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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.
Economic Stimulus Bill…Where’s My Rebate?
Article 1: IRS has released some information now that President Bush has signed the Act. Here is a summary of the latest news.
1) The advance rebates will be directly deposited for taxpayers who have their 2007 Federal refunds directly deposited.
2) Checks will begin in early May and continue through December 31. No advance checks will be sent out after December 31. Taxpayers filing too late to get the advance check will have to get any credit due when their file their 2008 returns.
3) IRS is planning to send out two letters. The first letter will explain the payment program. The second letter will confirm the recipients? eligibility, the payment amount, and the approximate time table for the payment. IRS WILL NOT BE CONTACTING TAXPAYERS THROUGH THE TELEPHONE OR EMAILS.
4) Anyone who moves will need to notify IRS by filing the normal Form 8822, Change of Address.
5) SHOWING QUALIFYING INCOME
A) Only taxpayers who file 2007 tax returns will be able to get the advance checks. Therefore qualifying taxpayers who donít normally have to file a return may want to do so since this is the only way they will get the advance checks.
B) Taxpayers who only qualify for the minimum rebate due to Social Security, RR benefits, and veterans? benefits (disability, pension, or survivors? benefits) need to show the income on their tax returns in box 20a of the Form 1040 (or box 14a of Form 1040A).
Normally these boxes aren't required to be printed unless some of the SS is taxable, but they will need to be shown in order for IRS to know the taxpayer has qualifying income. IRS also states qualifying veteranís benefits and Railroad Retirement benefits should be entered in this same box. †Taxpayers with qualifying veterans benefits can estimate the amount they received by multiplying the monthly benefit by the number of months they received the benefits (normally this will be 12 months). If these taxpayers have already filed a 2007 return but didn't show the qualifying income, they can amend the return. SSI is not qualifying income.
6) OFFSETS - The advance checks will be offset against any outstanding tax and non-tax liabilities in the same fashion as regular tax refunds.
The IRS web site has additional information including a Fact Sheet with questions and answers and one giving examples of the calculations of rebates for various scenarios. More information will be posted as it becomes available, so check often for the latest.
Article 2:
For purposes of this article a married couple filing Married Filing Jointly (MFJ) is one "taxpayer." Most of your clients will receive $600 ($1,200 if MFJ) + $300 for each child qualifying for the Child Tax Credit. †Here are the provisions of this Act.
REBATES
Similar to the previous rebate back in 2001 this "rebate" is a credit allowed against the taxpayer's 2008 income tax. This is an additional one-time credit above and beyond other credits the taxpayer may have. In order to stimulate the economy, the Act also directs the Secretary of the Treasury to issue ADVANCE REBATES this year.
When the taxpayer files the 2008 income tax return, this one-time credit will be calculated and reduced by the advance rebate. Therefore the rebate a taxpayer receives this year will have to be accounted for on the 2008 income tax return.
If you go back to the 2001 Form 1040, line 47, you will see the provisions that were made at that time. It should be the same type of procedure for the 2008 income tax returns. †Make sure your clients keep track of the amount they receive in the Advance Rebate.
For example - Emma, a single taxpayer receives an advance rebate of $450 based on her 2007 income tax return. Emma has higher tax on her 2008 income tax return and is actually allowed a tentative credit of the full $600. The advance rebate of $450 is applied against the $600 and the taxpayer is permitted a nonrefundable credit of the remaining $150 on the 2008 income tax return.
TWO PARTS TO REBATES
There are two parts of the rebates: a base amount for taxpayers and an additional amount for each dependent.
PART I
** Base Amount The base rebate is the smaller of:
1) the taxpayer's net income tax liability, or 2) $600 ($1,200 in the case of MFJ)
(The only tax that is available to be rebated is the federal income tax the taxpayer paid. This does not include any self-employment taxes.)
Each of the following taxpayers will receive a minimum
of $300 ($600 if MFJ):
- - A taxpayer has at least $3,000 of 1) earned income, 2) social security benefits, and 3) compensation or pension received under chapter 11, chapter 13, or chapter 15 of title 38, United States Code.
[We have not traced the title 38 sections yet, but believe this compensation includes VA disability benefits.]
For this purpose "earned income" does not include income that is subject to SE taxes but not income taxes, such as a minister's housing allowance.
- - A taxpayer has at least $1 of income tax liability AND gross income greater than the basic standard deduction plus the exemption amount for the taxpayer (and spouse when MFJ). †This totals to $8,750 for Single/MFS and $17,500 for MFJ. It appears this amount is also $14,100 for QW and $11,250 for HH.
For example - Eric, a single taxpayer, only has gross rental income of $15,000. Eric has $10 of income tax on his 2007 income tax return after all expenses. Eric is entitled to a base rebate of $300.
PART TWO ** Additional Part - The base amount is increased by $300 for each "qualifying child" as defined in IRC Section 24(c). This section of the Code is the Child Tax Credit section. Children that qualify the taxpayer for the Child Tax Credit also qualify the taxpayer for the additional part of the rebate.
OTHER INFORMATION ON REBATES
** Who will not get the rebate? Rebates will not be:
- Issued to any nonresident alien
- Issued to anyone whose dependency exemption is allowable to be claimed by another taxpayer
- Issued for anyone who does not have a valid Social Security number (taxpayer, spouse, and children).
ITINs issued by IRS are not valid SS numbers.
** Higher income taxpayers - Taxpayers filing other than as MFJ with AGI over $75,000 and taxpayers filing MFJ with AGI over $150,000 will receive smaller rebates or no rebates at all.
The rebate amount is reduced by 5% of the taxpayer's AGI that exceeds the
levels just mentioned. †
Our calculations show taxpayers filing Single would receive a $0 credit if the AGI is $86,990 or higher (not quite $87,000 due to rounding) and taxpayers filing MFS would receive a $0 credit if their AGI is $173,990 or higher (not quite $174,000 due to rounding).
Example - Caden is filing as Single. His AGI is $80,000 and paid lots of income tax. †His rebate would normally be $600 except he has higher AGI. The rebate amount is reduced to $350. This is calculated as follows:
-- $80,000 AGI less $75,000 limit equals $5,000
-- $5,000 times 5% equals $250 reduction
-- $600 full rebate less $250 reduction = $350 advanced rebate allowed
The Act does not address the taxability of the rebates in 2008. However, since federal tax refunds are not taxable for Federal tax purposes, these rebates should not be taxable either. Even taxpayers who receive a larger rebate than their 2007 income taxes shouldn't have income since there it no income currently for taxpayers with no tax who receive EIC or the Additional Child Tax Credit.
The advance rebates will be issued through December 31, 2008. Taxpayers who file their 2007 returns late in 2008 or in a later year will not receive the advance rebate. †They will only receive the credit on their 2008 returns.
Back in 2001 IRS sent out letters to taxpayers informing them of the Advanced Rebate they would be receiving. †We have not yet heard if IRS is planning to do this again. Obviously it costs IRS lots of money to send such letters.
IRS has indicated it will take about 10 weeks to issue all of the checks. †It may send this money as direct deposit if taxpayers have elected direct deposit on their 2007 income tax returns.
OTHER PROVISIONS IN ACT
- The Section 179 expense limit increases to $250,000 for tax years starting in 2008, with a phase-out starting at $800,000 of purchases.
- Bonus depreciation is back. †For property placed in service after December 31, 2007, a taxpayer is allowed bonus depreciation. There also appears to be a higher limitation for listed property under this provision.
We will discuss these bonus depreciation provisions in an email at a later date.
For further information please visit the IRS at http://www.irs.gov/irs/article/0,,id=177937,00.html or by contacting us via e-mail at jpmfinancialservices@verizon.net or by calling our office at 757-455-6763.
Article 1 & 2 are shared 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.
For further information, contact us today.
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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