The Treasury and IRS have issued final regulations excepting certain partnership-related items from the centralized partnership audit regime created by the Bipartisan Budget Act of 2015 (BBA), providing alternative examination rules for the excepted items, conforming the existing centralized audit regime regulations to Internal Revenue Code changes, and clarifying the existing audit regime rules.

The Treasury and IRS have issued final regulations excepting certain partnership-related items from the centralized partnership audit regime created by the Bipartisan Budget Act of 2015 (BBA), providing alternative examination rules for the excepted items, conforming the existing centralized audit regime regulations to Internal Revenue Code changes, and clarifying the existing audit regime rules. The regulations finalize with revisions 2020 proposed regulations ( REG-123652-18).

Centralized Partnership Audit Regime

The Bipartisan Budget Act of 2015 (BBA, P.L. 114-74) replaced the Tax Equity and Fiscal Responsibility Act (TEFRA, P.L. 97-248) partnership procedures with a centralized partnership audit regime for making partnership adjustments and tax determinations, assessments, and collections at the partnership level. These changes were further amended by the Protecting Americans from Tax Hikes Act of 2015 (PATH Act, P.L. 114-113) and the Tax Technical Corrections Act of 2018 (TTCA, P.L. 115-141). The centralized audit regime, as amended, generally applies to returns filed for partnership tax years beginning after December 31, 2017. A partnership with no more than 100 partners may generally elect out of the centralized audit regime if all the partners are eligible partners.

Under the post-2017 centralized partnership audit regime, the IRS examines “partnership-related items” of all domestic and foreign partnerships and their partners. A "partnership-related item" is any item relevant to the determination of the income tax liability of any person. However, Code Sec. 6241(11), added by the BBA, authorizes Treasury to except “special enforcement matters” from the centralized partnership audit regime and to issue regulations providing alternative assessment and collection rules for those matters. The 2020 proposed regulations and these final regulations implement Code Sec. 6241(11) and make changes to previously issued final regulations pertaining to the centralized partnership audit regime.

Special Enforcement Matters

Code Sec. 6241(11) sets forth six categories of "special enforcement matters":

• (1) failures to comply with the requirements for a partnership partner or S corporation partner to furnish statements or compute and pay an imputed underpayment;
• (2) assessments relating to termination assessments of income tax or jeopardy assessments of income, estate, gift, and certain excise taxes;
• (3) criminal investigations;
• (4) indirect methods of proof of income;
• (5) foreign partners or partnerships; and
• (6) other matters identified in IRS regulations.

The final regulations add three new types of special enforcement matters:

• partnership-related items underlying non-partnership-related items;
• relationship of a partner to the partnership under the Code Sec. 267(b) or Code Sec. 707(b) related-party rules and extensions of the partner’s period of limitations; and
• penalties and taxes imposed on the partnership under chapter 1.

The final regulations also require the IRS to provide written notice of most special enforcement matters to taxpayers to whom the adjustments are being made.

In addition, the final regulations clarify that the IRS may adjust partnership-level items for a partner or indirect partner without regard to the centralized audit regime if the adjustment relates to termination and jeopardy assessments, the partner is under criminal investigation, or the adjustment is based on an indirect method of proof of income.

However, the final regulations provide that a determination about partnership-related items made outside of the centralized partnership regime is not binding on any person who is not a party to that proceeding. The final regulations clarify that neither the partnership nor the other partners are bound by a determination regarding a partnership-related item from a partner-level examination and that neither the partnership nor the other partners need to adjust their returns.

In addition, the special-enforcement-matter rules do not apply to the extent a partner can demonstrate that adjustments to partnership-related items in the deficiency or an adjustment by the IRS were (i) previously taken into account under the centralized audit regime by the person being examined or (ii) included in an imputed underpayment paid by a partnership (or pass-through partner) for any tax year in which the partner was a reviewed-year partner (but only if the amount exceeds the amount reported by the partnership to the partner that was either reported by the partner or included in the deficiency or adjustment).

Imputed Underpayments

The IRS and Treasury believe that a mechanism must exist for including adjustments from a centralized-regime audit in the partnership’s imputed underpayment, even if the partnership elects to “push out” the adjustment to its partners.

Under existing regulations for calculating imputed underpayments, an adjustment to a non-income item (that is, an item that is not an item of income, gain, loss, deduction, or credit) that is related to, or results from, an adjustment to an item of income, gain, loss, deduction, or credit is generally treated as zero. The final regulations require a partnership to take into account an adjustment to a non-income item on its adjustment-year return by adjusting the item to be consistent with the adjustment, but only to the extent the item would appear on that return without regard to the adjustment. If the item already appeared on the partnership’s adjustment-year return as a non-income item or the item appeared as a non-income item on any return of the partnership for a tax year between the reviewed year and the adjustment year, the partnership does not create a new item on the partnership’s adjustment-year return.

The final regulations provide that if the partnership is required to adjust its basis in an asset, the partnership does so in the adjustment year; however, the partnership only recognizes income and gain as a result of the basis adjustment in situations in which income or gain would be recognized. The final regulations also demonstrate how adjustments to liabilities are taken into account when they do not result in an imputed underpayment, and how an amended return should reflect adjustments to non-income items.

The final regulations follow the proposed regulations in allowing either the IRS or the partnership to treat an adjustment to a non-income item as zero. The final regulations also permit a partnership to treat such an adjustment as zero if the adjustment is related to, or results from, another adjustment to a non-income item. The partnership may not, however, treat such an adjustment as zero if one adjustment is positive and the other is negative.

Partnership Ceasing to Exist

Code Sec. 6241 states that if a partnership ceases to exist before any partnership adjustments take effect, the former partners of the partnership must take the adjustments into account in the manner prescribed in regulations. The final regulations clarify that even if a partnership has ceased to exist, it may make the election to push out the adjustments, request modification of the imputed underpayment, or pay the imputed underpayment within ten days of notice and demand for payment.

A section of the proposed regulations that would define "former partners" is not included in the final regulations and remains proposed.

Effective and Applicability Dates

The final regulations, which are effective December 8, 2022, apply to tax years ending on or after November 20, 2020 (except that final Reg. § 301.6241-7(b) applies to tax years beginning after December 20, 2018).

An IRS Notice provides guidance on the prevailing wage and apprenticeship requirements that the Inflation Reduction Act of 2022 ( P.L. 117-169) added to several new and amended tax credits and deductions.

An IRS Notice provides guidance on the prevailing wage and apprenticeship requirements that the Inflation Reduction Act of 2022 ( P.L. 117-169) added to several new and amended tax credits and deductions. The IRS also anticipates issuing proposed regulations and other guidance with respect to the prevailing wage and apprenticeship requirements.

These requirements generally apply if construction of a qualified facility, or installation of qualified property in an energy efficient commercial building, begins on or after the date that is 60 days after the IRS publishes guidance. This notice serves as the guidance that starts the 60-day clock. Thus, these rules apply when a qualified facility begins construction or the installation of qualified property begins on or after January 29, 2023.

The notice also provides guidance for determining the beginning of construction of a facility for certain credits, and the beginning of installation of certain property with respect to the energy efficient commercial buildings deduction.

The notice includes examples to illustrate these rules.

Prevailing Wage Requirements

For purposes of the credits, a taxpayer must satisfy the prevailing wage requirements with respect to any laborer or mechanic employed in the construction, alteration, or repair of a facility, property, project, or equipment by the taxpayer and the taxpayer’s contractors and subcontractors. The taxpayer must also maintain and preserve sufficient records to establish compliance, including books of account or records for work performed by contractors or subcontractors.

The prevailing wage rate is generally the one published by the Secretary of Labor on www.sam.gov for the geographic area and type of construction applicable to the facility, including all labor classifications for the construction, alteration, or repair work that will be done on the facility by laborers or mechanics.

If the Secretary has not published a prevailing wage rate for the geographic area or the particular type of work, the taxpayer may request a wage determination or wage rate from the Wage and Hour Division. The taxpayer must follow prescribed procedures in order to rely on the provided wage or rate.

Similarly, for purposes of the deduction for energy efficient commercial buildings, the prevailing wage rate for installation of energy efficient commercial building property, energy efficient building retrofit property, or property installed pursuant to a qualified retrofit plan, is determined with respect to the prevailing wage rate for construction, alteration, or repair of a similar character in the locality in which the property is located, as most recently determined by the Secretary of Labor.

Apprenticeship Requirements

A taxpayer satisfies the apprenticeship requirements if:

1. The taxpayer satisfies the Apprenticeship Labor Hour Requirements, subject to any applicable Apprenticeship Ratio Requirements;
2. The taxpayer satisfies the Apprenticeship Participation Requirements; and
3. The taxpayer maintains sufficient records.

Under the Good Faith Effort Exception, the taxpayer will be considered to have made a good faith effort in requesting qualified apprentices if the taxpayer requests qualified apprentices from a registered apprenticeship program in accordance with usual and customary business practices for registered apprenticeship programs in a particular industry.

Beginning of Construction or Installation

The beginning of construction is determined under the Physical Work Test and the Five-Percent Safe Harbor established in Notice 2013-29. The Continuity Safe Harbor established by Notice 2016-31 also applies.

The IRS has notified taxpayers, above the age of 72 years, that they can delay the withdrawal of the required minimum distributions (RMD) from their retirement plans and Individual Retirement Accounts (IRA), until April 1, following the later of the calendar year that the taxpayer reaches age 72 or, in a workplace retirement plan, retires.

The IRS has notified taxpayers, above the age of 72 years, that they can delay the withdrawal of the required minimum distributions (RMD) from their retirement plans and Individual Retirement Accounts (IRA), until April 1, following the later of the calendar year that the taxpayer reaches age 72 or, in a workplace retirement plan, retires. The Service also reminded taxpayers that they must meet the deadlines to avoid penalties and that such RMDs may not be rolled over to another IRA or retirement plan. The Service also informed taxpayers that not taking a required distribution, or not withdrawing enough, could mean a 50% excise tax on the amount not distributed.

The deadlines for the different RMDs are as follows:

• Taxpayers holding traditional IRAs , and SEP, SARSEP, and SIMPLE IRA should take their first RMD, even if they’re still working, by April 1, 2023, and the second RMD by Dec. 31, 2023, and each year thereafter.
• For taxpayers with retirement plans, the first RMD is due by April 1 of the later of the year they reach age 72, or the participant is no longer employed. A 5% owner of the employer must begin taking RMDs at age 72.
• An IRA trustee, or plan administrator, must either report the amount of the RMD to the IRA owner or offer to calculate it. They may be able to withdraw the total amount from one or more of the IRAs. However, RMDs from workplace retirement plans must be taken separately from each plan.

An RMD may be required for an IRA, retirement plan account or Roth IRA inherited from the original owner. A 2020 RMD that qualified as a coronavirus-related distribution may be repaid over a 3-year period or the taxes due on the distribution may be spread over three years. A 2020 withdrawal from an inherited IRA could not be repaid to the inherited IRA but may be spread over three years for income inclusion.

The Financial Crimes Enforcement Network (FinCEN) has issued a Notice of Proposed Rulemaking (NPRM) that would implement the beneficial ownership information provisions of the Corporate Transparency Act (CTA) that govern access to and protection of beneficial ownership information.

The Financial Crimes Enforcement Network (FinCEN) has issued a Notice of Proposed Rulemaking (NPRM) that would implement the beneficial ownership information provisions of the Corporate Transparency Act (CTA) that govern access to and protection of beneficial ownership information. The proposed regulations address the circumstances under which beneficial ownership information may be disclosed to certain governmental authorities and financial institutions, and how that information must be protected.

The proposed regulations would—

• specify how government officials would access beneficial ownership information in support of law enforcement, national security, and intelligence activities;
• describe how certain financial institutions and their regulators would access that information to fulfill customer due diligence requirements and conduct supervision; and
• set high standards for protecting this sensitive information, consistent with CTA goals and requirements.

The NPRM also proposes amendments to the final reporting rule issued on September 30, 2022, effective January 1, 2024, to specify when reporting companies may report FinCEN identifiers associated with entities.

Limiting Access to Beneficial Ownership Information

The NPRM follows the final reporting rule which requires most corporations, limited liability companies, and other similar entities created in or registered to do business in the United States, to report information about their beneficial owners to FinCEN. Per CTA requirements, the proposed regulations limit access to beneficial ownership information to—

• federal agencies engaged in national security, intelligence, or law enforcement activities;
• state, local, and Tribal law enforcement agencies, if authorized by a court of competent jurisdiction;
• financial institutions with customer due diligence requirements, and federal regulators supervising them for compliance with those requirements;
• foreign law enforcement agencies, judges, prosecutors, central authorities, and other agencies that meet specific criteria, and whose requests are made under an international treaty, agreement, or convention, or via law enforcement, judicial, or prosecutorial authorities in a trusted foreign country; and
• U.S. Treasury officers and employees whose official duties require beneficial ownership information inspection or disclosure, or for tax administration.

The proposed regulation would subject each authorized recipient category to unique security and confidentiality protocols that align with the scope of the access and use provisions.

Proposed Effective Date

FinCEN is proposing an effective date of January 1, 2024, to align with the date when the final beneficial ownership information reporting rule becomes effective.

Request for Comments

Interested parties can submit written comments on the NPRM by or before February 14, 2023 (60 days following publication in the Federal Register). Comments may be submitted by the Federal E-rulemaking Portal ( regulations.gov), or by mail to Policy Division, Financial Crimes Enforcement Network, P.O. Box 39, Vienna, VA 22183. Refer to Docket Number FINCEN-2021-0005 and RIN 1506-AB49/AB59.

The IRS and the Treasury Department have released final regulations that provide some clarity and relief with regards to certain provisions of the Affordable Care Act ( P.L. 111-148), including the definition of minimum essential coverage under Code Sec. 5000A and reporting requirements for health insurance issuers and employers under Code Secs. 6055 and 6056. The final regulations finalize 2021 proposed regulations with some clarifications ( REG-109128-21).

The IRS and the Treasury Department have released final regulations that provide some clarity and relief with regards to certain provisions of the Affordable Care Act ( P.L. 111-148), including the definition of minimum essential coverage under Code Sec. 5000A and reporting requirements for health insurance issuers and employers under Code Secs. 6055 and 6056. The final regulations finalize 2021 proposed regulations with some clarifications ( REG-109128-21).

The final regulations provide that the term "minimum essential coverage" does not include Medicaid coverage limited to COVID-19 testing and diagnostic services provided under the Families First Coronavirus Response Act ( P.L. 116-127). If an individual qualifies solely for this coverage, then it does not prevent them from claiming the premium tax credit under Code Sec. 36B. This amendment to Reg.§ 1.5000A-2 applies for months beginning after September 28, 2020.

The final regulations also provide:

• An automatic 30-day extension of time under Code Sec. 6056 for "applicable large employers" (generally employers with 50 or more full-time employees, including full-time equivalent employees) to furnish statements relating to health insurance that the applicable large employers offer to their full-time employees; ·
• An automatic 30-day extension of time under Code Sec. 6055 for providers of minimum essential coverage (such as health insurance issuers) that would provide an automatic extension of time for furnishing statements to responsible individuals; and
• An alternative method for reporting entities to furnish statements to their insured members when their shared responsibility payment is zero. The regulations under Reg.§1.6055-1(g)(4)(ii)(B) provide sample language for furnishing these statements.

The regulations under Reg. §§1.6055-1 and 301.6056-1 apply for years beginning after December 31, 2021.

The final regulations affect some taxpayers who claim the premium tax credit; health insurance issuers, self-insured employers, government agencies, and other persons that provide minimum essential coverage to individuals; and applicable large employers.

A theme running through the recent Internal Revenue Service Independent Office of Appeals Focus Guide for fiscal year 2023 is moving on past the issues created by the COVID-19 pandemic and getting back to helping taxpayers through the appeals process.

A theme running through the recent Internal Revenue Service Independent Office of Appeals Focus Guide for fiscal year 2023 is moving on past the issues created by the COVID-19 pandemic and getting back to helping taxpayers through the appeals process.

"It's time, as we leave some of those pandemic issues behind us, to focus more on our core mission in appeals, which is the quality resolution of taxpayer cases," Independent Office of Appeals Chief Andy Keyso said in a recent interview with Federal Tax Daily. "I think that's the theme you see throughout the focus guide," which was issued November 4, 2022.

To that end, Keyso highlighted two key areas that will enable the office to meet that core mission – staffing and technology upgrades.

Rebuilding Staff

On the staffing side, Keyso noted that 10 years ago, the Appeals staff was at 2,100 employees, but in that window dropped to a low of about 1,100.

"We have made a big push to restack, using any kind of approval we could get here internally, and we currently are sitting at about 1,500 employees," he said, adding that the office currently has about 1,500 employees, with a goal in 2023 to get up to 1,725.

Keyso noted that the office is different from other parts of the IRS that have an exam or a collections function.

"If you don’t have the number of people you’d like to have, you just do fewer collection actions or you do fewer audits," Keyso said. "In Appeals, we have unique challenges. We’ve got to work every case that comes in the door. We can’t say, ‘We don’t have enough people, so we are not going to work your case.’ So for us, hiring is particularly an acute issue and recruiting and hiring will be one of our focus areas for this year."

He added that the staffing targets are based on the IRS’ set budget for 2023 and do not include potential increases that could come with the additional funding provided by the Inflation Reduction Act.

Improving Technology

Like the rest of the agency, the Office of Appeals is working through its own technology issues and is in need of upgrades.

In particular, Keyso highlighted the need to get away from paper.

"I think we learned during the pandemic a few things about technology and how paper can really be our Achilles heel when you have to move paper case files," he said. "That was a particular issue during the pandemic when you didn’t have all of your people in the office to ship case files around."

Moving to a more paperless environment is a "continuing challenge," Keyso said, not only for communicating between Appeals employees, but between staff and taxpayers. "Should we really be mailing things back and forth through the U.S. Postal Service? Or is there a better way to communicate with taxpayers that’s faster and maybe preferable to taxpayers?"

As part of the technology challenges, the Independent Office of Appeals also is looking to continue to use video conferencing, something that gained traction during the pandemic.

"With the service wide return to the office, we are again offering in person conferences, which is something Appeals is very excited about," Amy Giuliano, senior advisor to the Chief and Deputy Chief in the Office of Appeal, said. "But we want video conferences to remain a permanent option to alongside in person. We requested comments in August … for people to submit input on experiences they had with video conferences with appeals that should inform our longer term guidelines. And we've received a lot of positive feedback that video conferences, when they're managed effectively, are a great way for a taxpayer to present their case to appeals."

She applauded the fact that video conferences have the benefits of a face-to-face conference in that one can see the IRS agent they are dealing with, but they avoid the logistical issues with traveling to an IRS office to conduct the meeting. It makes things more accessible, especially if the taxpayer has medical or other mobility issues.

"That's why it's so important that it remain an option going forward alongside in person and alongside telephone," she said.

Improving Overall Access

Keyso also noted that a key area of focus going forward is improving the overall access to the Independent Office of Appeals now that access has been codified into law through the Taxpayer First Act of 2019. Treasury is currently working on regulations that will implement the law.

"Our position in the Appeals Office is, you know, we want the broadest access to appeals possible for us to hear controversies or disputes between IRS and taxpayer," Keyso said. "So we will continue to push for broad access to taxpayers to appeals."

Giuliano added that "enhancing the taxpayer experience is really what sort of animates and informs everything else that we're doing."

Keyso also mentioned that Appeals is planning on continuing convening practitioner panels, during which the office invites practitioners to talk about issues they are facing as they deal with the appeals process. He noted that it was through these panels that the office made changes to letters that went out to taxpayers and their representatives that included more contact information on managers so taxpayers and their representatives have it handy if they need to escalate a situation.

Audits by the Internal Revenue Service in 2017 and 2019 were not conducted to target specific individuals, according to a new report by the Treasury Inspector General for Tax Administration.

Audits by the Internal Revenue Service in 2017 and 2019 were not conducted to target specific individuals, according to a new report by the Treasury Inspector General for Tax Administration.

The report, dated November 29, 2022, but released December 1, found that "key decisions and information related to the tax return selection process for Tax Years 2017 and 2019 were determined prior to the start of each year’s respective filing season and prior to the selection of any returns," the Treasury watchdog said in a statement. "TIGTA also confirmed that the computer program used to select tax returns worked as designed and di not included any malicious code that would force the selection of specific taxpayers for an NRP [National Research Program] audit."

TIGTA conducted the analysis of the audit selection process following a July 2022 media report that suggested the selection for those tax years may not have been random. To answer the allegations, TIGTA hired a contractor that, according to the report, "replicated the process. Specifically, the contractor replicated each week’s original sample selection file through April 2018 and July 2020 for TYs 2017 and 2019, respectively."

Once replicated, a return-by-return comparison of the replicated files and the original sample selection was conducted to verify the files matched.

"They concluded that the tax returns in the original samples were the same tax returns selected when the process was replicated using the respective seed numbers," the report states. "TIGTA also compared the contractor’s replicated weekly output files to the original weekly output files, and same as the IRS, TIGTA determined they matched."

The report noted that a line-by-line review of the original source code was conducted "to determine whether information (i.e., TIN) was improperly coded in the program that would result in a specific taxpayer being selected for an NRP audit. The contractor concluded that no specific taxpayer information was included in the original source code."

President Obama’s health care package enacted two new taxes that take effect January 1, 2013. One of these taxes is the additional 0.9 percent Medicare tax on earned income; the other is the 3.8 percent tax on net investment income. The 0.9 percent tax applies to individuals; it does not apply to corporations, trusts or estates. The 0.9 percent tax applies to wages, other compensation, and self-employment income that exceed specified thresholds.

President Obama’s health care package enacted two new taxes that take effect January 1, 2013. One of these taxes is the additional 0.9 percent Medicare tax on earned income; the other is the 3.8 percent tax on net investment income. The 0.9 percent tax applies to individuals; it does not apply to corporations, trusts or estates. The 0.9 percent tax applies to wages, other compensation, and self-employment income that exceed specified thresholds.

Additional tax on higher-income earners

There is no cap on the application of the 0.9 percent tax. Thus, all earned income that exceeds the applicable thresholds is subject to the tax. The thresholds are $200,000 for a single individual; $250,000 for married couples filing a joint return; and $125,000 for married filing separately. The 0.9 percent tax applies to the combined earned income of a married couple. Thus, if the wife earns $220,000 and the husband earns $80,000, the tax applies to $50,000, the amount by which the combined income exceeds the $250,000 threshold for married couples.

The 0.9 percent tax applies on top of the existing 1.45 percent Hospital Insurance (HI) tax on earned income. Thus, for income above the applicable thresholds, a combined tax of 2.35 percent applies to the employee’s earned income. Because the employer also pays a 1.45 percent tax on earned income, the overall combined rate of Medicare taxes on earned income is 3.8 percent (thus coincidentally matching the new 3.8 percent tax on net investment income).

Passthrough treatment

For partners in a general partnership and shareholders in an S corporation, the tax applies to earned income that is paid as compensation to individuals holding an interest in the entity. Partnership income that passes through to a general partner is treated as self-employment income and is also subject to the tax, assuming the income exceeds the applicable thresholds. However, partnership income allocated to a limited partner is not treated as self-employment and would not be subject to the 0.9 percent tax. Furthermore, under current law, income that passes through to S corporation shareholders is not treated as earned income and would not be subject to the tax.

Withholding rules

Withholding of the additional 0.9 percent Medicare tax is imposed on an employer if an employee receives wages that exceed $200,000 for the year, whether or not the employee is married. The employer is not responsible for determining the employee’s marital status. The penalty for underpayment of estimated tax applies to the 0.9 percent tax. Thus, employees should realize that the employee may be responsible for estimated tax, even though the employer does not have to withhold.

Planning techniques

One planning device to minimize the tax  would be to accelerate earned income, such as a bonus, into 2012. Doing this would also avoid any increase in the income tax rates in 2013 from the sunsetting of the Bush tax rates. Holders of stock-based compensation may want to trigger recognition of the income in 2012, by exercising stock options or by making an election to recognize income on restricted stock.

Another planning device would be to set up an S corp, rather than a partnership, for operating a business, so that the income allocable to owners is not treated as earned income. An entity operating as a partnership could be converted to an S corp.

If you have any questions surrounding how the new 0.9 percent Medicare tax will affect the take home pay of you or your spouse, or how to handle withholding if you are a business owner, please contact this office.

Certain planning techniques involve the use of interest rates to value interests being transferred to charity or to private beneficiaries. While the use of these techniques does not necessarily depend on the interest rate, low interest rates may increase their value.

Certain planning techniques involve the use of interest rates to value interests being transferred to charity or to private beneficiaries. While the use of these techniques does not necessarily depend on the interest rate, low interest rates may increase their value.

Taxpayers can obtain a deduction by giving a partial interest in property to a charity, using a trust. Two types of trusts for this purpose are charitable lead trusts and charitable remainder trusts. In a charitable lead trust, the taxpayer funding the trust gives an income interest to charity and the remainder interest to a family member or other preferred beneficiary. In a charitable remainder trust, an individual receives trust income and a charity is entitled to the remainder interest.

AFRs

The IRS’s applicable federal rate (AFR) is used to value these different interests in trusts. Right now, AFRs are relatively low. For example, for May 2017, the AFR for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest is only 2.4 percent, a low rate when compared to many past years.

CLTs

When AFRs are low, certain transfer mechanisms become even more useful. In a charitable lead trust (CLT), a low AFR increases the present value of the charity’s income interest. This increases the value of the charitable deduction for the income interest, and reduces the value of the remainder interest passing to private individuals. (For a charitable remainder trust, the same mechanism increases the present value of the individual beneficiary’s income interest, and reduces the value of the remainder interest going to charity.)

PRTs

Another device is a personal residence trust (PRT), where the grantor retains the right to live in the house, instead of receiving income payments, and gives the remainder interest in the property to charity. This provides a current charitable deduction. The amount of the charitable contribution is the fair market value of the property, discounted by the AFR. The lower the AFR, the higher is the value of the remainder interest, and the greater the charitable deduction.

A PRT can also be used to give the remainder interest to a family member or other individual. In this case, the transfer of the remainder interest is subject to gift tax. The lower the AFR, the greater is the value of the remainder interest, and the greater the gift tax.

Loans to family members

Another situation in which low interest rates can work to a taxpayer’s advantage is a loan between family members. For the loan to be bona fide, interest generally must be charged on the loan. However, the lower the AFR, the lower will be the market rate for interest that has to be charged to the borrower. If the interest rate is too low, the IRS may impute a higher rate of interest on the loan, which could result in a gift of the foregone interest to the borrower. Again, when the AFR is low, the lender can make a loan at a lower interest rate.

If you are interested in exploring further how any of the above-mentioned planning techniques can benefit your tax situation especially while interest rates remain low, please do not hesitate to contact this office.

Although it is generally not considered prudent to withdraw funds from a retirement savings account until retirement, sometimes it may appear that life leaves no other option. However, borrowing from certain qualified retirement savings account rather than taking an outright distribution might prove the best solution to getting you through a difficult period. If borrowing from a 401(k) plan or other retirement savings plan becomes necessary, for example to pay emergency medical expenses or for a replacement vehicle essential to getting to work, you should be aware that there is a right way and a number of wrong ways to go about it.

Although it is generally not considered prudent to withdraw funds from a retirement savings account until retirement, sometimes it may appear that life leaves no other option. However, borrowing from certain qualified retirement savings account rather than taking an outright distribution might prove the best solution to getting you through a difficult period. If borrowing from a 401(k) plan or other retirement savings plan becomes necessary, for example to pay emergency medical expenses or for a replacement vehicle essential to getting to work, you should be aware that there is a right way and a number of wrong ways to go about it.

When a plan loan is not a taxable distribution

In general, a loan from a qualified employer plan, such as a 401(a) or 401(k) account, must be treated as a taxable distribution unless you can meet certain requirements with respect to amount, repayment period, and repayment method.

First, however, the terms of the employer-plan must allow for plan loans. Due to administrative costs and other considerations, plan loans are made optional for employer plans. If permitted, however, loans must be made available to all employees.

A loan to a participant or beneficiary is generally not treated as a taxable distribution if:

• The loan is evidenced by a legally enforceable written agreement that specifies the amount and term of the loan and the repayment schedule;
• The amount of the loan does not exceed $50,000 or half of the participant's vested accrued benefit under the plan (whichever is less);
• The loan, by its terms, requires repayment within five years, except for certain home loans; and
• The loan is amortized in level installments over the term of the loan.

Plan loans may be made only from employer-based plans. Individual retirement accounts (IRAs) cannot be used as collateral for a loan, nor can a direct loan be made from the IRA to the account holder.

Calculating the amount of the plan loan

In addition to the $50,000 or 50 percent vested benefit rule, several other provisions apply to the amount of the plan loan. First, a plan participant may take out a loan of up to $10,000, even if that $10,000 is more than one-half of the present value of his vested accrued benefit. Second, if a plan participant decides to take out another plan loan, the new maximum amount of the total plan loans will be determined by the following method:

($50,000 − (highest outstanding loan balance during the preceding 12-month period − outstanding balance on the date of the new loan)) = new plan loan maximum.

That new plan maximum must be reduced further by any outstanding loan balance.

Repayment period

Participants must repay a loan within five years. There is one exception, however, for a loan used to make a purchase of a first-time home that is a principal residence. The loan term may then be as long as 30 years.

If a participant defaults on a loan payment, the entire principal may become due under the terms of the plan. In addition, most plan terms require that you repay the loan within 60 days if you leave or lose your job. If you cannot repay at that time, the balance of the loan is usually considered a taxable distribution deducted from your remaining retirement plan account balance. That deemed distribution may also incur a 10 percent early distribution penalty.

Repayment method

Loan repayments must be made at least every quarter, and are generally deducted automatically from a participant’s paycheck. Defaulting on a loan causes the IRS to treat the entire outstanding loan balance as a premature (and therefore a taxable) distribution from the employer plan. A deemed distribution occurs at the time of the failure to pay an installment, but the plan administrator can allow a grace period. The deemed distribution then becomes subject to both income tax and the 10 percent early withdrawal penalty.

There are benefits to borrowing from an employer retirement plan, such as providing a ready-made source of credit and the benefit of returning interest paid back into the plan account rather than into the pockets of a third-party lender. There are also many drawbacks to taking out a plan loan. To learn more, please contact our offices.

In recent years, the IRS has been cracking down on abuses of the tax deduction for donations to charity and contributions of used vehicles have been especially scrutinized. The charitable contribution rules, however, are far from being easy to understand. Many taxpayers genuinely are confused by the rules and unintentionally value their contributions to charity at amounts higher than appropriate.

In recent years, the IRS has been cracking down on abuses of the tax deduction for donations to charity and contributions of used vehicles have been especially scrutinized. The charitable contribution rules, however, are far from being easy to understand. Many taxpayers genuinely are confused by the rules and unintentionally value their contributions to charity at amounts higher than appropriate.

Vehicle donations

According to the U.S. Department of Transportation (DOT), there are approximately 250 million registered passenger motor vehicles in the United States. The U.S. is the largest passenger vehicle market in the world.  Potentially, each one of these vehicles could be a charitable donation and that is why the IRS takes such a sharp look at contributions of used vehicles and claims for tax deductions. The possibility for abuse of the charitable contribution rules is large.

Bona fide charities

Before looking at the tax rules, there is an important starting point.  To claim a tax deduction, your contribution must be to a bona fide charitable organization. Only certain categories of exempt organizations are eligible to receive tax-deductible charitable contributions. 

Many charitable organizations are so-called “501(c)(3)” organizations (named after the section of the Tax Code that governs charities. The IRS maintains a list of qualified Code Sec. 501(c)(3) organizations. Not all charitable organizations are Code Sec. 501(c)(3)s. Churches, synagogues, temples, and mosques, for example, are not required to file for Code Sec. 501(c)(3) status. Special rules also apply to fraternal organizations, volunteer fire departments and veterans organizations. If you have any questions about a charitable organization, please contact our office.

Tax rules

In past years, many taxpayers would value the amount of their used vehicle donation based on information in a buyer’s guide. Today, the value of your used vehicle donation depends on what the charitable organization does with the vehicle.

In many cases, the charitable organization will sell your used vehicle. If the charity sells the vehicle, your tax deduction is limited to the gross proceeds that the charity receives from the sale. The charitable organization must certify that the vehicle was sold in an arm’s length transaction between unrelated parties and identify the date the vehicle was sold by the charity and the amount of the gross proceeds. 

There are exceptions to the rule that your tax deduction is limited to the gross proceeds that the charity receives from the sale of your used vehicle. You may be able to deduct the vehicle’s fair market value if the charity intends to make a significant intervening use of the vehicle, a material improvement to the vehicle, or give or sell the vehicle to a qualified needy individual. If you have any questions about what a charity intends to do with your vehicle, please contact our office.

Written acknowledgment

The charitable organization must give you a written acknowledgment of your used vehicle donation. The rules differ depending on the amount of your donation.  If you claim a deduction of more than $500 but not more than $5,000 for your vehicle donation, the written acknowledgment from the charity must:

• Identify the charity’s name, the date and location of the donation
• Describe the vehicle
• Include a statement as to whether the charity provided any goods or services in return for the car other than intangible religious benefits and, if so, a description and good faith estimate of the value of the goods and services
• Identify your name and taxpayer identification number
• Provide the vehicle identification number

The written acknowledgement generally must be provided to you within 30 days of the sale of the vehicle.  Alternatively, the charitable organization may in certain cases, provide you a completed Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, that contains the same information.

The written acknowledgment requirements for claiming a deduction under $500 or over $5,000 are similar to the ones described above but there are some differences. For example, if your deduction is expected to be more than $5,000 and not limited to the gross proceeds from the sale of your used vehicle, you must obtain a written appraisal of the vehicle. Our office can help guide you through the many steps of donating a vehicle valued at more than $5,000.

If you are planning to donate a used vehicle, please contact our office and we can discuss the tax rules in more detail.

When disaster strikes, a casualty tax loss may provide some comfort. A casualty is the damage or destruction of property resulting from an identifiable event that is sudden, unexpected, or unusual. Damage resulting from the progressive deterioration of property through a steadily operating cause would not be a casualty loss. A deductible loss can result from a number of events, such as fire, flood, storm (including hurricanes and tornadoes), or earthquake. Storm losses can involve damage from flooding or wind, for example. Other “sudden and unexpected events,” such as an automobile accident, also qualify as a casualty for tax purposes.

When disaster strikes, a casualty tax loss may provide some comfort. A casualty is the damage or destruction of property resulting from an identifiable event that is sudden, unexpected, or unusual. Damage resulting from the progressive deterioration of property through a steadily operating cause would not be a casualty loss. A deductible loss can result from a number of events, such as fire, flood, storm (including hurricanes and tornadoes), or earthquake. Storm losses can involve damage from flooding or wind, for example. Other “sudden and unexpected events,” such as an automobile accident, also qualify as a casualty for tax purposes.

According to the most recent reading of the U.S. Drought Monitor and other indicators, moderate to exceptional drought covered approximately 60 percent of the contiguous U.S. as of the end of August and is being compared to the droughts of the 1930’s, 1950’s and the summer of 1988. Unless a loss attributable to drought occurs in a trade or business or a for-profit transaction, however, it is generally not deductible. A loss must occur within a short period of time, for it to be deductible as a casualty loss. The IRS has said that most droughts lack the suddenness necessary for a casualty loss deduction. The conventional tax wisdom has been that, as a practical matter, a casualty loss should not be claimed unless there has been an officially declared water emergency or some general drought designation by the IRS. For example, a casualty loss deduction was allowed for structural damage to a house because of subsoil shrinkage in a 1977 Missouri drought that was declared a federal disaster. So far, the IRS has not spoken to the drought of 2012 but some guidance is expected to be announced in the near future.

Taxpayer has burden of proof

To deduct a casualty loss, the taxpayer must be able to show that there was a casualty loss and to justify the amount taken as a deduction. A taxpayer should be able to show: the type of casualty and its date of occurrence; that the loss was a direct result of the casualty; that the taxpayer owned the property (or was liable for the damage to the owner of the property); and whether there is a claim for reimbursement with a reasonable expectation of recovery.

Business property

The allowable deduction for business property destroyed in a casualty is usually different from the loss of personal property. If the property is used in a trade or business or other activity conducted for profit, the allowable deduction is the lesser of the property’s adjusted basis (before the casualty) or its decline in value because of the casualty. If business property is completely destroyed, the deduction is the full amount of the property’s adjusted basis, reduced by any insurance recovery, even if the basis exceeded the property’s value before the casualty.

Personal-use property

If property owned outside of the business or investment setting, like a personal residence, is damaged, the loss is the lesser of the property’s decline in value or its adjusted basis, reduced by insurance proceeds or other reimbursement. Unlike business property, if personal property is completely destroyed, the loss cannot exceed the decline in value from the casualty, even if this is less than the basis. Furthermore, the loss must be reduced by $100 per casualty, and is deductible only to the extent that net casualty and theft losses exceed 10 percent of the taxpayer’s adjusted gross income. Unlike businesses, however, individuals have the option of treating a casualty loss as occurring in the immediately prior year, thereby often allowing for a quick refund through filing an amended return.

“Timely” insurance claim

To deduct a personal casualty loss, the taxpayer must have filed a timely insurance claim. The loss may be disallowed if the taxpayer fails to file a claim. Any portion of the loss that is not covered by insurance is not subject to this rule.

A recent court case discusses the requirement to file a timely insurance claim. A homeowner suffered loss of his home from fire. The homeowner immediately notified his insurance company of the loss, was assigned a claim number, and had the insurance company inspect the damage. However, the insurance company denied the claim. One reason it gave was that the homeowner failed to provide a statement as to proof of loss within 60 days, as required under the policy. After the insurance company denied the claim, the homeowner took a casualty loss deduction on his amended tax return.

Taxpayer deduction upheld

The IRS denied the casualty loss deduction, claiming that the taxpayer had failed to file a “timely insurance claim” as required by the tax code. The Federal Court of Claims rejected the IRS’s action and allowed the claim. The court said it was clear that the homeowner had filed a claim with the insurance company and that this was sufficient to comply with the tax code. The company’s ultimate denial of the claim under the terms of the policy was not relevant.

If you have suffered a casualty, it is important that you claim the full amount of the tax deduction to which you are entitled. If you have any questions about casualty losses, please contact our office.

The IRS has unveiled the IRS Data Retrieval Tool (DTR), a time-saving tool designed to minimize the time required for college-bound students and their parents to complete the Department of Education’s Free Application for Federal Student Aid (FAFSA). The new IRS DTR is available through the website www.fafsa.gov.

The IRS has unveiled the IRS Data Retrieval Tool (DTR), a time-saving tool designed to minimize the time required for college-bound students and their parents to complete the Department of Education’s Free Application for Federal Student Aid (FAFSA). The new IRS DTR is available through the website www.fafsa.gov.

The FAFSA form is necessary for college-bound students and their parents who are applying for numerous federal government education programs or subsidies, such as the Pell Grant, low-interest federal student loans, and the Federal Work Study Program. Eligible taxpayers may use the tool for either the initial or the renewal FAFSA.

Completion of the FAFSA requires certain federal tax information such as the student and parents’ adjusted gross income, tax, and exemptions. The free IRS DTR tool enables applicants to automatically transfer their tax return information onto the FAFSA form. The tool will also increase the accuracy of the income information reported on the FAFSA form and minimize processing delays. Taxpayers who are eligible to use the DRT can access it one to two weeks after the federal income tax return is filed if the return is filed electronically. In the cases of a paper tax return, taxpayers may access the tool approximately six to eight weeks after filing.

Who can use the DRT?

To use the DRT to complete the 2012–2013 FAFSA, taxpayers must meet several prerequisites:

1. They must have filed a federal 2011 tax return;
2. Have a valid SSN;
3. Have a valid Federal Student Aid PIN; and
4. Have not changed marital status since December 31, 2011.

What if I don’t have a PIN?

If an individual does not have a Federal Student Aid PIN, he or she may apply for one beforehand through the FAFSA application process. An online application is available at www.pin.ed.gov.

What if I can’t use the DRT?

In some cases the IRS DRT is unavailable. The tool is not accessible for completion of the 2012-2013 FAFSA if either the student or parents:

1. Filed an amended 2011 tax return or did not file a 2011 tax return;
2. Filed their 2011 tax return as married, filing separately; or
3. Filed a foreign tax return or Puerto Rican tax return.

If a student cannot or chooses not to use the IRS DRT, that student, his or her parents or spouse can verify income information submitted to the Financial Aid Office through a tax transcript from the IRS. Applicants may request a transcript on IRS Form 4506-T, Request for Transcript of Tax Return. Transcripts may be requested online through www.irs.gov or by phone at 1-800-908-9946.

The number of tax return-related identity theft incidents has almost doubled in the past three years to well over half a million reported during 2011, according to a recent report by the Treasury Inspector General for Tax Administration (TIGTA). Identity theft in the context of tax administration generally involves the fraudulent use of someone else’s identity in order to claim a tax refund. In other cases an identity thief might steal a person’s information to obtain a job, and the thief’s employer may report income to the IRS using the legitimate taxpayer’s Social Security Number, thus making it appear that the taxpayer did not report all of his or her income.

In light of these dangers, the IRS has taken numerous steps to combat identity theft and protect taxpayers. There are also measures that you can take to safeguard yourself against identity theft in the future and assist the IRS in the process.  

IRS does not solicit financial information via email or social media

The IRS will never request a taxpayer’s personal or financial information by email or social media such as Facebook or Twitter. Likewise, the IRS will not alert taxpayers to an audit or tax refund by email or any other form of electronic communication, such as text messages and social media channels.

If you receive a scam email claiming to be from the IRS, forward it to the IRS at phishing@irs.gov. If you discover a website that claims to be the IRS but does not begin with 'www.irs.gov', forward that link to the IRS at phishing@irs.gov.

How identity thieves operate

Identity theft scams are not limited to users of email and social media tools. Scammers may also use a phone or fax to reach their victims to solicit personal information. Other means include:

-Stealing your wallet or purse
-Looking through your trash
-Accessing information you provide to an unsecured Internet site.

How do I know if I am a victim?

Your identity may have been stolen if a letter from the IRS indicates more than one tax return was filed for you or the letter states you received wages from an employer you don't know. If you receive such a letter from the IRS, leading you to believe your identity has been stolen, respond immediately to the name, address or phone number on the IRS notice. If you believe the notice is not from the IRS, contact the IRS to determine if the letter is a legitimate IRS notice.

If your tax records are not currently affected by identity theft, but you believe you may be at risk due to a lost wallet, questionable credit card activity, or credit report, you need to provide the IRS with proof of your identity. You should submit a copy of your valid government-issued identification, such as a Social Security card, driver's license or passport, along with a copy of a police report and/or a completed IRS Form 14039, Identity Theft Affidavit, which should be faxed to the IRS at 1-978-684-4542.

What should I do if someone has stolen my identity?

If you discover that someone has filed a tax return using your SSN you should contact the IRS to show the income is not yours. After the IRS authenticates who you are, your tax record will be updated to reflect only your information. The IRS will use this information to minimize future occurrences.

What other precautions can I take?

There are many things you can do to protect your identity. One is to be careful while distributing your personal information. You should show employers your Social Security card to your employer at the start of a job, but otherwise do not routinely carry your card or other documents that display your SSN.

Only use secure websites while making online financial transactions, including online shopping. Generally a secure website will have an icon, such as a lock, located in the lower right-hand corner of your web browser or the address bar of the website with read “https://…” rather than simply “http://.”

Never open suspicious attachments or links, even just to see what they say. Never respond to emails from unknown senders. Install anti-virus software, keep it updated, and run it regularly.

For taxpayers planning to e-file their tax returns, the IRS recommends use of a strong password. Afterwards, save the file to a CD or flash drive and keep it in a secure location. Then delete the personal return information from the computer hard drive.

Finally, if working with an accountant, query him or her on what measures they take to protect your information.

Claiming a charitable deduction for a cash contribution is straightforward. The taxpayer claims the amount paid, whether by cash, check, credit card or some other method, if the proper records are maintained. For contributions of property, the rules can be more complex.

Contributions of property

A taxpayer that contributes property can deduct the property's fair market value at the time of the contribution. For example, contributions of clothing and household items are not deductible unless the items are in good used condition or better. An exception to this rule allows a deduction for items that are not in at least good used condition, if the taxpayer claims a deduction of more than $500 and includes an appraisal with the taxpayer's income tax return.

Household items include furniture and furnishings, electronics, appliances, linens, and similar items. Household items do not include food, antiques and art, jewelry, and collections (such as coins).

To value used clothing, the IRS suggests using the price that buyers of used items pay in second-hand shops. However, there is no fixed formula or method for determining the value of clothing. Similarly, the value of used household items is usually much lower than the price paid for a new item, the IRS instructs. Formulas (such as a percentage of cost) are not accepted by the IRS.

Vehicles

The rules are different for "qualified vehicles," which are cars, boats and airplanes. If the taxpayer claims a deduction of more than $500, the taxpayer is allowed to deduct the smaller of the vehicle’s fair market value on the date of the contribution, or the proceeds from the sale of the vehicle by the organization.

There are two exceptions to this rule. If the organization uses or improves the vehicle before transferring it, the taxpayer can deduct the vehicle’s fair market value when the contribution was made. If the organization gives the vehicle away, or sells it far well below fair market value, to a needy individual to further the organization’s purpose, the taxpayer can claim a fair market value deduction. This latter exception does not apply to a vehicle sold at auction.

To determine the value of a car, the IRS instructs that "blue book" prices may be used as "clues" for comparison with current sales and offerings. Taxpayers should use the price listed in a used car guide for a private party sale, not the dealer retail value. To use the listed price, the taxpayer’s vehicle must be the same make, model and year and be in the same condition.

Most items of property that a person owns and uses for personal purposes or investment are capital assets. If the value of a capital asset is greater than the basis of the item, the taxpayer generally can deduct the fair market value of the item. The taxpayer must have held the property for longer than one year.

Please contact our office for more information about the tax treatment of charitable contributions.

With school almost out for the summer, parents who work are starting to look for activities for their children to keep them occupied and supervised. The possibilities include sending a child to day camp or overnight camp. Parents faced with figuring out how to afford the price tag of these activities may wonder whether some or part of these costs may be tax deductible. At least two possible tax breaks should be considered: the dependent care credit in most cases, and the deduction for medical expenses in certain special situations.

Dependent care credit. To qualify for the dependent care credit, expenses must be employment-related. The child also must be under age 13 unless he or she is disabled.

The child care expenses must enable the parent to work or to look for employment. The IRS has indicated that the costs of sending a child to overnight camp are not employment-related. However, the costs of sending a child to day camp are treated like day-care costs and will qualify as employment-related expenses (even if the camp features educational activities). At the same time, the costs of sending a child to summer school or to a tutor are not employment-related and cannot be deducted even though they also watch over your child while you are at work..

In some situations, the IRS requires that expenses be allocated between child care and other, nonqualified services. However, the full cost of day camp generally qualifies for the dependent care credit, without an allocation being required. If the parent works part-time, camp costs may only be claimed for the days worked. However, if the camp requires that the child be enrolled for the entire week, then the full cost qualifies.

Example. Tom works Monday through Wednesday and sends his child to day camp for the entire week. The camp charges $50 per day and children do not have to enroll for an entire week. Tom can only claim $150 in expenses. However, if the camp requires that the child be enrolled for the entire week, Tom can claim $250 in expenses.

Amount of Credit. The maximum amount of employment-related expenses to which the child care credit may be applied is $3,000 if one qualifying individual is involved or $6,000 if two or more qualifying individuals are involved. If you earn over a certain amount, the credit may be reduced. The credit amount is equal to the amount of qualified expenses times the applicable percentage, as determined by the taxpayer's adjusted gross income (AGI). Taxpayers with an AGI of $15,000 or less use the highest applicable percentage of 35 percent. For taxpayers with an AGI over $15,000, the credit is reduced by one percentage point for each $2,000 of AGI (or fraction thereof) over $15,000 The minimum applicable percentage of 20 percent is used by taxpayers with an AGI greater than $43,000. Bottom line: those with higher incomes are entitled to a maximum child care credit for one qualifying dependent is $1,050 and $2,100 for two or more qualifying dependents.

Dependent care costs also may be reimbursed by a flexible spending account (FSAs) under an employer-sponsored arrangement. FSAs allow pre-tax dollars to fund the account up to specified maximum. Each FSA may limit what it covers so check with your employer before assuming the day camp or similar child care is on its list of reimbursable expenses.

Medical expenses. The cost of camp generally is not deductible as a medical expense. The cost of providing general care to a healthy child is a nondeductible personal expense.

Example. The child's mother works; the child's father is ill and cannot take care of the child. The cost of sending the child to summer camp is not deductible as a medical expense; however, the costs may still qualify for the dependent care credit.

However, camps specifically run for handicapped children and operated to assist the child may come under the umbrella of medical expenses. The degree of assistance is usually determinative in these situations.

Dependency exemption. In any case, the cost of sending a child to camp can be treated as support, for claiming a dependency exemption. For a parent to claim a dependency exemption, the child cannot provide more than half of its own support. The parent must provide some support but does not necessarily have to provide over half of the child's support. If the child is treated as a qualifying relative (because he or she is too old to be a qualifying child), the parent must still provide over half of the child's support.

The rules on the deductibility of camp costs are somewhat complicated, especially in borderline situations. Please check with this office if you have any questions.

Many more retirees and others wanting guarantee income are looking into annuities, especially given the recent experience of the economic downturn. While the basic concept of an annuity is fairly simple, complex rules usually apply to the taxation of amounts received under certain annuity and life insurance contracts.

Amounts received as an annuity are included in gross income to the extent that they exceed the exclusion ratio, which is determined by taking the original investment in the contract, deducting the value of any refund features, and dividing the result by the expected yield on the contract as of the annuity starting date. In general, the expected return is the product of a single payment and the anticipated number of payments to be received, i.e., the total amount the annuitant(s) can expect to receive. In the case of a life annuity, the number of payments is computed based on actuarial tables.

If the annuity payments are to continue as long as the annuitant remains alive, the anticipated number of payments is based on the annuitant's (or annuitants') life expectancy at the birthday nearest the annuity starting date. The IRS provides a variety of actuarial tables, within unisex tables generally applicable to all contracts entered into after June 1986. The expected return multiples found in the actuarial tables may require adjustment if the contract specifies quarterly, semiannual or annual payments or if the interval between payments exceeds the interval between the annuity starting date and the first payment.

In connection with annuity calculations, one recent tax law change in particular is worth noting. Under the Creating Small Business Jobs Act of 2010, enacted on September 27, 2010, if amounts are received as an annuity for a period of 10 years or more or on the lives of one or more individuals under any portion of an annuity, endowment, or life insurance contract, then that portion of the contract will now be treated as a separate contract for tax purposes. As result, a portion of such an annuity, endowment, or life insurance contract may be annuitized, while the balance is not annuitized. The allowance of partial annuitization applies to amounts received in tax years beginning after December 31, 2010.

If you need help in "crunching the numbers" on an annuity, or if you'd like advice on what annuity options might best fit your needs, please do not hesitate to contact our office.

Most people are familiar with tax withholding, which most commonly takes place when an employer deducts and withholds income and other taxes from an employee's wages. However, many taxpayers are unaware that the IRS also requires payors to withhold income tax from certain reportable payments, such as interest and dividends, when a payee's taxpayer identification number (TIN) is missing or incorrect. This is known as "backup withholding."

Backup Withholding in General

A payor must deduct, withhold, and pay over to the IRS a backup withholding tax on any reportable payments that are not otherwise subject to withholding if:

• the payee fails to furnish a TIN to the payor in the manner required;
• the IRS or a broker notifies the payor that the TIN provided by the payee is incorrect;
• the IRS notifies the payor that the payee failed to report or underreported the prior year's interest or dividends; or
• the payee fails to certify on Form W-9, Request for Taxpayer Identification Number and Certification, that he or she is not subject to withholding for previous underreporting of interest or dividend payments.

The backup withholding rate is equal to the fourth lowest income tax rate under the income tax rate brackets for unmarried individuals, which is currently 28 percent.

Only reportable payments are subject to backup withholding. Backup withholding is not required if the payee is a tax-exempt, governmental, or international organization. Similarly, payments of interest made to foreign persons are generally not subject to information reporting; therefore, these payees are not subject to backup withholding. Additionally, a payor is not required to backup withhold on reportable payments for which there is documentary evidence, under the rules on interest payments, that the payee is a foreign person, unless the payor has actual knowledge that the payee is a U.S. person. Furthermore, backup withholding is not required on payments for which a 30 percent amount was withheld by another payor under the rules on foreign withholding.

Reportable Payments

Reportable payments generally include the following types of payments of more than $10:

• Interest;
• Dividends;
• Patronage dividends (payments from farmers' cooperatives) paid in money;
• Payments of $600 or more made in the course of a trade or business;
• Payments for a nonemployee's services provided in the course of a trade or business;
• Gross proceeds from transactions reported by a broker or barter exchange;
• Cash payments from certain fishing boat operators to crew members that represent a share of the proceeds of the catch; and
• Royalties.

Reportable payments also include payments made after December 31, 2011, in settlement of payment card transactions.

Failure to Furnish TIN

Payees receiving reportable payments through interest, dividend, patronage dividend, or brokerage accounts must provide their TIN to the payor in writing and certify under penalties of perjury that the TIN is correct. Payees receiving other reportable payments must still provide their TIN to the payor, but they may do so orally or in writing, and they are not required to certify under penalties of perjury that the TIN is correct.

A payee who does not provide a correct taxpayer identification number (TIN) to the payer is subject to backup withholding. A person is treated as failing to provide a correct TIN if the TIN provided does not contain the proper number of digits --nine --or if the number is otherwise obviously incorrect, for example, because it contains a letter as one of its digits.

The IRS compares TINs provided by taxpayers with records of the Social Security Administration to check for discrepancies and notifies the bank or the payer of any problem accounts. The IRS has requested banks and other payers to notify their customers of these discrepancies so that correct TINs can be provided and the need for backup withholding avoided.

A limited liability company (LLC) is a business entity created under state law. Every state and the District of Columbia have LLC statutes that govern the formation and operation of LLCs.

The main advantage of an LLC is that in general its members are not personally liable for the debts of the business. Members of LLCs enjoy similar protections from personal liability for business obligations as shareholders in a corporation or limited partners in a limited partnership. Unlike the limited partnership form, which requires that there must be at least one general partner who is personally liable for all the debts of the business, no such requirement exists in an LLC.

A second significant advantage is the flexibility of an LLC to choose its federal tax treatment. Under IRS's "check-the-box rules, an LLC can be taxed as a partnership, C corporation or S corporation for federal income tax purposes. A single-member LLC may elect to be disregarded for federal income tax purposes or taxed as an association (corporation).

LLCs are typically used for entrepreneurial enterprises with small numbers of active participants, family and other closely held businesses, real estate investments, joint ventures, and investment partnerships. However, almost any business that is not contemplating an initial public offering (IPO) in the near future might consider using an LLC as its entity of choice.

Deciding to convert an LLC to a corporation later generally has no federal tax consequences. This is rarely the case when converting a corporation to an LLC. Therefore, when in doubt between forming an LLC or a corporation at the time a business in starting up, it is often wise to opt to form an LLC. As always, exceptions apply. Another alternative from the tax side of planning is electing "S Corporation" tax status under the Internal Revenue Code.

A business with a significant amount of receivables should evaluate whether some of them may be written off as business bad debts. A business taxpayer may deduct business bad debts if the receivable becomes partially or completely worthless during the tax year.

In general, most business taxpayers must use the specific charge-off method to account for bad debts. The deduction in any case is limited to the taxpayer's adjusted basis in the receivable.

The deduction allowed for bad debts is an ordinary deduction, which can serve to offset regular business income dollar for dollar. If the taxpayer holds a security, which is a capital asset, and the security becomes worthless during the tax year, the tax law only allows a deduction for a capital loss. However, notes receivable obtained in the ordinary course of business are not capital assets. Therefore, if such notes become partially or completely worthless during the tax year, the taxpayer may claim an ordinary deduction for bad debts.

For a taxpayer to sustain a bad debt deduction, the debt must be bona fide. The IRS looks carefully at a bad debt of a family member.

To be entitled to a business debt write off, the taxpayer must also make a reasonable attempt to collect the debt. However, in a nod to reality, the IRS does not request the taxpayer to turn the debt over to a collection agency or file a lawsuit in an attempt to collect the debt if doing so has little probability of success.

Deadlines for claiming a write off for any past business bad debt must be watched. Taxpayers have until the later of (1) seven years from the date they timely filed their tax return or (2) two years from the time they paid the tax, to claim a refund for a deduction for a wholly worthless debt not deducted on the original return.

Often, timing is everything or so the adage goes. From medicine to sports and cooking, timing can make all the difference in the outcome. What about with taxes? What are your chances of being audited? Does timing play a factor in raising or decreasing your risk of being audited by the IRS? For example, does the time when you file your income tax return affect the IRS's decision to audit you? Some individuals think filing early will decrease their risk of an audit, while others file at the very-last minute, believing this will reduce their chance of being audited. And some taxpayers don't think timing matters at all.

Often, timing is everything or so the adage goes. From medicine to sports and cooking, timing can make all the difference in the outcome. What about with taxes? What are your chances of being audited? Does timing play a factor in raising or decreasing your risk of being audited by the IRS? For example, does the time when you file your income tax return affect the IRS's decision to audit you? Some individuals think filing early will decrease their risk of an audit, while others file at the very-last minute, believing this will reduce their chance of being audited. And some taxpayers don't think timing matters at all.

What your return says is key

If it's not the time of filing, what really increases your audit potential? The information on your return, your income bracket and profession--not when you file--are the most significant factors that increase your chances of being audited. The higher your income the more attractive your return becomes to the IRS. And if you're self-employed and/or work in a profession that generates mostly cash income, you are also more likely to draw IRS attention.

Further, you may pique the IRS's interest and trigger an audit if:

• You claim a large amount of itemized deductions or an unusually large amount of deductions or losses in relation to your income;
• You have questionable business deductions;
• You are a higher-income taxpayer;
• You claim tax shelter investment losses;
• Information on your return doesn't match up with information on your 1099 or W-2 forms received from your employer or investment house;
• You have a history of being audited;
• You are a partner or shareholder of a corporation that is being audited;
• You are self-employed or you are a business or profession currently on the IRS's "hit list" for being targeted for audit, such as Schedule C (Form 1040) filers);
• You are primarily a cash-income earner (i.e. you work in a profession that is traditionally a cash-income business)
• You claim the earned income tax credit;
• You report rental property losses; or
• An informant has contacted the IRS asserting you haven't complied with the tax laws.

DIF score

Most audits are generated by a computer program that creates a DIF score (Discriminate Information Function) for your return. The DIF score is used by the IRS to select returns with the highest likelihood of generating additional taxes, interest and penalties for collection by the IRS. It is computed by comparing certain tax items such as income, expenses and deductions reported on your return with national DIF averages for taxpayers in similar tax brackets.

E-filed returns.  There is a perception that e-filed returns have a higher audit risk, but there is no proof to support it. All data on hand-written returns end up in a computer file at the IRS anyway; through a combination of a scanning and a hand input procedure that takes place soon after the return is received by the Service Center. Computer cross-matching of tax return data against information returns (W-2s, 1099s, etc.) takes place no matter when or how you file.

Early or late returns. Some individuals believe that since the pool of filed returns is small at the beginning of the filing season, they have a greater chance of being audited. There is no evidence that filing your tax return early increases your risk of being audited. In fact, if you expect a refund from the IRS you should file early so that you receive your refund sooner. Additionally, there is no evidence of an increased risk of audit if you file late on a valid extension. The statute of limitations on audits is generally three years, measured from the due date of the return (April 18 for individuals this year, but typically April 15) whether filed on that date or earlier, or from the date received by the IRS if filed after April 18.

Amended returns. Since all amended returns are visually inspected, there may be a higher risk of being examined. Therefore, weigh the risk carefully before filing an amended return. Amended returns are usually associated with the original return. The Service Center can decide to accept the claim or, if not, send the claim and the original return to the field for examination.

790

With the economic downturn taking its toll on almost all facets of everyday living, from employment to personal and business expenditures, your business may be losing money as well. As a result, your business may have a net operating loss (NOL). Although no business wants to suffer losses, there are tax benefits to having an NOL for tax purposes. Your business can use the NOL in future years to offset its taxable income. Your business can also use an NOL to offset income from the prior two years; in this type of "carryback" situation, it can mean an immediate tax refund to help with current operating expenses.

NOLs, generally

A trade or business has an NOL when its allowable deductions exceed its gross income for the tax year. A business can have an NOL whether it is a corporation, partnership or sole proprietorship. For example, NOLs can be generated if you operate a trade or business as a sole proprietorship that is taxed to the individual.

Note. The American Reinvestment and Recovery Act of 2009 (2009 Recovery Act) temporarily increases the carryback period to five years for small businesses (defined by the new law as businesses with average gross receipts of $15 million or less). These businesses can elect to carryback NOLs three, four or five years. However, this treatment applies only to NOLs beginning or ending in 2008. Businesses that qualify can apply for an immediate refund of taxes paid during the extended carryback period. Forms 1045, Application for Tentative Refund, and Form 1139, Corporate Application for Tentative Refund, must generally be filed within one year after the end of the tax year of the NOL.

Deductible expenses for computing NOLs

Generally, business deductions are those deductions related to a taxpayer's trade or business or employment. For this purpose, the following types of losses are considered business deductions that can be used to compute an NOL:

• Losses from the sale or exchange of depreciable or real property used in the taxpayer's trade or business, including Code Sec. 1231 property;
• Losses attributable to rental property;
• Losses incurred from the sale of stock in a small business corporation or from the sale or exchange of stock in a small business investment company, to the extent that these types of losses qualify as ordinary losses;
• Losses on the sale of accounts receivable (but only if the taxpayer uses the accrual method of accounting); and
• Business losses from a partnership or S corporation.

In addition, the following expenses are considered business deductions for purposes of computing an NOL:

• Personal casualty and theft losses and nonbusiness casualty and theft losses from a transaction entered into for profit;
• Moving expenses;
• State income tax on business profits;
• Litigation expenses and interest on state and federal income taxes related to a taxpayer's business income;
• The deductible portion of employee expenses, such as travel, transportation, uniforms, and union dues;
• Payments by a federal employee to buy back sick leave used in an earlier year;
• Unrecovered investment in a pension or annuity claimed on a decedent's final return; and
• Deduction for one-half of the self-employment tax.

Carryback and carryforward rules

Generally, an NOL must be carried back and deducted against taxable income in the two tax years before the NOL year before it can be carried forward and applied against taxable income, up to 20 years after the NOL year. An NOL must be used in the earliest year available; however, you can waive the use of the carryback period and immediately carry the NOL forward. To claim an NOL carryback, an individual or a corporation must file an amended return within three years of the year the NOL was incurred.

Generally, the carryback and carryforward periods cannot be extended. Any NOL remaining after the 20-year carryforward period will be lost. However, you may be able to use an expiring NOL in the final year by accelerating the recognition of income.

Comment. There are certain exceptions to the two-year carryback period. The carryback period is three years for an NOL from a casualty or theft, and also three years for losses from a Presidentially-declared disaster affecting a small business or a farmer. A "farming loss" can be carried back five years and a 10-year period is available for product liability losses and environmental claims.

Partnerships and S corporations

If your business operates as a partnership or an S corporation, the NOL flows through to the partners or shareholders who can use the NOL to offset other business and personal income. The partnership or S corporation itself cannot use the NOL.

Note. Shareholders may not deduct a C corporation's NOLs. Moreover, because a corporation is a separate taxpayer, NOLs do not automatically flow between the corporation and another entity that takes over the corporation.

Individuals

Individuals may have an NOL not only from business losses but from other expenses, although this is less common. In addition to business losses, an individual includes in his or her NOL computation the following deductions:

• Employee business expenses;
• Casualty and theft;
• Moving expenses for a job relocation; and
• Expenses of rental property held for the production of income.

If you would like to discuss whether you have an NOL and how you might use it, please contact our office.