. The change is designed to give those with IRAs quicker access to their funds for medical expenses, but it is also expected to spur interest in HSAs. The election to make the rollover is irrevocable, and the new rules apply to tax years beginning after Dec. 31, 2006.
In addition to the last-minute changes in the tax regulations, tax forms, and new informational booklets the IRS routinely provides taxpayers, the IRS has had its arsenal of weapons for fighting the “tax gap,” the difference between taxes owed and the amount of taxes actually paid, strengthened and increased. Under congressional pressure to close that tax gap, the IRS will now be allowed to use the proceeds from its undercover operations to pay additional expenses incurred.
This provision the IRS uses to self-fund its tax cheat and tax fraud prevention efforts is due to expire at the end of 2006. It has now been extended through 2007. Plus, the IRS has been given the authority to share information with several other agencies, including state and municipal tax collectors, at least until the end of 2007.
It has also become more expensive to test the IRS’s patience. The penalty for so-called “frivolous” tax return submissions has increased from $500 to $5,000, and has expanded to cover all taxpayers and all types of federal taxes. This increased penalty also applies to frivolous submissions for lien and levy collection due process, installment agreements, offers-in-compromise, and taxpayer assistance orders.
On a personal note
The new tax legislation is not all business. In fact, only a few of the bill’s provisions benefit the average dental business or are related to business. By far, the majority of the extended or resurrected provisions in this bill apply to individuals. Those provisions cover such things as:
- An “above-the-line” deduction for higher education expenses;
- The deduction of state and local sales taxes;
- An above-the-line deduction for certain expenses of elementary and secondary schoolteachers;
- Extension of energy-efficient new homes credit;
- Extension of credit for residential energy-efficient property; and
- Alternative minimum tax credit relief for individuals.
After the fact
Since the extenders bill passed after the IRS’s deadline for printing 2006 tax year materials, they have announced they will not be revising the already printed tax forms. Instead, the IRS plans a “media blitz,” in the IRS’s own words, to alert taxpayers that the extenders are back and should not be overlooked in preparing 2006 tax returns.
The IRS has begun its program to publicize the tax law changes, using a variety of media, including the IRS Web site (www.irs.gov). They are also expected to come out with a newly-issued publication, Pub. 553 (Highlights of 2006 Tax Changes) sometime in the first quarter of 2007.
Despite these efforts, however, most tax experts have predicted significant confusion on the part of both tax professionals and taxpayers. Fortunately, the tax laws now permit automatic extensions of time in which to file income tax returns - but not the taxes due.
Thus, unlike the IRS, every dental dealer and manufacturer - as well as their tax advisors - should have adequate time to digest the contents of the latest changes to our income tax laws. If the tax returns have been filed, our tax laws permit everyone to correct errors and omissions on that already filed tax return.
Once a tax return is filed, the claim by an individual who filed Form 1040, 1040A, or 1040EZ, is made on Form 1040X. A corporation that filed Form 1120 uses Form 1120X to include previously overlooked or neglected deductions and tax credits and to claim a refund. Generally, a dental sales operation must file a claim for refund within three years from the time the return was filed.