District Court Rules that Severance Pay Not Subject to Social Security Taxes
After nearly two years of believing the issue was settled, employers received news last month that certain severance benefits may not be subject to taxation under the Federal Insurance Contributions Act (FICA). In United States v Quality Stores, Inc., No. 1:09-cv-44 (W.D. Mich. Feb. 23, 2010), a decision affirming a Bankruptcy Court decision, the U.S. District Court for the Western District of Michigan highlighted the historical uncertainty regarding whether certain severance payments made to employees pursuant to an involuntary reduction in force were not “wages” that are subject to FICA taxation. In this instance, the court held that such payments were not subject to FICA, as they did not constitute wages.

S Corporations with Pre-S Election Retained Earnings
For S Corporations with retained earnings from years prior to their S election, this year may be a final window on taking out those earnings at the currently low dividend income tax rate. A corporation with accumulated earnings from pre-S election years can lose its S election if passive investment income exceeds 25 percent of its gross receipts for three consecutive years. The remedy is to pay taxable dividends to the extent of the old earnings. If all shareholders agree, an S corporation can elect to treat distributions to shareholders as taxable dividends to remove these pre-S election earnings. Those dividends will generally qualify for the maximum federal income tax rate of 15 percent. This rate is scheduled to expire at the end of 2010 and revert to the top individual income tax rate. Congress could act to reduce the dividend rate below the top individual rate in 2011, but that would require new legislation.

Annual Opportunity – Elective Capitalization under Treas. Reg. 1.263(a)-4(f)(7)
While the 12-month rule for eligible prepaids is a non-elective method, taxpayers do have the ability to annually elect to capitalize prepaids otherwise subject to the 12-month rule. The election is made by capitalizing the amounts with respect to all similar transactions during the tax year on the timely filed original federal income tax return (including extensions) for the tax year during which such amounts are paid. This is not considered a method change. For example, a taxpayer may elect to capitalize its costs of prepaying insurance contracts for 12 months, but may continue to apply the 12-month rule to its costs of entering into non-renewable 12-month service contracts. This provides taxpayers with the ability to increase taxable income to utilize expiring NOL carryforwards or to extend the period for credit carryforwards. In the case of a consolidated group, the election is made separately by each member and not for the group as a whole. In the case of an S corporation or partnership, the election is made at the entity level and not by the shareholders or partners. Once the election is made for a specific tax year, it is only revocable with the consent of the Commissioner. In addition, the election only applies to the tax year for which it is made. Thus, prepayments made in the subsequent tax year that are subject to the 12-month rule should be deducted, unless an election for a category of similar transactions for that year is made as well. 

Please contact your BC Engagement Executive or one of our tax partners below, if you have questions.
 
Ronald J. Manse, CPA
Corporate Tax & Succession Planning

Scott T. Warburton, CPA/PFS
Corporate, Individual & Estate Tax Planning

Gregory F. McNulty III, CPA, JD
Individual Tax & Estate Planning

David L. Groves, CPA
Corporate & International Tax Planning

Daniel R. Riemenschneider, CPA, CMA
Corporate & Individual Tax Planning