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JPM Provides you with the latest news and information from the financial services world. Please review the news and upcoming events below and do not hesitate to contact us for more information.
Casual Gambler Can Net Wins Against Losses on a Per Visit Basis
We all know gambling winnings are Other Income, while gambling losses are deductible on Schedule A but only up to the amount of winnings. Some tax professionals have interpreted the regulations to require each individual bet to stand on its own. Now IRS has addressed this issue a little more.
This Chief Counsel Advice (CCA), numbered EMISC 2008-011, from December 12, 2008, addresses the question: How does a casual gambler determine wagering gains and losses from slot machine play?
Facts presented: X, a casual gambler, visited the casino 10 times during the year. Each time X committed only $100 to slot machine play. She would exchange her $100 for slot machine tokens. She did not use cash, credit, or playerís cards to gamble. At the end of the visit X would redeem any remaining tokens for cash. Five visits resulted in entire losses of the $100s. The other five visits resulted in the following amounts of cash: $20, $70, $150, $200, and $300.
IRS position: X can net each visit because X has not accumulated any wealth until she redeems her tokens. As such, X has five losses of $100, plus losses of $80 ($100 less $20 cash out) and $30 ($100 less $70 cash out). X has three wins of $50, $100, and $200 (the cash outs less the original $100 starting amount each of these three visits). Therefore X has gambling winnings (income) of $350 to report and gambling losses of $610 which are limited to $350 (the amount of gambling winnings).
Editor comments: Does this mean if the tokens were taken home instead of being cashed out that X would be able to net the entire year? (We donít think IRS would be this liberal.) The CCA specifically states X does not use cash, credit, or players cards. Does this mean if these items were used instead of tokens that each bet stands on its own?
This text has been shared with you courtesy of: David & Mary Mellem, EAs & Ashwaubenon Tax Professionals
Cell Phone Recordkeeping Required
Occasionally a taxpayer with an IRS problem will ask for help from his/her congressional representatives. When this happens the representative may ask IRS for a response to the taxpayerís concerns. The IRS response may take the form of an INFO letter which is available to the public, after the taxpayerís name and identifying information has been removed. The recordkeeping of cell phone usage is the topic of INFO 2007-0030.
The taxpayer in this case is a government employer probably connected with an Emergency Medical Service department. The request was for information on the recordkeeping and income inclusion requirements for cell phone usage by employees. Following is a summary of the IRS INFO.
Employers frequently provide their employees with cell phones for business purposes. Section 280F(d) (4)(A)(v) includes cell phones as listed property. This was changed in 1989 based on Congressí belief that cell phones and similar telecommunications equipment are often used for personal or investment reasons rather than in the conduct of a trade or business.
The INFO letter states an employer can exclude the value of an employeeís use of an employer-provided cell phone from the employeeís income if the employer has some method of requiring the employee to keep records that distinguish business from personal phone charges and the employee uses the cell phone exclusively for business. If the phone is used for personal use, the cost of the individual personal calls, as well as a pro rata share of the monthly service charges must be included in the employee's wages. Section 274(d) requires the employee to keep a record of each call and its business purpose. If the employee receives a monthly itemized statement, the employee should identify each call as personal or business. If the employee does not use the cell phone to make personal calls, or has only minimal personal use of the cell phone, the business use of the phone is not taxable to the employee.
Charitable Contributions Denied Didn't Comply With Regulations
Internal Revenue Code section 179(f)(8)(A) and Regulation section 1.170A-13(f)(1) require taxpayers to have contemporaneous written acknowledgment for contributions of $250 or more in order for a charitable contribution deduction to be allowed.
Although IRS did not dispute the amount the taxpayer contributed to the church in this case, IRS denied most due to their failure to have the necessary records. Hereís the story.
During 2005 Mr.& Mrs. Gomez contributed almost $7,000 to charities, mostly to their church. Ten of the checks to their church totaled $6,100 and were over $250 each. They produced their checks and a letter from the church showing total contributions of $6,552.
Although IRS did not dispute the accuracy of the amounts and Tax Court felt the letter and canceled checks were reliable, the amount was disallowed. Tax Court agreed with IRS stating Mr. & Mrs. Gomez did not comply with the requirements of the IRC and regulations. Here is the Courts reasoning.
The verification letter from the church was dated January 22, 2008. IRC section 170(f)(8)(A) states the taxpayers must have a contemporaneous written acknowledgment from the organization received on or before the earlier of 1) the date their file their tax return for that year, or 2) the due date (including extensions) for filing such a return. Since the letter was dated January 22, 2008, it fails the timing requirement to be contemporaneous.
In addition to being contemporaneous the required acknowledgment of the contributions must state whether the charity provided any goods or services in consideration for the contributions and describe and set forth a good faith estimate of the value of those goods or services. The letter from the church apparently did not include such a statement or any such value.
This text has been shared with you courtesy of: David & Mary Mellem, EAs & Ashwaubenon Tax Professionals
Disaster Provisions in the Bail out Bill
As we said in our last email, the Bail Out Bills real name is the Emergency Economic Stabilization Act of 2008 (Public Law 110-343). The disaster provisions are also known as the Heartland Disaster Tax Relief Act of 2008.
Here are some of the highlights. For details and limitations check out the specifics, some of which are provided in IRS Publication 4492-B.
MIDWESTERN SEVERE STORMS, TORNADOS, AND FLOODING
Many of the benefits included in the Go Zone Act of 2005 are now extended to the Midwestern disaster area. This is defined as the area declared by the President as a Federally declared disaster area on or after May 20, 2008 and before August 1, 2008, by reason of severe storms, tornados, or flooding occurring in any of the states of Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, and Wisconsin. The specific counties are listed on IRS web site. Following are highlights of this portion of the bill. Most of these provisions apply to expenses from the date of applicable disaster date through 2009.
-- These benefits include increasing the education credit benefits for anyone attending school in the area. The Hope Credit increases to 100% of the first $2,400 of tuition and 50% of the second $2,400. The Lifetime Learning Credit increases from 20% of the first $10,000 of expenses to 40% of the first $10,000 of expenses. The qualified expenses are also changed to include room and board expenses for at least half time students.
-- Taxpayers can elect to treat 50% of clean-up costs as an expense instead of charging them to capital. (Any of these clean-up costs written off under this provision are treated depreciation under section 1245 when the property is sold.)
-- Costs related to cleaning up a qualified contaminated site damaged due to the disaster can be deducted when paid/incurred.
-- Increase in the Rehabilitation Credit from 10%/20% to 13%/26%.
-- NOL carryback period of 5 years instead of 2 years for the portion of the NOL due to the disaster. The normal AMT-NOL limitation of 90% of AMTI is suspended for this same portion.
-- Exclusion from income for lodging furnished in-kind to employees (including the employees spouse and dependents) by qualified employers, subject to limitations.
-- Distributions from retirement accounts of up to $100,000 are not subject to the 10% early distribution penalty. Amounts taken from IRAs to fund a home purchase or construction that was cancelled as a result of the storms can recontribute the amount without tax or penalty, subject to limitations.
-- Employer credit for retaining employees working in the disaster area.
-- Charitable contributions tied to the disaster area have an AGI limitation of 100% instead of the normal 50%. The charitable mileage rate for volunteers serving in the area is increased to 36 cents per mile from the disaster date to June 30, 2008; 41 cents per mile from July 1, 2008 through December 31, 2008.
-- Casualty losses are not subject to the 10% floor or $100 if they are in the disaster area.
-- EIC can be calculated using the prior years earned income instead of the current year if the priors earned income is higher than the current years.
-- Cancellation of certain debts is not income.
-- Provisions in the Go Zone Act which do NOT apply to the Midwestern disaster areas include the 50% bonus depreciation, the higher §179 expensing,
LOSSES ATTRIBUTABLE TO FEDERALLY DECLARED DISASTERS
Disasters occurring in other Federally Declared Disaster areas in 2008 or 2009 have special provisions including:
--Presidentially declared disasters are now called Federally declared disasters.
-- A net disaster loss portion of an NOL can be carried back five years instead of the normal two years.
-- A net disaster loss is not subject to the 10% of AGI floor.
-- The casualty loss floor increases from $100 to $500 for casualty losses after December 31, 2008 and before 2010.
-- Bonus 50% depreciation is allowed.
-- Section 179 expense maximum is increased by the cost of qualified disaster assistance property, but not more than $100,000. The phase-out range is increased by the amount of qualified disaster related purchases, but not more than an extra $600,000.
This text has been shared with you courtesy of: David & Mary Mellem, EAs & Ashwaubenon Tax Professionals
LLC Members and At-Risk Limitations
In the case of Hubert, Tax Court ruled the members of an LLC taxed as a partnership are not able to use a deficit capital account restoration provision for purposes of the at-risk test.
BACKGROUND
Taxpayers are allowed to claim losses from business and investment activities only if the taxpayers are at risk for the losses. This at-risk limitation normally includes amounts the taxpayer has invested in the activity and other amounts the taxpayer is considered at-risk for. In the case of an entity taxed as a partnership, the at-risk amount includes the taxpayerís share of recourse debts and qualified nonrecourse debts, but does not include other (nonqualified) nonrecourse debts. In the case of an S corporation, the taxpayer is considered at-risk for any loans made by the taxpayer directly to the S corporation, but is not considered at-risk for any other debts of the S corporation even if the taxpayer personally guaranteed them.
The at-risk treatment of debts incurred by an LLC has been discussed many times in many ways and often in disagreement with other discussions. One reason for the various discussions is due to the fact that an LLC is not a tax status for the activity, but is a legal status granted under state law. The tax status is determined by IRS default rules and election opportunities.
A single member LLC (SMLLC) is by default a disregarded entity. As such the owner of the SMLLC reports the income on the owners return as if the owner received the income and expenses of the SMLLC directly. For an individual this means the income and expenses are reported on a Schedule C if the activity is a business and the normal Schedule C rules are followed. If the SMLLC is a farm, a Schedule F is filed and the normal Schedule F rules are followed.
A multiple member LLC (MMLLC) is by default a partnership. As such, a partnership return (Form 1065) is filed and the partnership rules are followed.
Either a SMLLC or a MMLLC can ELECT to be taxed as a regular corporation (Form 1120) or an S corporation (Form 1120S). In these cases the LLC follows the tax rules pertaining to the particular corporation status elected.
Since the normal tax rules are followed based on the LLCs tax status, the at-risk amount for members of the LLC are also followed. For example, if the LLC has elected to be taxed as an S corporation, the LLC member is only at-risk for investments the member has made to the LLC plus loans made directly from that member to the LLC.
HUBERT CASE
This LLC was taxed as a partnership. There were many debts at the LLC level. Some of the debts were recourse and some were nonqualified nonrecourse. The members amended the LLCs operating agreement to include a deficit capital account restoration (DCAR) provision that requires each LLC member to contribute to the LLC an amount equal to the amount of that memberís deficit capital account that exists on the date the LLC liquidates.
IRS denied the LLC members any at-risk amount for any of the nonqualified nonrecourse debts. In court the LLC took the position the DCAR provision made the members liable for the entire debts of the LLC including the nonqualified nonrecourse.
Tax Court ruled in favor of IRS. The court took the position the DCAR did not give the nonrecourse creditors the right to pursue any LLC members unless two conditions were met: 1) the LLC liquidated, and 2) the LLC member had a negative capital account. Nor did the DCAR give the creditors the right to force the LLC to liquidate. Further the DCAR did not require any LLC member to contribute enough to satisfy any particular debts, but merely to contribute enough to cover that memberís negative capital account. The DCAR also contained a provision that permitted the LLC to transfer the additional contributions to the members who had positive capital accounts. Therefore Tax Court ruled the LLC members did not have at-risk amounts for the nonqualified nonrecourse debts of the LLC.
[This case should help solve the previous conflicting positions regarding at-risk for LLC members. Based on this case members of an LLC taxed as a partnership are only at-risk for the recourse and qualified nonrecourse debts of the LLC. Likewise, members of an LLC taxed as a S corporation should only be treated as at-risk for debts the LLC member personally lent to the LLC.]
Hubert Enterprise, Incorporated, Successor by Merger to Hubert Holding Company, TC Memo 208-46. A copy of this case can be found at www.ustaxcourt.gov by clicking on Opinions Search in the header area and then entering Hubert in the case name. We can also send you a PDF copy of this 19 page case attached to an email upon request.
This text has been shared with you courtesy of: David & Mary Mellem, EAs and Ashwaubenon
Part I: New Regulations Regarding Form 8332 Including Revocability
Before we get into the changes involving the definition of a custodial parent and the revoking of a Form 8332, here are two paragraphs briefly discussing the prior rules.
Back in 1984 Congress changed the rules involving a noncustodial parentís right to claim a child as a dependent. The rules basically state the custodial parent has the right to claim the child. They further state the noncustodial parent can claim the child as a dependent when the custodial parent signs Form 8332 or a statement that says the same thing.
Divorce decrees often have a provision that states something like (name of noncustodial parent) can claim (name of child) as a dependent for tax purposes for (identified years). Form 8332 generally states ** I will not claim _____________ for the tax year _____. ** The divorce decree wording we used here is not the same as the Form 8332 wording. Some taxpayers have used the divorce decree as the authority to claim the child even though the wording is different. The courts have generally enforced the requirement to have a Form 8332 or similar statement.
NOW IRS HAS RELEASED NEW REGULATIONS DEALING WITH THIS ISSUE
New Regulation 1.152-4 states the child is a qualifying child for parent with whom the child resides for a longer period of time during the taxable year. It further states if the child resides with both parents for an equal period of time, [the child is treated as the qualifying child] of the parent with the higher adjusted gross income.
A noncustodial parent can claim the qualifying child if the custodial parent provides a proper release.
The custodial parent is now defined as the parent with whom the child resides with for the greater number of nights during the calendar year. No longer will this be determined based on the number of days, but now it is based on the number of nights.
Further a child is not considered residing with either parent starting with the date the child is emancipated under state law (reaches the age of majority). Therefore a child who reaches the age of majority on or before the day after the half-way point of the year (normally July 3) will not be in the custody of the parents for MORE THAN ¬Ω of the year.
RESIDE A child is deemed to reside with a parent if the child sleeps:
1) At the residence of that parent (whether or not the parent is present), or
2) In the company of the parent, when the child does not sleep at the parents residence (such as when on vacation together).
OVERLAPPING NIGHT if the night overlaps two taxable years, such as December 31st, the night is counted towards the year it begins (December).
ABSENCES if the child does not reside with either parent for a night, the child is considered to be residing with the parent with whom the child would have resided for the night. This is true even if the parent with whom the child would have resided is away on military duty. If it cannot be determined which parent the child would have resided with for the night, the child is deemed to be residing with NEITHER parent for that night.
EQUAL NIGHTS if the number of nights is equal; the parent with the highest AGI is the custodial parent for that year.
EXCEPTION if a child resides with one parent for a greater number of days, but not a greater number of nights; DUE TO THE PARENTS NIGHTTIME WORK SCHEDULE, this parent is deemed to be the custodial parent. For this purposes, on school days, the child is deemed to be residing during the day with the primary residence registered with the school.
RELEASE OF EXEMPTION TO NONCUSTODIAL PARENT
As provided in the Internal Revenue Code, the new regulation permits the custodial parent to release the exemption to the noncustodial parent. However the method has changed slightly. The changes are partly due to the results of Court cases and comments from the public and tax professionals.
The custodial parentís release of the exemption must name the noncustodial parent, the year or years for which it is effective. A release that states all future years is treated as starting the year AFTER the year the release is signed. Therefore if the release is to be effective earlier, it must specify the year.
This release can be accomplished by the use of Form 8332 or by the custodial parent providing a written declaration that is an UNCONDITIONAL release. A release is NOT unconditional if the release has ANY conditions, such as having to be current in support payments. This written declaration must conform to the substance of the Form 8332 and also must be a document executed for the SOLE PURPOSE of serving as a written declaration. The regulations further state a court order or decree of a separation agreement may not serve as a written declaration. Again, court cases have repeatedly denied the exemption to the noncustodial parent based on divorce decrees because their wording does not conform to the Form 8332, so this last statement in the regulation is understandable. Written declarations issued on or before July 2, 2008, are still effective in the future as long as they were effective when written.
The Form 8332 or written declaration must be attached to the NONCUSTODIAL parentís return for each year the noncustodial parent claims the child.
REVOKING FORM 8332
The custodial parentís release of the childís exemption to the noncustodial parent can be revoked. Previously IRS gave us a ruling that stated a revocation can be accomplished by the noncustodial parent not claiming the child AND the custodial parent claiming the child. Now we have new rules.
The custodial parent can revoke a previous release by providing written notice of the revocation to the noncustodial parent. This revocation is effective for the year designated on the revocation, but not earlier than the year AFTER the year the revocation is provided to the other parent. In other words a revocation provided during 2008 can be effective no earlier than 2009. The custodial parent must make reasonable efforts to provide actual notice to the other parent AND must keep the evidence of the delivery of the notice to the other parent. It may be a good idea to have the custodial parent mail the revocation using CERTIFIED MAIL as proof of the fact that the revocation was sent and the date it was sent.
The revocation can be made using Form 8332 (as revised) or a written declaration that conforms to the substance of the Form 8332. The written declaration again must be a document executed for the SOLE PURPOSE of serving as a revocation. A revocation that does not specify a year is not a valid revocation. A revocation that states all future years will be treated as effective the year following the year the revocation is properly executed and all future years.
The Form 8332 or written declaration revoking the release must be attached to the CUSTODIAL parents return for each year the custodial parent claims the child and a copy of the revocation and evidence of delivery of the notice to the other parent or the reasonable efforts to provide actual notice.
These revocation procedures are effective to revoke any release of exemptions including ones from prior years. Written release declarations issued on or before July 2, 2008 can also be revoked under these new procedures.
This text has been shared with you courtesy of: David & Mary Mellem, EAs & Ashwaubenon Tax Professionals,
Part II: 8332 Revocation Due by Dec 31, 2008 to Be Effective for 2009 Tax Return
In order to be effective for 2009 tax returns this statement must be filed by December 31, 2008. Read on.
Last July we sent out an email regarding the new regulations dealing with the custodial parental release of a childís dependency exemption to the noncustodial parent through the use of the Form 8332 AND its revocability. At that time we discussed the revocability procedures.
In order to revoke a previously completed Form 8332 the taxpayer has to complete the revocation portion of the new Form 8332 OR use a statement that states the same thing. Also the revocation is only effective for a year(s) AFTER the date it is signed and sent to the noncustodial parent. In other words in order for the custodial parent to effectively revoke a previously completed Form 8332 for the 2009 tax return, the revocation has to be signed by the custodial parent and mailed (such as through certified mail) to the noncustodial parent on or before December 31, 2008.
Now IRS has released the Draft version of the new Form 8332. The version has not been finalized yet. However it should (should) be sufficient to have the custodial parent send the noncustodial parent a letter using the same wording as on this draft form. The wording says to revoke the release of claim to an exemption for _____(name of child)______ for the tax year(s) ____(specify year(s))_____. It also requires the custodial parentsí signature, the custodial parents SSN, and the date. We recommend this statement be mailed by certified mail w/return receipt so there is proof of the mailing & delivery.
This text has been shared with you courtesy of: David & Mary Mellem, EAs & Ashwaubenon Tax Professionals
Standard Mileage Rates for 2009
Instead of using the business portion of the actual expenses of operating a vehicle, the IRS permits taxpayers to use a standard mileage rate. IRS has issued new rates that are effective for travel on or after January 1, 2009.
Business rate is 55 cents per mile (down from the 58.5 cents per mile from 7/1/08-12/31/08).
Charitable rate is 14 cents per mile and is set by Congress therefore does not change until Congress makes such a change.
Medical and moving rate is 24 cents per mile (down from the 27 cents per mile for 7/1/08-12/31/08).
This text has been shared with you courtesy of: David & Mary Mellem, EAs & Ashwaubenon Tax Professionals
Mortgage Forgiveness Debt Relief Act of 2007 Signed into Law
The AMT act we sent out probably affects themost taxpayers, but this one has the most changes. Here are the highlights of the changes included in this Mortgage Forgiveness Debt Relief Act of 2007.
1) MORTGAGE DEBT RELIEF
Another exclusion has been added to IRC Section 108 for nontaxable debt discharge (bankruptcy, insolvency, qualified farmer, and qualified real estate). This new one excludes from income any indebtedness discharged that is “qualified principal residence indebtedness.” This is defined as acquisition indebtedness associated with a taxpayer’s principal residence.
The definition of “acquisition indebtedness” is the same as found in IRC Section 163 on mortgage interest, except this is only on the principal residence – not on the vacation home. It does not include equity indebtedness. If an acquisition indebtedness has been refinanced and the new loan has since been forgiven, this exclusion only applies to the acquisition indebtedness portion of the debt. The ceiling on acquisition indebtedness for this relief purpose is $2,000,000 (instead of the $1,000,000 ceiling on the debt for interest deductibility).
Any discharge that is nontaxable under this provision reduces the taxpayer’s basis in the principal residence, but not below zero. In other words, the taxpayer will have a smaller basis for the future which also means a larger gain upon the sale of the residence. (The sale of residence exclusion rules will still apply as normal, except for a new change – read on.)
This exclusion, “qualified principal residence indebtedness”, is used after the bankruptcy provision and before the insolvency provision unless the taxpayer ELECTS to apply the insolvency first.
This exclusion is NOT available to a taxpayer who has the debt reduced due to providing services for the lender or any other factor not directly related to a decline in value of the residence or to the financial condition of the taxpayer. In other words the property has to decrease in value or the taxpayer has to have a particular financial condition that caused the debt to be reduced. (A change in income would probably be a “financial condition”, but would the interest rate going up be considered a “financial condition”? This exclusion is effective for discharges after December 31, 2006 and before January 1, 2010. Therefore this affects calendar year taxpayers for 2007-2009.
2) MORTGAGE INSURANCE PREMIUMS
The one year window to deduct mortgage insurance premiums (2007) has been extended and now covers the years 2007-2010. Therefore this affects calendar year taxpayers for 2007-2010.
3) COOPERATIVE HOUSING CORPORATION
The definition of a cooperative housing corporation has changed for purposes of Section 216(b)(1)(D) to read:
“(D) meeting 1 or more of the following requirements for the taxable year in which the taxes and interest described in subsection (a) are paid or incurred:
--(i) 80 percent or more of the following requirements for the taxable year is derived from tenant-stockholders.
--(ii) At all times during such taxable year, 80 percent or more of the total square footage of the corporation’s property is used or available for use by the tenant-stockholders for residential purposes or purposes ancillary to such residential use.
--(iii) 90 percent or more of the expenditures of the corporation paid or incurred during such taxable year are paid or incurred for the acquisition, construction, management, maintenance, or care of the corporation’s property for the benefit of the tenant-stockholders.”
This may make it easier for owners to be able to claim an itemized deduction for real estate taxes on the cooperative property. This provision is effective to taxable years ending after December 20, 2007. (Yes we did say December “20”, 2007.)
4) VOLUNTEER FIREFIGHTERS AND EMERGENCY MEDICAL RESPONDERS
Any amounts received under any qualified State and local tax benefit, and any qualified payment does not have to be included in the income of a volunteer firefighter or emergency medical responder’s income.
The “qualified State and local tax benefit” is any reduction or rebate of a tax provided by a State or political division on account of services performed as a member of a qualified volunteer emergency response organization.
The “qualified payment” is any payment (whether reimbursement or otherwise) provided by the State or political division on account of the performance of services as a member of a qualified volunteer emergency response organization, but not to exceed $30 per month.
Any expenses relating to their activities are reduced by the excluded income, with the remaining amount allowed as a charitable contribution deduction.
This provision is effective with taxable years beginning after December 31, 2007 & before January 1, 2011. Therefore this affects calendar year taxpayers for 2008-2010.
5) SALE OF RESIDENCE EXCLUSION FOR SURVIVING SPOUSE
The maximum amount of sale of residence exclusion (Section 121) for a surviving spouse is $500,000 instead of $250,000 if the sale is not later than 2 years after the date of death of the deceased spouse. The tests of Section 121(b)(2)(A) have to have been met in regard to the deceased spouse immediately before the date of death. This means either of the spouses has to have owned the property for at least 2 out of the most recent 5 years immediately before the date of death AND both of the spouses have to have used the property as their principal residence for at least 2 out of the most recent 5 years immediately before the date of death AND they also cannot have used the Section 121 exclusion for another principal residence sold with 2 years before or after the date of death.
This provision is effective for sales and exchange after December 31, 2007.
6) PENALTY FOR NOT FILING PARTNERSHIP RETURN
The penalty for not filing a partnership return has changed from $50/month/partner with a maximum of 5 months to $85/month/partner with a maximum of 12 months. For example, a partnership that is filed over 1 year late and has 2 partners would have a maximum penalty of $500 ($50 x 2 partners x 5 months) for its 2006 return. This same partnership will have a maximum penalty of $2,040 penalty ($85 x 2 partners x 12 months) for its 2007 return if it is again over 1 year late. (This is ignoring any provisions that permit abatement of the late filing penalties.)
This provision is effective with partnership tax returns with due dates after December 20, 2007.
7) PENALTY FOR NOT FILING S CORPORATION RETURN New IRC Section 6699 imposed a penalty for failing to file an S corporation tax return. The penalty is the same as the revised penalties for failure to file partnership returns as shown above ($85/month/shareholder).
This provision is effective with S corporations returns with due dates after December 20, 2007.
8) CORPORATION ESTIMATED TAX PAYMENTS The corporation estimated tax payment due in July, August, and September, 2012 is increased to 114.75% of the otherwise amount due. This applies to corporations with assets of at least $1 billion.
Strategies for Surviving Spouses Designated as Beneficiaries of Decedent’s IRA’s
Beneficiaries of IRAs (or qualified plans) are well advised to get expert tax advice before taking action on their inheritance. As the Tax Court’s recent Gee decision illustrates, that is particularly true for spousal beneficiaries, who have more tax saving choices (and potential pitfalls) than other beneficiaries. In Gee, a spouse-beneficiary who rolled over her deceased husband’s IRA into her own IRA and then took a distribution wound up paying a penalty tax of $97,800 that she easily could have avoided without diminishing any of her other tax saving options. This explains the tax-saving avenues open to individuals who inherit IRAs from their deceased spouses.
Unique choices. If a taxpayer dies before exhausting the balance in his IRA, and his spouse is the sole designated beneficiary of the account, the spouse-beneficiary can simply leave the account as-is or may choose to roll over the descendant’s IRA into her own IRA or elect to treat the IRA as her own for all purposes, including the Code Sec. 72(t) rules for pre-age-591/2 withdrawals. The rollover or election is not available to non-spouse beneficiaries.
Whether the rollover or election should be made by the surviving spouse (and when) depends on the surviving spouse’s age.
Surviving spouse age 59 ½ or older.
The surviving spouse-beneficiary of an IRA who is age 59 1⁄2 or older has much to gain and little to lose by making this choice:
…By making the rollover or election, the surviving spouse can name her own beneficiaries for the IRA and thus give the IRA a longer life-span. I the surviving spouse dies before the IRA is depleted, the balance will be paid over her beneficiary’s life expectancy. By contrast, if the rollover or election isn’t made, the balance remaining in the IRA when the surviving spouse dies will be paid over what remains of the surviving spouse’s life expectancy.
…After the rollover or election, the receiving IRA is treated as if the surviving spouse has funded it. That means the surviving spouse can compute RMD’s (required minimum distributions) using the Uniform Lifetime Table for IRA owners, The Uniform Lifetime Table carries longer life expectancies and therefore results in smaller annual RMD’S and a longer payout period than the Single Life Table.
…With the rollover or election, the required beginning date (RBD) for distributions in April 1 of the year following the year in which the surviving spouse attains age 70 1⁄2. By contrast if the IRA remains in the decedent’s name, he died before his RBD, and the IRA permits lifetime distributions to the beneficiary, minimum distributions must begin by the later of (1) Dec. 31 of the year following the year in which the decedent would have attained age 70 1⁄2 had he or she lived. Thus, a surviving spouse who is younger than the decedent can arrange for longer deferral by making the rollover or electing to treat the decedent’s IRA as her own.
√ Observation: The Uniform Lifetime Table produces smaller annual payouts and a longer-lived tax shelter for a designed spouse beneficiary even if he or she is exactly the same as the decedent.
√ Illustration: When an IRA owner dies at age 69 is 2006, the designated beneficiary of the account is his surviving spouse, also age 69. The IRA’s balance of Dec. 31, 2005 was $500,000. The surviving spouse attains age 70 1⁄2 and also turns age 71 in 2006, which is the first distribution calendar year for RMDs.
…If the surviving spouse elects to treat the decedent’s IRA as her own, the RMD for 2006 is $18,868($500,000/26.5, which is the Uniform Lifetime Table life expectancy for a 71-year-old).
…If the surviving spouse does not elect to treat the decedent’s IRA as her own, the RMD for 2006 is $30,675 ($500,000/ 16.3, which is the Single Life Table life expectancy for a 71-year old).
Surviving spouse much younger than 59 1⁄2.
If the surviving-spouse beneficiary is much younger than age 59 1⁄2 , the spousal rollover or election to treat the decedent’s IRA as the surviving spouse’s IRA could have a significant disadvantage: Once the rollover or election is made, pre-age-59 1⁄2 withdrawals from that IRA generally will be subject to the 10% penalty tax on top of regular income taxes. By contrast, if the spousal rollover or election is not made, pre-age-59 1⁄2 withdrawals from the decedent’s IRAs are not subject to the penalty tax. Under Code Sec. 72(t)(2)(A)(ii), distributions made to a beneficiary (or estate) on or after the death of the IRA owner are excepted from the 10% penalty tax. Thus, if the surviving spouse knows he or she will have to tap the decedent’s retirement funds before attaining age 59 1⁄2, the rollover or election will result in unnecessary tax erosion.
√ Observation: Under Code Sec. 72(t) (2)(E), pre-age-591/2 withdrawals are free of the penalty tax if they don’t exceed qualified higher education expenses during the withdrawal year. To the extent that the surviving spouse plans to use pre-age-59 1⁄2 payouts from the decedent’s IRA to pay for college expenses, there would be no disadvantage to rolling over the decedent’s IRA into his or her own IRA.
√ Recommendation: A young surviving spouse who may need to tap the funds before he or she attains age 59 1⁄2 should keep the entire IRA balance in the decedent’s name until the spouse attains that age. This way, any withdrawals from the IRA before that age will be penalty-tax-free. When the spouse attains age 59 1/2 , he or she can roll over the IRA into an IRA in the spouse’s own name.
A surviving spouse beneficiary’s election to treat the decedent’s IRA as her own may be made any time after the account owner’s death.
√ Observation: Thus, if the IRA owner died before RMDs began (and as a result there was no minimum payout for the year of death), the surviving spouse can make the election in the year of death or at any time after that year, even in the survivor previously withdrew funds from it.
Older surviving spouse beneficiary. If the surviving spouse-beneficiary is substantially older than the deceased IRA owner, it will be difficult to choose between making and skipping the election.
…Making the election will accelerate the required beginning date for distributions. For example, assume Anne designated her husband, Al, as the beneficiary of her IRA. Al is exactly ten years older than his wife. Anne dies this year at age 61. If he makes the election, Al will have to begin taking RMD’s immediately. If Al leaves the IRA in Anne’s name, payouts from it can be deferred for another ten years.
…If the election is not made, the surviving spouse won’t be able to name his or her own beneficiaries for the IRA, and thereby defer payouts after the surviving spouse’s death over the beneficiary’s Single Life Table life expectancy.
Client Newsletter Explains Recent Developments That May Affect a Client’s Tax Situation
The following is a summary of the most important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.
New tax reconciliation act. The “Tax Increase Prevention and Reconciliation Act” (TIPRA) was signed into law by the President on May 17, 2006. The most talked about provisions in this law were the short term alternative minimum tax relief for 2006 and the extension of the current low-taxed capital gains and dividends rate that was due to expire about 2008. However, it also carried a number of other changes affecting individuals and business, and included corporate and foreign provisions, technical corrections and extensions of several provisions. Some of these are:
…kiddie tax age limit raised from under 14 to under 18 for tax years beginning after Dec. 31, 2005.
…income limit on Roth IRA conversions eliminated for tax years beginning after Dec. 31, 2009.
…extensions of increased Code Sec.179 expensing for small business through the end of 2009.
…modification of the 50% W-2 wage limit on the Code Sec. 199 domestic production deduction, effective for tax years beginning after May 17, 2006.
…information reporting required for tax-exempt interest after Dec. 31, 2005.
…changes for corporate estimated tax payments due on Sept. 15, 2010 and Sept. 15, 2011.
…capital gain treatment allowed for self-created musical works at the taxpayer’s election for a pre-Jan. 1. , 2011 sale or exchange in tax years beginning after May 17, 2006.
…amortization of expenses paid for musical works and copyrights for tax years beginning after Dec. 31, 2005 and before Jan. 1, 2010.
…the active business test for a tax-free corporate spin-off is simplified for distributions made after May 17, 2006 and before Jan. 1, 2010.
…changes (some not favorable to taxpayers) to the foreign earned income exclusion and housing allowance for U.S. citizens working abroad for tax years beginning after Dec. 31, 2005.
Military tax relief law. On May 29, 2006, the President signed the “Heroes Earned Retirement Opportunities Act” (HERO Act) into law. The HERO Act allows excluded combat pa to be treated as compensation for purposes of the individual retirement account (IRA) contribution rules. Most individuals who received excluded combat pay in 2004 or 2005 have until May 28, 2009 to make a IRA contribution for either or both of these years.
Code Sec.199 final regs and other guidance. The IRS has issued a barrage of new guidance on the Code Sec. 199 domestic production activities deduction, including final regs, temporary regs, and a new revenue procedure. This deduction, which has attracted much criticism, commentary, and several waves of interim guidance since it was added to the Code by the 2004 Jobs Act is 3% (for 2006; 6% through 2009; and 9% thereafter) of the lesser of a taxpayer’s qualified production activities income or taxable income, subject to a 50% of W-2 wages limitation. The long-awaited final regs, tough complex, carry a number of liberalizations, simplifying conventions, and examples. The guidance provides major breaks for the soft-ware and construction industries. Where either of two fairly broad exceptions to the general rules is satisfied, the IRS, reversing its previous position, allows gross receipts from providing software for a customers’ direct use while connected to the Internet to be treated as derived from a qualifying disposition. The IRS also broadens the definition of qualifying construction activities, allowing gross receipts derived from materials and supplies consumed in a constructions project to be included in domestic production gross receipts form the construction of real property.
The IRS concedes on long-distance telephone exise tax. The IRS, after repeatedly losing in one court after another, has finally conceded that the federal exise tax doesn’t apply to long-distance calls for which the charges are computed on an elapsed time basis regardless of distance. Taxpayers no longer have to pay the tax and can request a credit or refund under the terms of an IRS notice for amounts paid for service billed to them after Feb. 28, 2003 and before Aug. 1, 2006. Remarkably, the IRS has also conceded that the excise tax doesn’t apply with regard to Voice over Internet Protocol service, prepaid telephone cards, and plans that provide both local and long distance service for either a flat monthly fee or a charge that varies with the elapsed transmission time-all issues that the IRS hasn’t repeatedly litigated and lost. Individuals (including Schedule C filers), but not other taxpayers, can request a refund or credit using either the actual amount of tax paid for services or use a safe harbor amount (which the IRS has yet to specify).
How to revoke an election not to defer income. Generally, an employee or independent contractor is taxed on property received in connection with the performance of services only when the property is either not subject to a substantial risk of forfeiture, or is transferable to a third party free of this risk. However, a person may instead elect under Code Sec. 83(b) to include the income from the transfer for the year in which the property is received. The Code Sec. 83(b) election subjects an employee to immediate tax liability, but any increase in the value of the property after its receipt and up to the time its disposal is taxed as capital gain. The IRS has explained how to request its consent to revoke a Code Sec. 83(b) election not to defer income from restricted stock or property. While the formalized procedures basically leave the existing rules unchanged, they underscore how care must be taken by a taxpayer making the Code Sec. 83(b) election because circumstances in which the IRS will allow it to be revoked are relatively narrow. In a market that suddenly declines, an electing employee can find that he’s paid tax on property (e.g., stock) that’s worth less than when he made the election, or worse, is worthless, with the result that he’s not only paid tax sooner but that he’s paid more tax then he would have at a later point in time. Once elected, undoing the election isn’t easy.
Interest on S corporation’s overpayment. In general, the interest rate on a tax over payment by a corporation is the federal short-term rate, plus two percentage points. However, to the extent that a tax overpayment by a corporation for any tax period exceeds $10,000, the interest rate for such a “large corporate overpayment” is the federal short-term rate plus 0.5 percentage points. The Tax Court has held that the interest on an S corporation’s refund wasn’t limited to the rate applied only to C corporations, and not S corporations. However, the Court also said that the S corporation wasn’t entitled to the higher overpayment rate for noncorporate taxpayers-the federal short-term rate, plus three percentage points.
Ford, Honda, and Toyota vehicles qualify for the alternative motor vehicle income tax credit. The IRS has said that the various model years of the Ford Escape Hybrid, Mercury Mariner Hybrid, Honda Civic Hybrid, Honda Insight, Honda Accord Hybrid, Toyota Prius, Toyota Highlander, Toyota Camry, Lexus GS 450TH and Lexus RX400th qualify for the alternative motor vehicle income tax credit. The credit amount may be as much as $3,400 for a hybrid vehicle. Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th vehicle. Additional phaseouts apply to later periods. The IRS’s sales report for the first quarter indicate the Ford and Toyota haven’t hit this limit yet and that their customers may continue to claim the full Code Sec. 30B alternative motor vehicle credit at least through Sept. 30, 2006.
Plan Now to Avoid Dealer Status for “Investment” Land
This explains how the increased involvement of real estate investors in land they own unintentionally turn their capital gains into ordinary income unless they take appropriate steps to solidify investor status.
The problem. By being classified as a dealer in real estate, a taxpayer can owe at least double the tax an investor would have paid. Without proper knowledge and planning, an “investor” can fall into the “dealer” trap even before Uncle Sam asks why the investor reported the gain as long-term capital gain. To incur self-employment taxes on his or her “dealer” income. Proper classification depends on a subjective analysis of all the facts and circumstances. Fortunately for the taxpayer, planning can help structure the “facts” and circumstances” in his or her favor.
Growing concern. Why is this classification issue more of problem today? While the dealer versus investor issue has been the subject of many tax controversies over the last 50 years, the manner in which real estate progress from investment to development (investor to user) has significantly changed in recent years. In high growth areas of our country, the old investment scenario of buying a chunk of undeveloped land (raw land), holding it for many years until the growth pattern of the communities nearby caught up, and then selling the chunk to a homebuilder who would convert it into usable plats, lots, or subdivisions is no longer viable. Today, homebuilders and shopping center developers are “just in time” inventory control mechanisms (just like their manufacturing brethren) to control their supply of ready-to-build lots. Meanwhile, governments have matured in their regulatory processes so that it is very difficult for the unsophisticated investor to make much out of his chunk land.
The result is the size of such chunks are increasing, the number of speculative investors are decreasing, and those that remain must do much more to advance the status of their property as a maturing investment. Raw land investing has become almost as sophisticated as “going public” in the corporate world. Just as in the corporate world, more time, planning, and sophisticated knowledge (requiring more money) are necessary ingredients. The upside is that the numbers are larger, but so is the incentive for the IRS to challenge the “investor’s” status.
Legal principles. The operative Code provision is Code Sec. 1221(a)(1). It defines the term “capital asset” as property held by the taxpayer (whether or not connected with the taxpayer’s trade or business), but expressly excludes, among other items, “property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.” The U.S. Supreme Court has noted that the purpose of this provision is to differentiate profits and losses arising from the everyday operation of a business on the one hand, and the realization of appreciation in value accrued over a substantial period on the other.
The decision that perhaps best illustrates the attributes that need to be examined is Fraley, where the Tax Court confirmed the “attribute” laundry list that needs to be examined to determine the owner’s intent. This list of attributes was detailed in a series of Sixth Circuit decisions issued in the late ‘70’s, in which the court upheld the axiom that, “whether land is held primarily for sale to customers in the ordinary course of a taxpayer’s trade or business is a purely factual determination.” The ’93 Fraley case merely reconfirms these attributes. They are:
1) The purpose for which the property was acquired.
2) The purpose for which the property was held.
3) The extent of improvements made to the property.
4) The frequency of sales.
5) The nature and substantiality of the transactions.
6) The nature and extent of the taxpayer’s dealings in similar property.
7) The extent of advertising to promote sales.
8) Whether the property was listed for sale either directly or through brokers.
No one attribute is clearly determinative of the holding intent. Rather, all of the attributes are weighed with consideration of the importance or applicability of each.
More recent clarification. One recent Tax Court case and three very recent private letter rulings (all favorable for the taxpayer) add much improved definition to the interpretation of dealer versus investor in light of today’s real estate cycle.
In Phalen, the Tax Court applied the taxpayer’s factual situation to the attributes in its previous Fraley decision and to several other Tax Court and circuit decisions dealing with specific individual factual attributes. It further considered the factors articulated by the Tenth Circuit, to which this case would be appealed. The activities articulated in Phalen are very similar to those an investor may have to undertake today to maximize the value of his investment without crossing the line to engage in “dealership.” The Phalen attributes include:
…The owners of the development entity (some of whom were real estate developers in their other activities and owned their interests in the same percentages as investors) did not taint the taxpayer partnership’s investment status.
…A guarantee by the investment partnership of the performance of the development agreement with the municipal improvement district was not fatal.
…The investment partnership succeeded to rights under the master plan and the development agreement put in place by the former bankrupt developer/owner, and assumption of these rights did not taint the investment purpose.
…The sale of multiple tracts to different buyers (who also were developers) over four years, in this case, was acceptable.
…The investment partnership’s participation in financing the activity of the developer who was the buyer and financing the municipal improvement district (which was obligated to construct the improvements) was not fatal.
…Soil testing to evaluate the development alternatives for the property was acceptable.
…The investor partnership’s participation in amended and final site plans was acceptable.
…All corporate and partnership formalities were carefully followed-even between related investor/dealer entities.
…Good business reasons existed for the sale to related (through ownership) development entities and for structuring of activity among the investment partnership, municipal improvement district, and the financing.
…The individuals, personally, were not real estate brokers or agents.
…All sales were unsolicited.
…”Development” activities (in this context, physical improvements) were not directly undertaken by the investor partnership.
Three recent private letter rulings reveal how IRS views activities that owners undertake in their “maturing” real estate investment markers. The three rulings were issued to tax-exempt organizations that were concerned their investment activities would classify them as dealers, thus yielding unrelated business income tax. While the specific issue was UBIT, IRS essentially had to examine the organizations’ real estate attributes to determine if they were investors or dealers. If an organization was an investor, the gain would not be UBIT. The facts considered by IRS as positive or negative on the issue are instructive of how it might view a client’s specific facts.
In IRS Letter Ruling 200510029, the sale of nine land parcels was not unrelated business income. The charity, a school for disadvantaged children, owned farmland which was no suitable for development. The facts examined by IRS include:
…The proposed buyers would bear the cost of the site plan and improvements. (The discussion there by IRS seems to imply it is concerned with “physical” not “paper” improvements.)
…They will use a passive, patient, market approach.
…The historic use of the land was for farming, an activity related to the school’s exempt purpose.
…The parcel was too large to sell to one buyer to “receive maximum value”. (This implied that the investor could maximize value by selling to multiple buyers in different market segments.)
…Multiple sales would allow the seller to “control the pace and type of development.”
…The buyers (developers) were responsible for on-site and off-site construction activities.
…No improvement was required to make the property more attractive for sale. Utilities already abutted the site. (This implies again that IRS is concerned about physical improvements.)
…The buyer would plat the subdivision of the lots.
…There was a definitive change in ability to use the land for farming resulting in a “surplus land” status.
The taxpayer in IRS Letter Ruling 200242041 was a religious school situated on a portion of the land to be sold. The land had been held for a long time. Attributes examined in this positive (for the taxpayer) ruling include:
…This portion of the land was not suitable for school purposes (i.e. surplus property)
…The parcel (45 acres) had to be divided in order to sell and maximize the gain.
…A roadway needed to be constructed for access to the parcel, which was to be subdivided into three residential lots. The charity proposed to build the roadway, drainage, landscape, and trails are required by the township in which the parcel was located, and the charity was required to enter into a subdivision agreement with the town.
…No active marketing would occur, although the charity may list with a realtor, if necessary, after a period of “self marketing.”
…The charity has no history of subdividing real estate.
…In IRS Letter Ruling 200530029, a private foundation received, over time, various parcels of unimproved land from its founder, including several from his estate. Again, they were too large for most single buyers. IRS examined the following attributes in ruling for the foundation:
…The parcels were to be subdivided into lots no smaller than 20 acres each.
…A passive marketing approach was to be used. The foundation would attempt to sell through its prospectus sent to interested parties (sounds like a sales flyer/brochure). (Note that the passive marketing approach that appears in all three rulings and several cases.)
…There would be a maximum of two sales per year over 20 years. (Is that good or bad? Could one not say they were regularly carrying on a trade or business?)
…The foundation performed land planning and preliminary engineering to determine how to maximize the value of its investment.
…All parcels were sold to developers.
…The word “improvement” is connected to “construction” to connote a physical change in the property, not a paper change.
Conclusion. The dealer versus investor issue with regard to real estate recently has become the object of more attention because of the overheated real estate market. The growth of cities and urban areas has brought many long-held parcels to their ultimate market- i.e., residential and commercial development. The old attributes articulated in Fraley in ’93, and cited in many cases thereafter, have been reexamined, confirmed, and given new application to recent marker trends in real estate. Fortunately, there now is quite a bit of guidance, and at least in this area, favorable application of those investors who are willing to carefully structure their activities in bringing their investment property to market.
√ Observation: RIA editors note that non-C corporation taxpayers holding land should see if they qualify for the favorable Code Sec. 1237 five-year land subdivision rule. Under the rule, an individual, trust, estate or S corporation won’t be treated as holding land primarily for sale to customers merely because the taxpayer subdivided a tract of land into lots or parcels and engaged in advertising, promotion, selling activities or the use of sales agents in selling lots in the subdivision, if the taxpayer:
…hasn’t previously held any part of the same land primarily for sale to customers in the ordinary course of business, and, in the year of sale doesn’t hold any other real estate for sale to customers;
…doesn’t (while he holds the land or as part of a contract of sale with the buyer) make “substantial improvements” on the land that substantially increase the value of the lost sold (except, if elected, improvements needed to make marketable land that has been held for ten years or more); and
…either has owned the land for five years or more, or acquired it by inheritance or devise.
However, if more than five lots or parcels in the same tract are sold or exchanged, 5 % of any gain from the year in which the sixth lot or parcel is sold, and later years, is ordinary gain.
Win the “War” of Independence
It’s been going on for years: Business owners frequently clash with the IRS over work classifications. Usually, owners claim that certain workers should be treated as independent contractors, whole the IRS maintain that they are actually employees subject to federal employment taxes and other burdensome requirements.
Our advice: Don’t surrender quickly if the IRS challenges your worker classifications. It’s an uphill battle, but you can prevail if you have a legitimate gripe and your stick to your guns. Here’s some ammunition for your battle ahead.
What’s at stake?
When a worker is classified as an “employee,” you must withhold federal income tax and the employee’s half of Social Security and Medicare taxes (FICA) from the paycheck.
Even Worse: You must pay the employer’s half of the FICA tax and the federal unemployment tax (FUTA). Finally, you must issue a Form W-2 for the employee’s wages earned and send a copy to the IRS.
In contrast, if a worker qualifies as an independent contractors, your business doesn’t have to worry federal income tax withholding, FICA or FUTA! Nor do you have to provide fringe benefits, such as health insurance, that are offered to employees.
Your only duty: If you pay $600 or more to any independent contractor, you must issue him or her a Form 1099, with a copy going to Uncle Sam.
Sounds like a good deal, right? It is, and that’s why business owners love to hire people as independent contractors.
But here’s the rub: If you improperly treat a worker who is actually a common-law employee as an independent contractor, your company could be hit hard with a big bill for unpaid employment taxes, plus interest and penalties.
What’s the difference?
Essentially, the differences between independent contractors and common-law employees boil down to this: If you have little or no control over the way the worker gets the job done, he or she is an independent contractor. But if you closely control how the worker performs the job, he or she should be considered a common-law employee.
It makes no difference how you refer to the worker. Nor does it matter whether the person works full time or part time. All that matters is your working relationship.
Advice: If you want to retain an independent contractor’s status, give him or her more slack. While you can clearly define what needs to be done, don’t necessarily explain how, when and where they do it.
To assess a particular worker’s contractor-to-employee classification, work through the IRS’s infamous 20-question test for determining a worker’s status.
Strategy: Use written contracts for independent contractors. Having a written contract on file may help resolve borderline calls in your favor.
4 Ways to Wriggle Off the Tax Hook
Let’s say you’ve taken the 20-question test and the results are disappointing: The worker is clearly an employee, not an independent contractor. Don’t despair, all is not lost.
Strategy: Rely on Section 530 relief in a pinch. This special tax rule, named for a provision in a 1978 law, allows you to claim independent contractor status as long as you can show a reasonable basis for putting the worker in that category.
Furthermore, you must have consistently treated other workers in the same category in the same manner.
Following are four accepted ways to pass the reasonableness test for Section 530 relief. And any one of them, by itself, is enough to save the day:
1) The classification is a long-standing practice. You can preserve independent contractor status for workers if you can show this treatment is a long-standing practice of a significant segment of your industry or profession. For this purpose, long-standing can mean less than 10 years, while a significant segment may be less than 25 percent.
Note: The IRS will want to see some hard proof of your contention.
2) The classification has survived an IRS audit. If the IRS has audited your business since 1996 regarding the employment-tax treatment of such workers and the classification was allowed to stand, you qualify under the prior exception audit.
For audits conducted prior to 1997, it doesn’t matter if the audit involved worker classification issues: You’re home free as long as the treatment of the workers wasn’t changed.
3) You can provide a precedent. If you can find an authoritative court decision or IRS ruling to support our position, you meet the reasonableness test.
4) You relied in a professional’s advice. Finally, you may win if you can show that you based your determination on the sound reasoning of a paid tax professional. That’s why it’s best to have your tax adviser document the conclusions of their reviews and then keep copies of those conclusions with your payroll-tax documents.
Online Resource: The relevant rules for Section 530 relief are summarized in IRS Publication 1976 (Section 530 Relief Requirements). You can find it at www.irs.gov/pub/irs-pdf/p1976.pdf
Independent Contractor or Employee? The 20-Question IRS Test
These 20 questions aren’t a game to trifle with. This list, designed to help you determine a worker’s classification, has evolved from various court cases and IRS rulings over the years. Most questions relate to the degree of control that you exert over the worker.
If you answer “Yes” to most questions, it generally indicates that the worker should be treated as a common-law employee. More “No” answers than “Yes” will favor independent contractor status.
Key point: The first few questions are the most decisive. For example, if you answer “No” to the first five questions, the worker is almost certainly an independent contractor, regardless of the answers to the remaining questions.
__1. Is there a continuing relationship between the worker and your company?
__2. Are the services required to be completed by a specific person?
__3. Does the worker receive instructions from you?
__4. Does the company supply the worker with tools and materials?
__5. Does the worker have any significant investment in the activity?
__6. Are the payments based on time rather than completion of the job?
__7. Is the payment arrangement such that the worker cannon incur a financial loss?
__8. Does your company set the working hours?
__9. Does your company require a full-time commitment from the worker?
__10. Is your company the worker’s only significant client or customer?
__11. Does the worker forgo offering services to the public?
__12. Does the worker receive training from your company?
__13. Are the worker’s services integrated with your company’s business?
__14. Does your company employ assistants for the worker?
__15. Is the work performed on your company’s premises?
__16. Is the work performed according to a set sequence determined by your company?
__17. Does your company require the worker to submit reports?
__18. Does your company pay the worker’s business-related expenses?
__19. Do you have the right to fire the worker?
__20. Does the worker have the right to quit without penalty?
How to Use Defective Grantor Trusts for an Effective Triple Play
(Reprinted with Permission from Federal Taxes – Weekly Alert)
Kuno S. Bell, CPA, J.D.
Defective grantor trusts (DGTs) have become a popular vehicle for freezing the taxable value of estates. Until now, most professionals had concluded that to achieve the estate freeze, taxpayers had to sacrifice the step up in income tax basis that would come had the taxpayer retained ownership of the asset at the time the taxpayer died. However, this Practice Alert (excerpted from a more extensive article in Practical Tax Strategies), explains how taxpayers can achieve an estate freeze and still receive a step up in income tax basis to fair market at the time of death. Furthermore, a taxpayer can use a DGT to make a lifetime transfer of built-in losses and have those losses survive death.
What are defective grantor trusts?
As used in practice, a DGT is a trust that has been carefully drafted so that the transfer of property to the trust is not a gift for gift and estate tax purposes and is not a sale for income tax purposes. By transferring enough of the ownership to make the property no longer the property of the grantor for gift and estate tax purposes, the assets transferred to a properly structured DGT are no longer included in the taxable estate of the grantor. However, the grantor continues to be taxed on the income generated by the asset, and the grantor continues to deduct losses generated by the property.
Basic Operating Rules & Structure
A DGT comes into existence when an individual (grantor) who has enough assets to be concerned about estate and gift taxes sets up a trust to achieve certain benefits.
In general, a DGT is a trust in which the grantor is denied the actual use and enjoyment of assets contributed to the trust. Therefore, contributions to such a trust must be irrevocable transfers, and the grantor cannot be a trust beneficiary. Since the grantor has irrevocably parted with use and enjoyment of the contributed assets, the property is treated as removed from the grantor’s taxable estate.
However, the DGT document reserves to the grantor at least one of several powers that for income tax purposes results in the trust and all of its property still being treated as the grantor’s property for income tax purposes. The powers and situations in which the grantor is treated as the ongoing owner for the income tax purposes are in Code Sec. 671 through Code Sec. 677. For instance, the trust document will give the grantor the ability to replace the property in the trust with property of similar value. (Code Sec. 675(4)). The grantor’s right to exchange property in the trust for property not in the trust is the cornerstone for one of the tremendous, although generally ignored, opportunities available from using a DGT.
By having the property transferred to the trust treated as the property of the individual for income tax purposes, a sale of property by the grantor to the trust is treated as a transfer from the grantor to himself. Under Rev Rul 85-13, 1985-1 CB 184, the transaction is not a sale for income tax purposes.
A transfer of property to the trust is generally done via an installment sale. Many tax professionals believe that the trust must have some property before the sale for the IRS and the courts to respect the sale as legitimate. Consequently, before the sale occurs, the grantor gives the trust money equal to 10% of the impending installment sale amount.
Gambling Income and Expenses
Hit a big one in 2007? With more and more gambling establishments, the IRS reminds people that they must report all gambling winning as income on their tax return.
Gambling income includes, but is not limited to, winnings from lotteries, raffles, horse and dog races and casinos, as well as the fair market value of prizes such as cars, houses, trips or other non-cash prizes.
Generally, if you receive $600 ($1,200 from bingo and slot machines and $1,500 from keno) or more in gambling winnings and your winnings are at least 300 times the amount of the wager, the payer is required to issue you a W-2G. If you have won more than $5,000, the payer may be required to withhold 25 percent of the proceeds for Federal income tax. However, if you did not provide you Social Security number to the payer, the amount withheld will be 28 percent.
The full amount of your gambling winnings for the year must be reported on line 21, Form 1040. If you itemize deductions, you can deduct your gambling losses for the year on line 27, Schedule A (Form 1040). You cannot deduct gambling losses that are more than your winning.
It is important to keep an accurate diary or similar record of your gambling winnings and losses. To deduct your losses, you must be able to provide receipts, tickets, statements or other records that show the amount of both your winnings and losses.
For further information please contact us today.
Common Errors to Avoid
Want to avoid frequent trouble spots? Check these areas to reduce problems:
• Use the peel-off label. You may line through and make necessary corrections right on the label. Be sure to fill in your Social Security number in the box provided on the return. It is not on the label.
• Check only one filing status on the tax return and check the appropriate exemption boxes. Make sure the writing is legible. Enter the correct Social Security numbers for all: taxpayer, spouse, dependents and exemptions. Incorrect or missing numbers will delay tax return processing.
• Double check all figures on the return. Math errors are common mistakes.
• Make sure that the financial institution routing and account numbers you have entered for a direct deposit of your refund are accurate. Incorrect numbers can cause a delayed or misdirected refund.
• Sign and date the return. If filing a joint return, both spouses must sign and date the return.
• Attach all Forms W2, Wage and Tax Statement, and other forms that reflect tax withheld to the front of the return. If you are also filing a Form 9465, Installment Agreement Request, attach that to the front of the tax return. Attach all other necessary forms and schedules in the attachment sequence order listed in the upper right corner of each form or schedule.
• Do you owe tax? If so, enclose a check or money order made payable to the "United States Treasury" and Form 1040-V, Payment Voucher, with the return. Or, you may choose to pay by credit card by contacting one of the credit card service providers. If you file electronically, you may authorize the U. S. Treasury to withdraw the payment directly from your bank account.
For further information, contact us today.
Seven Ways To Avoid Problems At Tax Time
1. Don't Procrastinate - Resist the temptation to put off your taxes until the last minute. Your haste to meet the filing deadline may cause you to overlook potential sources of tax savings and will likely increase your risk of making an error.
2. Organize Your Tax Records - The preparation time can be significantly reduced if you develop a system for organizing your records and receipts, Start with the income, deduction or tax credit items that were on last year's return.
3. File Your Return Electronically - About 61 million taxpayers filed their returns electronically in 2004, Aside from ease of filing, IRS e-file is the fastest and most accurate way to file a tax return. If you're due a refund, the waiting time for e-filers is half that of paper filers.
4. Double-Check Your Math and Data Entries - Review your return for possible math errors and make sure you have provided the names and correct Social Security or other Identification numbers for yourself, your spouse and your dependents. Make sure your handwriting is clear and easy to read.
5. Have Your Refund Deposited directly to Your Bank Account - Another way to speed up your refund and reduce the chance of theft is to have the amount deposited directly to your bank account. Check the tax instruction for details on entering the routing and account numbers on your tax return. Make sure the numbers you enter are correct. Wrong numbers can cause your refund to be misdirected or delayed.
6. Don't Panic if You Can't Pay - If you can't immediately pay the taxes you owe, consider some stress-reducing alternatives. You can apply for an IRS installment agreement, suggesting your own monthly payment amount and due date, and getting a reduced late payment penalty rate. You also have various options for charging your balance on a credit card, either as part of an electronic return of directly through a processing agent, either by phone or online. Note that if you file your tax return or a request for a filing extension on time, even if you can't pay, you avoid potential late filing penalties.
7. Request an Extension of Time to File-But Pay on Time. (NEW as of 11/4/2005) If the clock runs out, you can get an automatic full six-month extension of time by filing Form 4868, You only have to file one form, eliminating the need to file a second extension four months later. Note that the extension itself does not give you more time to pay any taxes due, You will owe interest on any amount not paid by the April 15th deadline, plus a late payment penalty if you have not paid at least 90 percent of your total tax due by that date.
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2006 Roth Options Complicate Retirement Puzzle
Beginning in January, the Retirement "Puzzle" becomes even more complicated with the introduction of non-taxable Roth accounts for both 401k and 403b retirement plans. After that date, clients will be able to choose from among the already existing myriad of plans available, and then must make an additional choice between making their contributions either tax deductible or non-tax deductible.
Whether or not the "Roth Option" is available in your retirement plan is dependent upon the employer choosing to have his firm participate. In the event an employer wishes to make this option available to their employees, it will be necessary for them to contact their plan administrators so that their existing plan documents can be amended to allow for these contributions.
Employees participating in these plans can decide to direct their contributions between the taxable and non- taxable accounts in any manner they might choose. An employee may choose to direct all contributions to either account, or should they prefer contributing to both, can allocate a specific % of their total contributions to each.
In order for distributions to be treated as tax free from the Roth account, an individual must have a "qualifying event". A qualifying event occurs either when the individual reaches age 59 and 1/2 or at least five years have passed after the initial contribution was made.
Unlike the Roth IRA, there are no income limits of any kind. Therefore, for those whose incomes exceed the Roth IRA limits, it presents a new opportunity to contribute to a Roth product. Another significant difference between these accounts and the Roth IRA is that the RMD rules do apply, so distributions from these accounts MUST begin at age 70 and 1/2.
The IRS has not yet issued final regulations for designated Roth contributions, so any or all of the above information may change when they actually do so. Final regulations are expected to be announced very late in the year.
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