June 22, 2011

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May 31, 2011

Estate Tax Reporting: Confusion Reigns

Recall that pursuant to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the estate tax was repealed for 2010 decedents. The executors of estates for 2010 decedents were required to file an information return, nonetheless, which was due on the due date of the decedent's final Form 1040 -- or April 18, 2011. Then along came Congress in late 2010 with the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRA 2010) which technically reinstated the estate tax -- at the "election" of the executor -- for persons who died in 2010.

So, executors are now faced with a dilemma: incur estate tax, in return for asset basis "step up" to full fair market value, or "elect out." If the election "out" were made by the executor, the "carryover basis" rules apply to assets passing to heirs with a couple of exceptions: the estate would receive $1.3 million of basis "step up", plus an additional $3 million "step up" for assets passing to a surviving spouse. (Learn more about the role of executors in Nolo's Executor FAQ.)

But how was this election "out" to be documented?

Initially, IRS released a draft of new Form 8939 ("Allocation of Increase in Basis for Property Acquired From a Decedent") and suggested that the form was to be filed by April 18, 2011 with the decedent's final individual income tax return. Then, on March 31, 2011, along came IR 2011-33, wherein IRS explicitly stated:

    "The Treasury Department and the Internal Revenue Service today announced that Form 8939 is not due on April 18, 2011, and should not be filed with the final Form 1040 of persons who died in 2010. New guidance that announces the form due date will be issued at a later date, and Form 8939 will be released soon after guidance is issued."

All of this leaves executors in a quandary resulting from having to compare the cost of paying some estate tax under the old rules and receiving a full basis step up, thus saving (potentially) future income taxes, or sticking with the carryover basis regime and possibly paying income taxes down the line (when assets may be sold) at some tax rate presently unknown.

In any case, stay tuned -- the next issue on the horizon will be the need to wrestle with the final version of Form 8939, at which time the executor's decision must be made. Rumor has it that the form will be finalized in time to enable a final due date of something like November 15, 2011.

May 26, 2011

$4 Per Gallon for Gas? Not High Enough for IRS!

Nope -- we guess it has to go a bit higher before IRS decides enough is enough, and the standard mileage rate ought to be raised.

Seems that during its May 12 payroll industry conference call, an IRS spokesperson said that the IRS has no current plans to increase the present standard rate of 51 cents per mile.

Recall that the standard rate for owned or leased cars (including vans and some trucks) was previously set at 51 cents for business travel after 2010. (Likewise, the 2011 rate for medical usage of your auto, or for its use in connection with moving is 19 cents per mile.)

The 51 cents per mile rate can also be used by employers for reimbursement of employees required to use their own auto for business, and who want to deem the reimbursement as having been made under an "accountable" expense reimbursement plan, as long as the employees appropriately document the usage to the employer. (More from Nolo on Business Tax and Deductions.)

IRS generally announces each year's standard mileage rate near the beginning of the new tax year, but it's not unheard of that they make a mid year correction - such as the action they took in 2008 when gas prices last spiked in a manner similar to recent experience.

But such is not in the cards, according to Ligeia Donis, Assistant Branch Chief, Office of the Chief Counsel, notwithstanding the recent spate of gas cost increases. And for two reasons, according to Donis: the possibility that gas prices could decline, and some recent whining by employers that mid-year changes are difficult to implement.

Time will tell -- the year isn't even half over yet.

May 18, 2011

IRS Hangs Tough on IRA 60-Day Rollover Deadline

In a recent private letter ruling (PLR 201118025), IRS got pretty tough with a taxpayer whose IRA rollover took a bit longer than the permissible 60 days.

IRS sometimes offers a bit of leniency in these cases. Rev Proc 2003-16 outlines the situations in which leniency might be appropriate, and notes "The Service will issue a ruling waiving the 60-day rollover requirement in cases where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster or other events beyond the reasonable control of the taxpayer." But not so in this case.

Here, the taxpayer and his siblings wanted to help their elderly mother purchase (for cash) a new residence, necessitated by her mobility limitations which made it unsafe for her to remain in her two-story residence. So, the taxpayer took a distribution from his IRA and applied the funds toward a new residence for his mother who then secured a reverse mortgage to generate the funds to repay the taxpayer and his siblings.

Despite assurances from the bank (that the mortgage process would be completed in time to enable the taxpayer to meet his 60-day rollover requirement) delays ensued and the taxpayer missed the deadline. He pled mercy -- claiming that his failure to timely complete the rollover was due to "numerous and unreasonable processing delays" which "were beyond his control."

But IRS concluded that the taxpayer had not presented any evidence as to how any of the factors outlined in Rev Proc 2003-16 affected his ability to timely complete the rollover. Those factors include:

  1. Errors committed by a financial institution;
  2. Inability to complete a rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error;
  3. The use of the amount distributed; and
  4. The time elapsed since the distribution occurred.

IRS' position in this case was that none of the above applied -- the taxpayer's IRA funds were simply used to make a short-term loan to Mom. Period.

Bottom line -- push the 60-day time limit at your own peril.

May 12, 2011

IRS Offers Continuing Education Opportunity

Now that the rigors of the tax filing season have eased a bit, it's time for those of us in the "tax professionals" community to start giving thought to the fulfillment of this year's continuing education requirements.

And the IRS has come forth with an offer -- forums for tax professionals in six cities, starting this summer. Enrolled agents, CPAs, certified finanacial planners and other tax professionals may wish to consider the offer -- three day events presented by IRS experts, discussing any number of topics involving federal and state tax issues. Some 40 different topics will be covered, each qualifying for continuing education credit, as may be approved by the various licensing bodies.

The forums will be conducted in the traditional seminar format, and will also feature a two day "expo," designed to fill tax professionals' needs, with representatives from IRS and other tax, financial, and business communities, offering their products and services. Attendees will also be exposed to the IRS "Preparer Services Room," to learn about the IRS's e-Services, offer comments on various initiatives and programs, or participate in a focus group.

And for those, perhaps, with unresolved pending problems, attendees will be invited to bring their most challenging unresolved case to the "Case Resolution Room," for some IRS assistance. The Service notes that last year, a total of 1,235 cases experienced a 97% on-site resolution rate.

Check out www.irstaxforum.com for details of dates, cities, costs and continuing education credits available.

May 4, 2011

Short Sales, Foreclosures, and Debt Forgiveness

The present economic environment has led many folks to lose their homes because of inability to satisfy their mortgages. Transactions take several forms, but foreclosures and short sales have become fairly common. While homeowners typically think of these deals as giving rise to a "loss," such is not always the case for tax purposes.

Generally speaking, a taxpayer realizes some form of income when a debt is cancelled, forgiven, or reduced by the lender. And lender actions of this nature often come into play when a taxpayer restructures the acquisition debt on his principal residence, loses a principal residence in a foreclosure, or sells his principal residence in a short sale.

But the Mortgage Relief Act, effective for debt discharged on or after January 1, 2007 and before January 1, 2013 generally allows taxpayers to exclude up to $2 million of such mortgage debt relief associated with their principal residence. The tax return for the year in which an event of this kind takes place should contain IRS Form 982, "Reduction of Tax Attributes Due to Discharge of Indebtedness". Though income may be excluded, the price of this favor bestowed by the IRS is reduction of the basis in the principal residence (though not below zero). More information from the IRS on cancelled or forgiven debt is here.

Note that these provisions relate only to one's principal residence -- there will be no exclusion for debt forgiven with respect to a vacation or second home, business property, or rental property.

Also, the mortgage debt exclusion may not fully apply in the case of a mortgage which has been refinanced. Refinanced principal residence debt is eligible for the exclusion up to the amount of the previous mortgage before the refinance.

And there may be further complications in any given situation -- don't confuse the issue of debt reduction (and how it's taxed) with any actual gain which might still arise on the sale of the house. In short sales, taxpayers might sustain gain from the sale of the property instead of or in addition to income from discharge of debt. Of course, another rule (IRC Section 121, allowing some joint filers to exclude gain of up to $500,000 on sale of their residence) might exempt some or all of such gain. It gets complicated. Do-it-yourselfers beware.

Learn more in Nolo's article Canceled Mortgage Debt: What Happens at Tax Time?

April 27, 2011

Internet Sales Tax -- Coming Sooner Than You May Think

If something called the "Main Street Fairness Act" clears Congress, the days of sales tax-free Internet commerce may be numbered.

U.S. Senator Dick Durbin (D-Illinois) plans to introduce the bill, we hear, shortly after the Easter recess.

"Why should out-of-state companies that sell their products online have an unfair advantage over Main Street bricks-and-mortar businesses?" queried Durbin recently in a speech. "Out-of-state compaines that aren't paying their fair share of taxes are sticking Illinois residents and businesses with the tab."

But we hear that the Direct Marketing Association (DMA), not surprisingly, takes a dim view of Durbin's idea. "You're just giving the states a blank check to make changes without any congressional oversight," says Jerry Cerasale, DMA's senior vice president for government affairs. "We oppose that.....We think that's abrogating the authority of Congress."

So far, nobody has been able to quite figure out just what to do with the Internet from a sales and use tax standpoint. (Check out Nolo's article Sales Tax and the Internet for more info.) And that's just the way the NetChoice Colalition likes it. The Coalition says, "Internet access -- and its concomitant ability to communicate, educate, and telework -- should not be taxed. At a time when most people agree that the U.S. needs more broadband, Internet access taxes will slow broadband deployment, particularly in rural and low-density areas. Fewer consumers will buy a higher-priced taxed product. A smaller pool of potential customers means providers can't justify investment in new broadband infrastructure build-out......NetChoice endorses a permanent tax moratorium to encourage continued innovation on the 'Net'."

The big boys of retailing, however, would likely support Durbin's proposal. Why wouldn't they -- their bricks-and-mortar presence is increasingly ubiquitous.

But as NetChoice points out, "The 'Internet' is not a specific place or thing, but a network of networks that transcend geographic and political borders." A virtual entity. And who's in charge of taxing that?

April 19, 2011

Stockbrokers to Start Reporting Clients' Tax Basis

Taxpayers will be receiving a little more assistance from their stock brokers when it comes to the preparation of the annual Schedule D in their tax returns -- the Energy Improvement and Extension Act of 2008 has mandated that every broker required to file a return with the IRS reporting sales proceeds must also report a customer's adjusted basis in the security, and whether any gain or loss on the sale is long or short term in nature.

A "covered security" is stock in a corporation acquired on or after January 1, 2011, or shares in a mutual fund, or shares acquired in a dividend reinvestment plan (DRP) acquired after January 1, 2012.

If a customer sells less than his or her entire position of a security in an account, a broker must report the customer's basis (other than mutual fund or DRP shares) generally using the first-in, first-out (FIFO) method unless the customer provides the broker an adequate and timely identification of the shares or units the customer wants to sell. A broker must report the adjusted basis of mutual fund or DRP stock (for which the customer may average the basis of the stock) in accordance with the broker's "default" method unless the customer notifies the broker that the customer elects a different permitted method.

The new rules change the way taxpayers determine the average basis of mutual fund stock and permit them to average stock held in a DRP. Starting in 2012, taxpayers who elect to average the basis of mutual fund shares will compute separate averages for fund shares held in different accounts. Taxpayers will also be permitted to average the basis of mutual fund shares in one account but not average them in another account.

The due date for brokers to so report will be February 15 after the end of the tax year in question. And when a taxpayer changes brokers, the rules will require the transferring broker to furnish to the receiving broker a written statement with all necessary information required for the receiving broker to comply with the Act's basis reporting requirements. Statements required by this rule are generally due no later than 15 days following the transfer of the covered securities.

Won't all the brokers just love this new burden upon them!

For more of the gory details, check out the IRS' 68 "frequently asked questions" at http://www.irs.gov/taxpros/article/0,,id=237099,00.html.

April 13, 2011

Tax Dodgers and Whistleblower Ethics

A curious section of the Internal Revenue Code allows the IRS to pay money to people who blow the whistle on persons who fail to pay taxes owed. Particularly curious when the whistleblower may be the tax dodger's own accountant!

The amount of the reward is determined by the IRS' "Whistleblower Office," and depends on the extent to which the whistleblower "substantially contributed" to the administrative or judicial action the IRS brings based on the information. All relevant factors, including the value of the information furnished in relation to the facts developed by an investigation of the violation are taken into account in determining the amount of the reward.

Section 7623 allows the Secretary to pay an "informant award" of at least 15 percent, but not more than 30 percent of the amount collected if the taxes, penalties, interest and other amounts in dispute exceed $2 million. If the case deals with an individual, his or her annual gross income must be more than $200,000. If the whistleblower disagrees with the outcome of the claim, he or she can appeal to the Tax Court.

There is also an award program for other whistleblowers -- generally those who do not meet the dollar thresholds mentioned above. Awards in the smaller cases are discretionary and the informant cannot dispute the outcome of the claim in Tax Court.

Recently, the IRS paid $4.5 million to an accountant who "blew the whistle" on his employer, and found something like $20 million for the government. Sounds like a "win-win," but the notion of Uncle Sam encouraging advisors to turn in their employers and clients is unsettling to say the least. Most of us consider our first obligation to provide honest, reputable advocacy to all of our good and valued clients, and not to function as government cops, policing the collection of revenue.

But if you're so inclined, consider IRS Form 211: Application for Award for Original Information.

April 6, 2011

State Tax Withholding Simplification Coming?

We hope so -- it would be a good thing indeed.

We hear that the Executive Committee of the Multistate Tax Commission (MTC) has approved a model law which would establish a uniform standard for the manner in which states tax compensation earned by nonresidents.

Under the model, compensation earned by a nonresident in a state would be exempt from taxation in that state if:

  1. The nonresident has no other taxable income from sources within the state for the tax year in which the compensation was received;
  2. The nonresident is present in the state to perform employment duties for no more than 20 days during the tax year in which the compensation was received; and
  3. The nonresident's state of residence provides a substantially similar exclusion or does not impose any individual tax.

The rules would not apply to professional athletes, professional entertainers, prominent folks who perform services for compensation on a per-event basis, construction workers, and certain "key employees."

A good step forward -- folks who earn income in multiple jurisdictions (like some independent contractors and consultants) have long been burdened with multiple state (and sometimes even local) tax return filing and payment obligations -- often a compliance nightmare!

March 29, 2011

Electronic Filing Becoming the Norm

If the IRS has its way, paper tax returns will soon become a thing of the past.

If your return is put together for you by a "specified tax return preparer," get ready to step into the 21st century and start "e-filing," if you haven't already.

A "specified tax return preparer" is a preparer of 100 or more "covered returns" in calendar year 2011 (11 or more in 2012 and thereafter). And a "covered return" is any return of income tax imposed by subtitle A of the Internal Revenue Code on individuals, estates, and trusts, such as Forms 1040, 1040A, 1040EZ and 1041. (Some forms cannot presently be e-filed and are, obviously, exempt from these requirements. But the forms generally filed by most individuals are covered.)

But what if you don't like the idea of e-filing? Say, for example, you're a little goosey about computer security -- a reasonable position to take. What does your preparer do in that event?

Well, it really shouldn't be a problem for him or her. Your preparer has to simply document your choice to file in paper format, and retain a signed statement from you to that effect, including a representation from you that your preparer did not attempt to influence your decision to go with paper filing. Also, your preparer will attach Form 8948 ("Preparer Explanation for Not Filing Electronically") to your paper filed return.

And what if your return is more complicated than most, which often necessitates any number of documents (other than the government forms themselves) to be attached in support of tax return items. Well, there's an "out" for your preparer in this area as well -- an "administrative exemption" to use the IRS's very own words. In this instance, paper filing is acceptable. And some returns can be e-filed and the attachments mailed to IRS using a transmittal Form 8453.

Get more information from Nolo on getting your personal income tax and business tax returns together.

March 23, 2011

Odds of an Audit: Interesting IRS Stats

So you're thinking about playing the old "audit lottery," and wonder what the stats show regarding your chances of getting caught, and what the consequences might be.

Check out the IRS 2010 Data Book (Publication 55B) which is supposed to be printed by mid April. The info there covers IRS fiscal year 2010, and covers not only tax audit rates, but other items, such as the categories of returns which interest the IRS most, and collections efforts.

In terms of the overall changes of being audited, only about 1.1% of all individual returns filed in the fiscal year were audited -- up from 1.0% in the prior year. And only 21.7% of the individual audits were actually conducted by revenue agent folk. The other 78.3% were correspondence audits.

Here are some key stats regarding individual audits (other than audits of taxpayers claiming the earned income tax credit):

  • Business returns (other than farmers) showing total gross receipts of $100,000 to $200,000: 4.7% audited
  • Business returns showing total gross receipts of $200,000 or more: 3.3% audited
  • Farmers (Schedule F filers): 0.4% audited
  • Individuals with adjusted gross income (AGI) between $100,000 and $200,000: 0.71% audited
  • Individuals with AGI between $200,000 and $500,000: 1.92% audited
  • Individuals with $1 to $5 million AGI: 6.67% audited

As for corporations (other than those filing Form 1120S), 1.4% were snagged for audit overall. But small corporations with assets of $1 to $5 million experienced a 1.7% audit rate.

Some more interesting stats: the total number of individual returns actually filed dropped 2% from the year before. When times are bad, the number of filers drops off. Nonetheless, IRS continues to find a way to penalize very many filers -- the top three penalties in percentage terms were 57.3% for failure to pay, 27.3% for underpayment of estimated taxes, and 13% for filing taxes late.

And beyond the common civil penalties, the stats show that crime doesn't pay -- IRS initiated 4,706 criminal investigations in 2010, and of those convicted, 81.5% were incarcerated - up from 81.2% the year before.

Learn how to stay off the IRS radar -- and get tips on what to do if you are audited -- in Nolo's articles How to Reduce the Chance of an Audit and Top 10 Tips for Surviving an Audit.

March 14, 2011

Got Offshore Income? IRS Announces New Disclosure Initiative

Ever on the lookout for international tax evaders, IRS recently announced yet a second special program to allow folks with previously undisclosed income from hidden offshore accounts to fess up. Not exactly what you would call an "amnesty," but still probably better than risking the alternative of continued silence, and later getting caught.

The new voluntary disclosure initiative will be available until August 31, 2011. "As we continue to amass more information and pursue more people internationally, the risk to individuals hiding assets offshore is increasing," noted IRS Commissioner Shulman recently. "This new effort gives those hiding money in foreign accounts a tough, fair way to resolve their tax problems once and for all. And it gives people a chance to come in before we find them."

The new initiative is different, in some ways, from its precursor in 2009. The overall penalty structure under the new program is higher than before, so that folks who did not come forth before will not be rewarded for remaining silent in the mean time.

For the 2011 initiative, there is a new penalty framework that requires individuals to pay a penalty of 25 percent of the amount in the foreign account(s) in the year with the highest aggregate account balance during the 2003 to 2010 period. Some taxpayers will be eligible for 5 percent or 12.5 percent rates of penalty. All participants will be required to pay all back taxes and interest, as well as the appropriate late payment and delinquency penalties.

IRS continues to discourage what it calls "quiet disclosure," by which a taxpayers may just file amended returns on their own, and pay related tax and interest for previously unreported offshore income without otherwise notifying IRS in a formal way.

Folks trying this approach run the risk of being examined and potentially criminally prosecuted for all applicable years. That's right -- "criminal" sanctions loom on the horizon and are generally not "pretty." IRS says it has identified, and will continue to identify and closely review amended returns coming their way which report increases in income.

This is a difficult and touchy area -- even though it appears in some sense that IRS is expressing some degree of leniency, perhaps the best approach for anyone with problems of this nature is to consider consulting with tax legal counsel, particularly if the amounts involved are large.

For more information on income earned abroad and how to handle back taxes you owe, check out Nolo's Filing a Tax Return When You Live Outside the U.S. article and Nolo's Back Taxes & Tax Debt section.

March 3, 2011

'S' Corporations and Employees, Round 2

A recent Tax Court decision (Donald G. Cave a Professional Law Corp., TC Memo 2011-48) reminds us once again of employment tax considerations associated with "S" corporations and their shareholders, as well the more general topic of distinguishing between employees and independent contractors.

In this case, the law corporation reporting entity did not view associate attorneys working for the firm as employees, but instead considered them independent contractors, and issued them Forms 1099-MISC for the years in question. And the same went for a law clerk. Further, even though the sole corporate shareholder worked actively in the business, the corporation issued to him neither a Form W-2 nor a 1099-MISC, thus allowing all of the bottom line to flow to his personal return as "S" corporation dividend distributions, presumably thereby escaping employment taxation altogether.

The age old issue of who is an employee as opposed to an independent contractor is not without guidance in the literature. Specifically, the Fifth Circuit (which would govern if an appeal ensues from the Tax Court's decision) considers the following primary factors as relevant to the question:

1. The degree of control the principal has over the worker
2. The worker's investment in the tools of his trade
3. The worker's opportunity for profit or loss resulting from his efforts
4. The permanence of the relationship between worker and master
5. The skill required of the worker

The bottom line for the Tax Court, relative to the classification of the associate attorneys and the law clerk, was the conclusion that all of these folks were "common law employees," to whom Forms W-2 should have been provided, and regarding whom appropriate employment taxes should have been considered.

And as for the sole corporate shareholder, the corporation's president, who made virtually all corporate decisions, for which he was compensated, the same conclusion ensued: employee status.

Bottom line -- corporation shells out the employment taxes for the years in question, plus the usual penalties, of course!

February 15, 2011

Are Punitive Damages Excludable From Income?

You've got to hand it to the Greenbergs. It was a nice try, attempting to read between the lines of the Internal Revenue Code in an effort to justify excluding a punitive damages award from their income tax return.

Unfortunately, they couldn't convince the Tax Court. In a recent decision, the Court not only slapped the Greenbergs down in affirming a tax deficiency of over $1 million, but further hammered the folks in sanctioning the IRS imposed accuracy-related penalty, because the taxpayers had neither substantial authority, nor reasonable cause underlying their posture on the damage award. (The decision is Gary L. Greenberg, et ux. v. Commissioner, TC Memo 2011-18.)

Seems Mr. Greenberg, owner of a disability income policy, became disabled, thus precipitating a claim. The insurer paid some benefits, but not as much as Greenberg thought was proper, so he sued, alleging breach of contract and insurance bad faith. And, by golly, he won a damage award which included $2.4 million of punitive damages, which the taxpayers excluded from their return, justifying the exclusion on the basis of Internal Revenue Code Section 104(a)(3). (Learn more from Nolo: I won a lawsuit; do I have to pay tax on my damage award?)

Unfortunately that section only permits exclusion of "amounts received through accident or health insurance.....for personal injuries or sickness...." which "amounts" Mr. Greenberg liberally interpreted to include the punitive damages.

But the Court wasn't buying it, noting that, "In general, exclusions from income are narrowly construed," and with specific reference to IRC Section 104, that the Supreme Court had clearly spoken in the O'Gilvie case, to the effect that punitive damages received in a suit for personal injuries are not received "on account of" the personal injuries, themselves, but rather in connection with assessing a form of punishment on the offending party. Bottom line: punitive damages are taxable.

Attempting a novel twist on words, the Greenbergs also claimed that the punitive damages they received were not punitive, but "bad faith damages" (whatever that means), and that "damage awards that serve both to compensate and punish are excludable."

Perhaps the Greenbergs would have gotten farther had they found some citation in the published authority for this position, which they apparently did not.

One last point, of course, should be notation of the fact that the current application of IRC 104 only pertains to exclusion of compensatory damages "on account of personal physical injuries or physical sickness."

Pain and suffering just won't cut it.