Big Brother is watching

Businesses and individuals alike should be prepared for increased scrutiny by the IRS in 2012 as the federal government, as well as states, look to increase collections.

A survey of 890 corporate tax executives released in November by KPMG, an audit, tax and advisory firm, found that nearly two-thirds (61%) of respondents said federal-tax-dispute activity had increased in the past 12 months, while more than one-third (37%) said the total number of state tax audits in jurisdictions in which they do business increased.

The majority of respondents expect this to continue. Over the next 12 months, 67% of the respondents said they expect federal-tax-dispute activity to increase; 53% expect the same on the state level.

"Federal, state and local governments are all taking extra measures to ensure that they are not leaving any corporate tax revenue on the table, as many are facing budget shortfalls," Frank Lavadera, the principal in charge of KPMG's Tax Dispute Resolution Services Network, said in a statement. "Tax directors, CFOs and corporate boards should keep the increased likelihood of an audit by taxing authorities high on their priority lists, as it presents a significant tax risk. It is clear that taxing authorities are demanding greater transparency and imposing more complex reporting requirements, while the IRS and various states are adding tax audit personnel to increase the number of exams they can conduct."

According to government statistics, IRS enforcement revenue increased by 18%, to $57.6 billion, and corporate examinations increased by 5% in fiscal year 2010.

This year will also see a continued focus by federal officials on overseas accounts through new requirements for reporting foreign assets.

The taxman taketh

While big and broad tax changes remain uncertain, taxpayers will nevertheless start seeing a variety of exemptions pulled away, meaning that many will need to plan on paying more unless Congress decides to reinstate such breaks retroactively.

According to the California Society of CPAs, 67 tax benefits were set to expire with 2011.

Two separate provisions affecting the alternative minimum tax expired at the end of 2011 that together "saved 26 million middle-class Americans from the clutches of the dreaded alternative minimum tax," the society said in a recent rundown of tax changes. For 2012 and future years, tax credits will offset the regular income tax, but not any alternative minimum tax.

Also, the temporarily patched exemptions for the alternative minimum tax may have come to an end in 2011. For 2012 and future years, the AMT exemption amounts will revert to a lower statutory amounts ranging from $22,500 to $45,000.

"This will result in more taxpayers being subject to the AMT, and will increase the adjustments for taxpayers already subject to the AMT," the society says.

The $2,500 maximum deduction for interest paid on student loans begins to phase out for married taxpayers filing joint returns at $125,000 and phases out completely at $155,000, an increase of $5,000 from the phase-out limits for tax year 2011. For single taxpayers, the phase-out remains at 2011 levels.

A $500 credit for energy-efficient home improvements (such as windows, insulation and heating systems) has expired. Also chopped: a state and local sales tax deduction, higher-education tuition and fees deductions, the deduction for student loan interest, teachers' classroom expense deductions and mortgage insurance premium deductions.

Retirees can no longer make up to a $100,000 charitable contribution directly from their IRAs to avoid taking a distribution into taxable income.

Small-business concerns

A key bit of uncertainty for businesses in 2012 is what happens to health care reforms set in motion by the Patient Protection and Affordable Care Act of 2010.

If all goes according to schedule, there may be some clarity by the end of June, when the Supreme Court is expected to render a decision in a case brought before it by the National Federation of Independent Business and 26 state attorneys general challenging the law's constitutionality.

Among the items that could be affected is a credit for small-business employers who pay at least one-half the cost of health insurance coverage for their employees. If the law stands, it is likely that the initiative will be altered.

In November, the Treasury Inspector General for Tax Administration issued a report that found that the volume of claims for the credit has been low despite IRS efforts to inform 4.4 million taxpayers who could potentially qualify for it. As of mid-May 2011, slightly more than 228,000 taxpayers had claimed the credit, for a total amount of more than $278 million. The Congressional Budget Office had estimated the credit would cost $37 billion over 10 years and that taxpayers would claim up to $2 billion of credit for tax year 2010.

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In response, the IRS has announced plans to conduct focus groups to determine why the claim rate was so low, and it may take steps to better inform businesses and encourage participation. Congress and the IRS may propose an overhaul of the way the credit is implemented.

Also on the table (for all taxpayers) is a 3.8% Medicare tax on investment income that is slated to go into effect in 2013.

Small businesses will also be anxiously awaiting news on potential changes to the estate tax, with some advocates arguing that higher rates can be blamed for family-owned businesses forced into dissolution due to tax bills that arise because a deceased owner's estate includes business assets.