Archive for Estate Planning Tax

Recent Developments in Estate and Trusts Planning: Part 1

iStock_000009598906XSmallNote: An Article Written By Justin P. Ransome, J.D., MBA, CPA, and Frances Schafer, J.D, in the AICPA, The Tax Advise on 9/1/13 and was reviewed, edited and posted by Harold Goedde Ph.D on TaxConnections Worldwide Tax Blogs.

The uncertainty about transfer-tax rates and exemption amounts that has plagued taxpayers and practitioners since 2001 was finally settled in 2013. On Jan. 2, 2013, President Obama signed the American Taxpayer Relief Act of 2012 (ATRA [1]. For estate, gift, and generation-skipping transfer (GST) tax purposes it makes permanent the following: (a) certain income and transfer-tax provisions in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) [2], (b) income tax provisions in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) [3], income and certain transfer-tax provisions in the Tax Relief,

(d) Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Act). [4]

In most instances the effective date of the act is Jan. 1, 2013. Read More

Written by | Posted in Estate Planning Tax • United States

Why The IRS Is Fed Up With Swiss Bankers!

Blog post why the United States is fed up with Swiss Banks.Working with a Swiss lawyer and others, the United States businessman father arranged for over $12 million in the undeclared accounts to be left to his surviving spouse and five of his children, including Seggerman.

As a result of the successful implementation of that plan, and to hide the undeclared funds from the IRS, Seggerman, who, together with three of his siblings, was an executor of his father’s estate, signed a tax return for his father’s estate that falsely under-reported the gross assets of the businessman father’s estate. In particular, the estate tax return fraudulently failed to report over $5 million left to the businessman father’s wife and over $7.5 million to be split among five of his children.

In addition, the Swiss lawyer thereafter assisted Seggerman’s siblings, including Suzanne Seggerman, Yvonne Seggerman, and Edmund Seggerman, in setting up undeclared Swiss bank accounts to hold the money left to them by their father.

Seggerman assisted his brother in surreptitiously transferring funds from the brother’s Swiss account to a bank account for a foundation controlled by Seggerman, who thereafter filtered the funds to the brother in the United States, labeling the transfer as “loans.” Read More

Written by | Posted in Estate Planning Tax • Federal • Individual • North America • United States

Trust Fund Recovery Penalty – #15 – Defense Tactics

TaxConnections Picture - Dollar Sign and Money15. DEFENSE TACTICS

§ 5:75 In General

The practitioner’s goal in defending a Trust Fund Recovery Penalty is to remove the onus from one’s client and place it on some other person or in the alternative to limit the amount of liability. Literally, one of the best ways to protect your client is to use the “he did it” defense. Blame someone else!

§ 5:76 “He Did It” Defense

The “he did it” defense can first be asserted at the initial interview of your client. Be prepared to present documentation to support why another person bore ultimate responsibility for payment of the taxes. The best evidence may be affidavits from third parties and your client asserting that some other party was responsible.

§ 5:77 Protest

Upon receipt of the letter proposing liability, submit a protest in the format set forth on the back of the IRS letter. Even if your client is a responsible person and willfully failed to pay the tax, you may protest the computation of the tax. It is not unusual for the IRS to miscalculate the Trust Fund Recovery Penalty and you have the right to assure that the penalty is in the proper amount. Read More

Written by | Posted in Estate Planning Tax

Tax Considerations-Dividing Divorce Property-Part II

Marital Estate Division Offers Challenges and Opportunities For Advisors

The emotional aspects of a divorce often interfere with planning for the efficient distribution of the marital estate. The shock and ill feelings may create a barrier between spouses that prevents even discussing issues. Tax practitioners need to know how to explain to a divorcing client the tax realities, to avoid any post-divorce tax surprises. Mistakes in property division or fraud can produce consequences that the tax practitioner may be unable to reverse.

This is Part II in a three part series.  See Part I and Part III.

Separation Agreement and Divorce Decree

If the parties present their separation agreement to the court and the court issues a decree dissolving the marriage, the court may incorporate the agreement in the divorce decree, usually referred to as a merger. According to Section 306(d)(1) of the Uniform Marriage and Divorce Act (UMDA), merger occurs when the decree sets forth the terms of the separation agreement and orders the parties to perform its terms as an enforceable contract with enforcement as a judgment. Section 306(e) of UMDA provides for enforcement as a judgment, as well as contract remedies, if the separation agreement is in the divorce decree. A court order that specifically modifies an original divorce or separation instrument relates to the ending of the marriage and thus is incident to the divorce (with tax implications described later), even if it is issued many years after the divorce.

Transfers During Marital Difficulties

A transfer of property by one spouse during a period of marital strife, whether or not divorce is imminent, might not be considered made unconditionally and is subject to additional scrutiny. All states give each spouse certain legal rights to share in the family’s assets if there is a divorce, but the scope of those rights varies significantly from state to state. In most states, the non-donor spouse may have set aside—as a fraudulent transfer—a gratuitous transfer of property made after the marriage has begun to deteriorate. Any unwritten custody arrangements where one spouse transfers property to a custodian for safekeeping with the understanding of a future repossession is highly suspect when the other spouse has no knowledge of the transfer.

Transfers of Property: Asset Dissipation

The judicial doctrine of fraud on marital rights or dissipation of marital assets is an attempt to balance the transferor’s right to freely transfer his or her own property against the need to protect the legal entitlement of the transferor’s spouse to property. In most states, the law invalidates lifetime transfers if they are made with intent to deprive the transferor’s spouse of marital property rights, or if the transfers are made under circumstances where it would be unfair to permit them to stand. To determine whether a spouse has attempted in a divorce situation to remove assets from the claims of the other spouse, courts look at all the relevant factors including:

1.  Other consideration is involved;
2.  Size of the property transferred versus the transferring spouse’s total wealth;
3.  Time elapsing between the transfer of property and the divorce;
4.  Relations between the spouses at the time of transfer;
5.  The source of the property transferred.
6.  Whether the transfer is revocable or illusory (i.e., the transferring spouse retains rights in or powers over the transferred property).

Tax Considerations

It is usually important that any property transfers between the divorcing spouses occur under circumstances that do not produce taxable gain or gift tax liability. Since no estate tax marital deduction is allowed for transfers to a former spouse, the transferor also will not want the transfer to be includible in his or her taxable estate.

Taxable gain:

Under the general rule of Sec. 1041(a), a transfer of property to a former spouse incident to divorce will not cause the recognition of gain or loss. A transfer of property is incident to a divorce if the transfer occurs within one year after the date on which the marriage  transfer ceases or is “related to the cessation of the marriage,” which requires that the transfer is pursuant to a divorce or separation instrument, and occurs not more than six years after the date on which the marriage ceases. A divorce or separation instrument includes a modification or an amendment to the decree or instrument (Temp. Regs. Sec. 1.1041-1T(b), Q&A-7).

Transfer taxes:

A transfer of marital property rights under a property settlement agreement that was incorporated into a divorce decree is not subject to gift tax. In Harris, 340 U.S. 106 (1950), the Supreme Court held that in such a case, the transfer would be pursuant to a court decree, not a “promise or agreement” between the spouses as required under gift tax law. However, subsequent decisions have limited the application of this rule to transfers that occur after the entry of a divorce decree.

If a transfer is not made under a property settlement agreement incorporated into a divorce decree, it may still not be subject to gift tax under Sec. 2516. Sec. 2516 provides that transfers of property or interests in property in settlement of marital property rights are treated as made for full and adequate consideration if the transfers are made pursuant to a written agreement and the divorce occurs within a three-year period beginning one year before the spouses enter into the agreement. Note that under Sec. 2516, the property transfer does not have to occur during the three-year period; the transfer may be made any time later, as long as it is “pursuant” to an agreement entered into during the three-year period.

Example. On Jan. 19, 2006, Mr. and Ms. Smith signed a separation and property settlement agreement to address contractual issues arising from the cessation of their marriage. The Smiths divorced in 2007. As part of the agreement, Mr. Smith transferred certain property to Ms. Smith. The agreement also provided:

Each party accepts the provisions herein made for him or her in lieu of and in full and final settlement and satisfaction of any and all claims or rights that either party may now or hereafter have against the other party for support or maintenance or for the distribution of property. However, each party has relied upon the representations of the other party concerning a complete and full disclosure of all marital assets in accepting the property settlement, and it is understood and agreed that this provision shall not constitute a waiver of any marital interest either party may have in any property owned but not fully disclosed by the other party as to existence or fair market value at the time this agreement is executed. Moreover, the failure of either party to disclose property shall constitute a material breach of this agreement, which shall give rise to whatever remedies at law or in equity may be available to the other party.

At some time after the parties signed the agreement, Ms. Smith began asking Mr. Smith whether all assets had been disclosed. She also hired an attorney to pursue claims arising from nondisclosure of assets. In 2011, Mr. Smith realized that he had inadvertently failed to disclose to Ms. Smith stock options ($16 million fair market value) that a court would consider marital assets. According to the terms of the agreement, Ms. Smith had not waived her marital interest in the stock options. Pursuant to a settlement (or an amendment to the original agreement), Mr. Smith paid Ms. Smith $6 million in 2011 in settlement of the claim that she had made regarding her interest in this property.

In considering this issue, Mr. Smith expressed concern that the transfer to Ms. Smith would exhaust his unified transfer tax credit and create a taxable gift transfer. However, because Mr. Smith made the payment pursuant to a written agreement relative to their marital and property rights, and Mr. and Ms. Smith divorced within the three-year period beginning one year prior to the signing of the agreement, under Sec. 2516, Mr. Smith was not subject to gift tax on the transfer and did not have to use his unified transfer tax credit.

The blog post will continue in Part III.

by Ray A. Knight, CPA, J.D. and Lee G. Knight, Ph.D. (April 2013)

Edited and posted by Harold Goedde CPA, CMA, Ph.D. (taxation and accounting)

Written by | Posted in Estate Planning Tax • Federal • Individual • North America • Real Estate

Five IRA Deadlines Every Smart Investor (Or Advisor) Should Know

To make the most of an IRA–whether your own or one you inherited–sometimes you need to keep an eye on the calendar. Five key deadlines can affect your ability to use various strategies. These are the deadlines to keep in mind.

1. April 1.

If you turned 70½ last year, you must take the first required minimum distribution from your traditional IRA by April 1 of this year. After that, you must take distributions by Dec. 31 of each year. The payout is based on the account balance on December 31 of the previous year divided by your expectancy, as listed in one of three different IRS tables (really) contained in Appendix C of IRS Publication 590, Individual Retirement Arrangements (IRAs),.  After doing the calculation the mandatory withdrawal is expressed as a dollar value. You are required to pay income tax on this amount.

The payout is based on the account balance on December 31 of the previous year divided by your expectancy, as listed in one of three different IRS tables (really) contained in Appendix C of IRS Publication 590, Individual Retirement Arrangements (IRAs),.  After doing the calculation the mandatory withdrawal is expressed as a dollar value. You are required to pay income tax on this amount.

You aren’t required to take yearly minimum distributions starting at age 70½ from a Roth, as you are from a traditional IRA, so the money can be preserved for your heirs, who after your death must take yearly tax-free distributions based on their own (presumably long) life expectancies. For more about converting a traditional IRA to a Roth, see my post, “Smart Moves For Battered IRAs.”

2. September 30.

This is often called the beneficiary designation date. The beneficiary form on file with the custodian of an IRA — not a will or living trust — controls who inherits it. For an IRA owner who died in 2011, you must know who the beneficiary is by September 30, 2012.

“Designated beneficiary” is a term defined in the Internal Revenue Code, with further elaboration in IRS regulations. It refers to people named to receive IRA assets when the account owner dies and to trusts that meet certain requirements.

Only a designated beneficiary can qualify for what’s called a stretch-out. The term does not denote a specific type of IRA, but rather a financial strategy to stretch out the life — and hence the tax advantages — of an IRA.

The term “stretch IRA” describes the strategy in which a spouse, child or grandchild inherits an IRA and then draws out distributions over his or her own life expectancy. The longer the life expectancy, the smaller — as a percentage of the IRA balance — each payout must be. This enables beneficiaries to enjoy decades of income-tax-deferred growth in a traditional IRA or tax-free growth in a Roth IRA.

This option is not available if an estate is named as beneficiary. (Put another way, an estate cannot be a “designated beneficiary.”)  If you’re dealing with a Roth IRA, all funds must be withdrawn within five years. For a traditional IRA the same rule applies unless the former owner was already 70 1/2 — the age at which a traditional IRA owner must begin cashing out. In that case the distribution rate for the heir is based on the age of the person who died.

If you are the only named beneficiary of an inherited IRA, you’re sitting pretty. Unless you’ve inherited from a spouse, you must retitle the IRA, including the original owner’s name and indicating it is inherited.

On the other hand, if you were one of multiple beneficiaries named to share the account, it may be necessary for you to take certain steps by September 30 to take advantage of the stretch-out. For example, if you are co-beneficiary with a trust that does not qualify as a designated beneficiary; or with a charity (which can’t qualify as the designated beneficiary), you will want to pay out their share. Otherwise, you would not be eligible for the stretch-out.

3. Nine months after the IRA owner’s death.

This is the date by which, under federal law, beneficiaries must decide whether or not to disclaim or decline an inheritance. Most often this is done because the person who would have otherwise inherited the assets wants to benefit another person or a specific charity (usually for tax reasons). People who disclaim, known as disclaimants, are generally treated as if they had died before the person from whom they are inheriting.

Non-IRA assets go to the person next in line as designated in a will or trust or under state law if the estate plan makes no such provision, or to a specific charity if that is what the estate plan specifies.

The process is different with an IRA because the beneficiary form controls who inherits the account. So if you disclaim an IRA, it will go to an alternate beneficiary, if there is one. For example, let’s say you name your spouse as primary and children as alternates or your children as primary and grandchildren as alternates. Your primary beneficiary then has the option of disclaiming the account, enabling it to pass to the younger alternate.

Keep in mind a potential wrinkle when you are one of multiple beneficiaries on the account. If, to comply with the disclaimer rules, you must disclaim before September 30.

4. October 15. 

This is a date to keep in mind if you converted a traditional IRA to a Roth — a maneuver in which you take money out of a pretax IRA, pay tax on it and plop it into a Roth, where it can grow tax free. If you want to leave retirement assets to family (and particularly to grandkids) a Roth conversion is one of the simplest, best planning tools available, as explained here. A Roth is also particularly useful if you are nearing 70 1/2 and want to invest in illiquid assets that aren’t easily distributed on an annual basis — a strategy described in my post, “How To Invest Your IRA In Real Estate, Gold And Alternative Assets.”

Of course, this assumes that assets will go up in value after you convert to a Roth and pay the associated tax. If they didn’t and you’re not prepared to wait things out, you may want to put things back the way they were. The process of undoing a Roth is called recharacterization. To do this you need to contact the financial institution that is the custodian of the account. It may be choked with similar requests as October 15 approaches, so don’t wait until the eleventh hour. If you have already filed your return and paid the tax, you will need to file an amended tax return to claim a refund.

Then keep this rule in mind: Once a conversion is undone, the same assets (or lump of money) cannot be converted again until the year following the original conversion or more than 30 days after the conversion was undone, whichever is later. In other words, if you undo the conversion on October 15, you can reconvert the same assets as soon as November 16; you can’t extend that deadline to the beneficiary designation date.

5. December 31.

Whether you have your own IRA or have received an IRA inheritance, December 31 is a key date. Here are the rules you need to know.

a. IRA Owners. You are considered the owner of an IRA that you set up and funded – either through annual contributions or the rollover of a 401(k). Unless the account is a Roth, you must take yearly minimum distributions starting at age 70 1/2. You have until April 1 of the year after you turn 70 ½ to take the first one. After that, you must take distributions by December 31 of each year.

b. Inherited IRAs. If they choose to, IRA inheritors can draw out these minimum required distributions over their own expected life spans. These are the IRA inheritance rules.

c. Non-spouses. Generally, non-spousal IRA heirs must withdraw a minimum amount each year, starting by December 31 of the year after the IRA owner died. Note: This is true whether it’s a traditional IRA or a Roth (a common misconception).

To calculate this distribution, you take the balance on December 31 of the previous year and divide it by the individual’s life expectancy, as listed in the IRS’ “Single Life Expectancy” table (see p. 88 of IRS Publication 590, Individual Retirement Arrangements (IRAs). Unless the account is a Roth, there is income tax on this required payout.

Don’t make the mistake, as some people do, of using the number from the table to figure a percentage. In subsequent years, you simply take the number you used in the first year and reduce it by one before doing the division.

What if there are co-beneficiaries on the account? Here too, the December 31 date is significant. Inheritors (or a parent, if they are minors) can ask the financial institution that holds the account to split it, giving each person the share he or she was entitled to under the beneficiary designation form.

Splitting the account avoids squabbles over investment strategies; it also allows beneficiaries to take distributions over their own life expectancy or, if they prefer, to cash out. The deadline for subdividing such an account is December 31 of the year following the year of the owner’s death. Watch this process carefully, because mistakes often occur when changing account names and moving assets.

When an individual and a charity are named as co-beneficiaries, there’s some disagreement about whether the December 31 deadline saves the stretch-out if you haven’t paid out the charity by September 30. Brooklyn, N.Y. CPA Barry C. Picker takes the position that if one fails to pay out the charity by September 30 in this situation “the ability to split the account by December 31 will save this for the individual beneficiary.” This is a gray area, though; to avoid bickering with the Internal Revenue Service, it’s best to cash out a charitable beneficiary by September 30.

d. Spouses.  Unlike other inheritors, who must begin making withdrawals by December 31 of the year following the account owner’s death, a spouse – let’s assume it’s the wife – who inherits an IRA has another option. She can roll the assets into her own IRA and postpone distributions from a traditional IRA until she turns 70 1/2.

The catch is that, like other IRA owners, she may have to pay a 10% early-withdrawal penalty if she takes money before age 59½ from her own IRA. So a young widow should generally wait until after reaching 59½ to do the rollover. Meanwhile, she doesn’t have to take out any money until her late spouse would have turned 70½.

by Deborah Jacobs, Forbes – Personal

Edited and posted by Harold Goedde CPA, CMA, Ph.D.

Written by | Posted in Estate Planning Tax • Individual

Developments In Individual Taxation – Part II

• The IRS issued proposed regulations permitting deductions for certain local lodging expenses.

• In Veriha, the Tax Court held that the Sec. 469 self-rental rule applied to a taxpayer who owned three companies, a trucking company and two truck-leasing companies, and thus the income from the S corporation truck-leasing company should be recharacterized as nonpassive, while the losses from his LLC truck-leasing company should remain passive.

• In Quality Stores, Inc., the Sixth Circuit held that severance payments paid to terminated employees as a direct result of a workforce reduction are not subject to FICA tax.

• In Rev. Rul. 2012-18, the IRS issued guidance about FICA taxes imposed on tips and the procedures for notice and demand for those taxes under Sec. 3121(q). Under Announcement 2012-50, the rules distinguishing between tips and service charges in the revenue ruling will not apply until 1/1/14.

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This article covers recent developments in individual taxation. The items are arranged in Code Section order and will be presented in Parts I, II and III.
Sec. 165: Losses

In Chief Counsel Advice (CCA) 201213022, (17)  an indirect investment in a Ponzi scheme was found to constitute a theft loss under Sec. 165, even though the taxpayer had not invested directly with the organizer (perpetrator) of the Ponzi scheme. The IRS noted that the “[p]erpetrator intended to appropriate Taxpayers’ property from Taxpayers.”

In Ambrose, (18) the taxpayers suffered a loss due to a fire in their home. The damage was repaired by their insurance company, but the following month their home was destroyed by another fire. Insurance claims were filed, but a dispute arose over whether the damage was covered. The taxpayers amended their return to claim a casualty loss deduction, and the IRS denied the loss for failure to file an insurance claim under Sec. 165(h). Although the homeowners had filed a claim within four hours of the fire, they did not timely submit proof of loss to the insurance company. The court held that the taxpayers were within the statute because they had filed a “claim.” This case includes extensive background on the origin of the “file a claim” requirement of Sec. 165(h).

In Letter Ruling 201240007, (19) a taxpayer was charged with insurance fraud and settled a suit with the insurance company by making payments to the company. The taxpayer was also charged under state law and entered into a plea agreement that called for restitution payments. The IRS determined that both of the payments qualified as restitution, which is deductible under Sec. 165(c)(2), as long as the income had been included in the taxpayer’s gross income in prior years and he received no contribution from any other party.

Sec. 170: Charitable, Etc., Contributions and Gifts

In Bentley, (20) a lawyer tried to deduct his charitable contributions on Schedule C rather than Schedule A, Itemized Deductions. At trial, he refused to testify regarding the claimed donations, instead choosing to “rest on the administrative file.” Not surprisingly, the court concluded that the deductions were not an ordinary and necessary business expense. Since his itemized deductions, even with the additional charitable contributions allowed on Schedule A, were below the standard deduction, the assessed deficiency was upheld. Somewhat surprisingly, though, the court used its discretion to refuse to impose a sanction under Sec. 6673 (penalty imposed on a taxpayer who instituted a proceeding primarily for delay or whose position is frivolous or groundless), requested by the IRS.

An IRS tax compliance officer was found to have claimed dependency exemptions, medical expenses, and charitable contributions to which she was not entitled (21). The court also imposed a civil fraud penalty against her. Among those whose testimony contradicted the taxpayer’s claim to be unaware of the documentation and other requirements were her husband, her supervisor, and representatives of seven charities to which she had claimed she made contributions. Receipts were found to be “doctored” and her testimony to be inconsistent and implausible.

The adage to “read the instructions” was shown to be vital in Mohamed  (22). The court denied a charitable contribution of more than $18 million because the taxpayers failed to get an independent appraisal, attach the proper information to their Form 8283, Noncash Charitable Contributions, or obtain the proper documentation before their return was due. The taxpayers attempted to challenge the validity of the regulations as being arbitrary and capricious, and argued that they substantially complied with them. The court ruled against all their arguments. The final paragraph of the ruling is worth reading in its entirety:

We recognize that this result is harsh—a complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued, their contributions—all reported on forms that even to the Court’s eyes seemed likely to mislead someone who didn’t read the instructions. But the problems of misvalued property are so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions, and we cannot in a single sympathetic case undermine those rules.

Conservation easement cases continue to occupy a large amount of time at the Tax Court. In a number of these cases, the appraisers relied on an article written by Mark Primoli of the IRS, “Façade Easement Contributions,” which indicated that the IRS generally recognized that donation of a façade easement resulted in a loss in value of 10% to 15%. The article has since been revised to omit that statement. In Scheidelman, (23) the Second Circuit overturned the Tax Court’s rejection of an appraisal that relied on this article and another Tax Court case. (For more on façade easements, see Durant, “First Circuit Breathes New Life Into Façade Easement Deductions,” on p. 154.)

The Tenth Circuit upheld the Tax Court’s ruling in Trout Ranch LLC, (24) saying that the court had used proper discretion in incorporating post-valuation data into its analysis. The appeals panel noted that the Tax Court had been mindful of the risks involved and had given the greatest weight to sales that occurred within a year of granting the conservation easement.

Sec. 179: Election to Expense Certain Depreciable Business Assets

In CCA 201234024, (25) IRS Chief Counsel determined that costs associated with placing a vineyard in service, including prior-year capital expenditures, could be expensed under Sec. 179. In doing so, the IRS declared that Rev. Rul. 67-51 (26) no longer applied to Sec. 179. The ruling hinged on the fact that “the definition of §179 property has significantly changed” under the 1986 version of the Code.

Sec. 183: Activities Not Engaged in for Profit

In Parks, (27) the Tax Court awarded a rare win to a taxpayer on the question of whether an activity was a trade or business or a hobby when the taxpayer had an extensive history of losses. The taxpayer was a teacher and athletic coach who did private track coaching, for which he had incurred losses, sometimes substantial, in every year from 2003 through 2010. The IRS audited his 2006 through 2008 returns, reclassified his activity as a hobby, and moved his expense deductions from Schedule C to Schedule A while limiting the deductions to the amount of his income. In analyzing the case, the Tax Court used its nine-factor analysis; while the two profit factors weighed against the taxpayer, five of the remaining seven factors were favorable (the other two were neutral). (It is worth noting that one of Parks’s trainees was Ryan Bailey, who finished fifth in the 100 meters at the 2012 Summer Olympics.)

Sec. 212: Expenses for Production of Income

In a Tax Court case, the taxpayer invested cash equal to 25% of the total capital of the joint venture he had entered into with a Chinese food production plant (28). After the plant had serious financial difficulties, the plant recapitalized under Chinese law, requiring additional payments of 200,000 yuan from the taxpayer, which the taxpayer’s sister in China paid. On his jointly filed 2007 and 2008 federal income tax returns, the taxpayer attached Schedule C, Profit or Loss From Business, for the proprietorship and deducted a debt expense of $27,070.30 and $29,099.80 for 2007 and 2008, respectively. The IRS issued a notice of deficiency and disallowed the claimed debt expenses. The Tax Court upheld the deficiency, finding that the taxpayer did not make any of the debt repayments, but instead claimed that payments his sister made on his behalf should be attributed to him, despite the lack of evidence of an agreement to repay his sister.

Sec. 215: Alimony, Etc. Payments

In Doolittle, alimony deductions were disallowed for a husband for amounts that were paid to the wife by a qualified trust under a qualified domestic relations order (29). In 2008, the petitioner, who had been paying monthly alimony for a number of years after his divorce, entered into a new agreement to pay his former wife $52,000 from a securities account within 30 days. Under the agreement, the qualified trust was obligated to make the payments, not the petitioner himself. On his 2008 Form 1040, U.S. Individual Income Tax Return, the petitioner claimed a deduction for alimony of $10,800, which was $900 of monthly payments that were required to be paid to his former wife in 2008. Under Sec. 215, the alimony deduction is allowed only to individuals, and “not allowed to an estate, trust, corporation, or any other person who may pay the alimony obligation of such obligor spouse.” Because the petitioner’s obligation was paid by a trust, the petitioner was not entitled to claim the alimony deduction.

Alimony deductions were disallowed for a husband even though there was an oral understanding between the husband and his former wife about the alimony payments (30). The petitioner and his wife had informally separated in 2004 and filed for divorce in 2008. During this time, the petitioner had paid $2,605 per month to his former spouse and their child, which was not separated into spousal or child support payments. On December 1, 2008, a judgment for the dissolution of the marriage provided that $1,400 per month would be paid for alimony to the former spouse, until either party died. Before that time, the parties had a mutual understanding, but because it was not in writing until Dec. 1, 2008, the earlier payments could not be deducted.  The court stated that this seemed unjust because the parties had already reached an understanding of the amounts, and that the agreement had already been approved by a court, but Congress had always required a written document.

Sec. 262: Personal, Living, and Family Expenses

A Tax Court case provides a great example of the methods the IRS uses to audit tax returns with a Schedule C (31). The IRS used a combination of methods, including bank account analysis, to reconstruct income and examine the taxpayer’s substantiation in the case of expenses. Tax Court Rule 142(a) states that deductions are a matter of legislative grace, and the taxpayer bears the burden of proving that he or she is entitled to any deduction or credit claimed. Additionally, the taxpayer must substantiate all expenses for which a deduction is claimed under Sec. 274(d) (travel expenses for meals and lodging while away from home). Under the Cohan (32) rule, estimates can be used for some expenses (although not for Sec. 274 expenses) if there is a basis for the estimation. In this case, however, several checks written to the owner of the company with notations in the memo section, such as “A/C Repair,” were not otherwise substantiated and were therefore disallowed as personal expenses under Sec. 262.

Practice Tip

With reports of increased Schedule C audits, this case provides a great example for explaining the audit process to a client. In Nolder, (33) the taxpayer was an over-the-road truck driver who completed Form 2106, Employee Business Expenses, to deduct expenses he incurred while traveling. Several expenses were disallowed as personal under Sec. 262, including uniforms that were suitable for personal wear, ATM withdrawal fees, and identity theft insurance purchased due to concerns of identity theft while traveling to a town near Mexico (the driver frequently had to show identification). This case is also a good reminder to ask clients if a reimbursement plan for employee expenses is available to them. If a plan is available, employees cannot deduct the expenses even though they do not participate.

Sec. 269: Acquisition Made to Evade or Avoid Income Tax

The husband-and-wife owners of a group of McDonald’s restaurants in Utah established two companies, an operating company and a management company, which they both owned equally (34). The petitioners established a profit sharing plan for the benefit of the management company employees, which performed poorly. It was terminated by establishing an employee stock ownership plan (ESOP) in its place, which in turn owned 100% of the stock of the new management company, which elected to be an S corporation. In 2002, the management company also created a nonqualified deferred compensation plan (NQDCP) for the benefit of senior officers and employees. The petitioners elected to participate in the NQDCP and deferred $3.066 million over three years. Since a large portion of the management company’s profit consisted of the deferred compensation, the money was unavailable for distribution to the ESOP. Even though the management company was profitable, the ESOP, which was the sole shareholder, was not taxed on this income. Due to the large amount of money the management company committed to pay the NQDCP, the stock of the management company had little value. This negatively affected the value of the rank-and-file employees’ beneficial interest in the ESOP.

In July 2004, the petitioners made the following decision because regulations under Sec. 409(p) would cause them to include all of the deferred compensation in their income: sell the management company stock to petitioners for FMV and have the management company pay to petitioners the $3.066 million deferred compensation and terminate the ESOP. By creating two short years for the management company, the management company generated a loss of $2.969 million, mostly for distribution of the NQDCP. The petitioners recognized $3.066 million in ordinary income from the NQDCP and offset the income with the loss.

The IRS argued that the loss generated was prohibited by Sec. 269 as a transaction to avoid or evade income tax. The court, siding with the petitioners, said, “Petitioners were entitled to arrange their affairs so as to minimize their tax liability by means which the law permits.”

Sec. 280E: Illegal Sale of Drugs

A taxpayer was not allowed a deduction for cost of goods sold in connection with his medical marijuana business (35). The taxpayer argued that he was not trafficking in an illegal substance and was operating a care giving business to indigent individuals in need of medical marijuana. The Tax Court held that the operation of his business still fell under Sec. 280E and, therefore, disallowed the deduction.

Sec. 469: Passive Activity Losses and Credits Limited

In Veriha, (36) the petitioner owned three companies: a trucking company, a C corporation, and two equipment leasing companies, one operated as an S corporation and the other as a single-member limited liability company (LLC). The sole customer of the two leasing companies was the petitioner’s trucking company. The petitioner’s leasing companies had separate lease agreements with the trucking company for each piece of equipment leased from the respective company. For the year in question, one of the leasing companies realized overall net income, while the other company realized a net loss. The petitioner claimed that both the income and losses came from a passive activity and that all the tractors and trailers he owned as a whole should be considered a single “item of property.” The court disagreed and stated that each tractor and trailer was an “item of property” of its own under Regs. Sec. 1.469-2(f)(6), which requires income from an item of property rented for use in a nonpassive activity to be treated as not from a passive activity. Therefore, the net income the S corporation generated was recharacterized as nonpassive income, and the net loss from the LLC leasing company continued to be characterized as passive (under the self-rental rule). The IRS did not object to the petitioner’s netting the profitable leases with the unprofitable leases within the same company to determine the company’s overall net income or loss from leasing activities.

In Chambers, (37) the Tax Court held that the petitioner was not a qualified real estate professional and therefore disallowed his losses from rental real estate. In addition, because his adjusted gross income for each year exceeded $150,000, the petitioner was not entitled to deduct $25,000 of losses from rental real estate activities under Sec. 469(i). The court did not uphold accuracy-related penalties because the petitioner had reasonable cause to believe he was a qualified real estate professional. The petitioner and spouse, who both worked full time in civilian positions for the U.S. Navy, owned one rental property directly. In addition, the petitioner owned 33% of an LLC that held four rental properties. Although the petitioner was unable to substantiate that he performed more than one-half of his personal services in real property trades or businesses in which he materially participated as required under Sec. 469(c)(7)(B)(i), his belief that he satisfied these requirements was reasonable.

Sec. 1001: Determination of Amount and Recognition of Gain or Loss

The Sixth Circuit affirmed the Tax Court’s decision that a shareholder’s transfer of floating rate notes to Optech Limited in exchange for a nonrecourse loan equal to 90% of the loan’s FMV was a sale and not a loan because the taxpayer transferred the burdens and benefits of owning the notes (38). The taxpayer sold over $1 million of low-basis stock in his company to an ESOP and then used the proceeds to purchase floating-rate notes in the face amount of $1 million. He then transferred the notes to Optech in exchange for a payment of 90% of the value of the notes. The loan agreement gave Optech the right to receive dividends and interest on the notes. The court held that the transaction was similar to an option in which the taxpayer retained the right to sell the notes, to transfer the registration in his own name, and to keep all interest. The court also found that the taxpayer was not personally liable on the note because the loan was nonrecourse.

The IRS issued a letter ruling in which it concluded that a conveyance of a perpetual conservation easement in exchange for mitigation credits is a sale or exchange of property under Sec. 1001 (39).

Sec. 1031: Like-Kind Exchange

The IRS chief counsel concluded that federal income tax law, not state law, controls whether exchanged properties are of a like kind for Sec. 1031 purposes (40). The Tax Court found that a taxpayer failed to establish that he acquired like-kind property in exchange for three residential properties because the taxpayer’s evidence was incomplete (41).

Sec. 1033: Involuntary Conversions

In Notice 2012-62, (42) the IRS provided a one-year extension of the four-year replacement period for certain livestock under Sec. 1033(e) to certain counties that experienced droughts.

Letter Ruling 201240006 (43) involved the involuntary conversion of a taxpayer’s principal residence in a presidentially declared disaster area. The taxpayer did not report the gain on his return. The IRS noted that under Regs. Sec. 1.1033(a)-2(c)(2), the taxpayer is treated as having elected to defer gain from the conversion because he did not report the gain on the return for the year in which the insurance proceeds were received. The IRS ruled that the taxpayer can file original and amended returns during the replacement period to notify the IRS of the acquisition of replacement property.

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by Karl L. Fava, CPA; Jonathan Horn, CPA; Daniel T. Moore, CPA; Susanne Morrow, CPA; Annette Nellen, J.D., CPA; Teri E. Newman, CPA; S. Miguel Reyna, CPA; Kenneth L. Rubin, CPA; Amy M. Vega, CPA; Donald J. Zidik Jr., CPA.

Edited and posted by Harold Goedde, CPA, CMA, Ph.D. (taxation and accounting)

Footnotes
17 CCA 201213022 (3/30/12). 30 Larievy, T.C. Memo. 2012-247.
18 Ambrose, No. 11-64T (Fed Cl. 8/3/12). 31 Onyekwena, T.C. Summ. 2012-37.
19 IRS Letter Ruling 201240007 (10/5/12). 32 Cohan, 39 F.2d 540 (2d Cir. 1930).
20 Bentley, T.C. Memo. 2012-294. 33 Nolder, T.C. Summ. 2012-50.
21 Quinn, T.C. Memo. 2012-178. 34 Love, T.C. Memo. 2012-166.
22 Mohamed, T.C. Memo. 2012-152. 35 Olive, 139 T.C. No. 2.
23 Scheidelman, 682 F.3d 189 (2d Cir. 2012). 36 Veriha, T.C. Memo. 2012-139.
24 Trout Ranch LLC, No. 11-9006 (10th Cir. 8/16/12). 37 Chambers, T.C. Summ. 2012-91.
25 CCA 201234024 (8/24/12). 38 Sollberger, No. 11-71883 (9th Cir. 8/16/12).
26 Rev. Rul. 67-51, 1967-1 C.B. 68. 39 IRS Letter Ruling 201222004 (6/1/12).
27 Parks, T.C. Summ. 2012-105. 40 CCA 201238027 (9/21/12).
28 Cheng, T.C. Summ. 2012-102. 41 Zurn, T.C. Memo. 2012-132.
29 Doolittle, T.C. Summ. 2012-103. 42 Notice 2012-62, 2012-42 I.R.B. 489.
43 IRS Letter Ruling 201240006 (10/5/12).
Written by | Posted in Corporate • Estate Planning Tax • Federal • Individual • North America • Property Tax • Real Estate • State And Local Tax (SALT) • Tax Policy

Developments in Individual Taxation – Part I

• The IRS issued proposed regulations permitting deductions for certain local lodging expenses.

• In Veriha, the Tax Court held that the Sec. 469 self-rental rule applied to a taxpayer who owned three companies, a trucking company and two truck-leasing companies, and thus the income from the S corporation truck-leasing company should be recharacterized as nonpassive, while the losses from his LLC truck-leasing company should remain passive.

• In Quality Stores, Inc., the Sixth Circuit held that severance payments paid to terminated employees as a direct result of a workforce reduction are not subject to FICA tax.

• In Rev. Rul. 2012-18, the IRS issued guidance about FICA taxes imposed on tips and the procedures for notice and demand for those taxes under Sec. 3121(q). Under Announcement 2012-50, the rules distinguishing between tips and service charges in the revenue ruling will not apply until 1/1/14.

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This article covers recent developments in individual taxation. The items are arranged in Code Section order and will be presented in Parts I, II and III.
Sec. 1: Tax Imposed

The First and Second Circuits found Section 3 of the Defense of Marriage Act (DOMA) unconstitutional (1). The effect of Section 3 is to deny federal income tax benefits, such as filing joint income tax returns, to same-sex couples. The First Circuit stayed its mandate that Section 3 not apply pending a likely Supreme Court review. The Supreme Court has granted certiorari in the Second Circuit case and will hear arguments on March 27.

Sec. 24: Child Tax Credit

Children of a U.S. citizen and her Israeli spouse, who were born and living in Israel, did not qualify as dependents under Sec. 152(b)(3), which states a dependent must be a citizen or resident of the United States (2).  Therefore, the child care and child tax credits under Sec. 21 and Sec. 24 were denied. The taxpayer also claimed that the IRS’s alternative argument that the credits were being denied because she did not file a joint return, as required by Sec. 21(e), was prohibited by Sec. 7522 because the notice of deficiency did not mention Sec. 21(e). The Tax Court noted Sec. 7522 does not require the IRS to identify all of the Code sections applicable to each tax adjustment.

Sec. 61: Gross Income Defined

In Notice 2012-12 (3) the IRS provides that mandatory restitution payments that victims receive from defendants under 18 U.S.C. Section 1593 (4) are excluded from income.

Sec. 104: Compensation for Injuries or Sickness

In Blackwood, (5) the taxpayer was terminated from her job for accessing her son’s medical records at the hospital where she worked. In the taxpayer’s unlawful termination suit, she indicated she suffered from a relapse of depression symptoms. The taxpayer received $100,000 and a Form 1099-MISC, Miscellaneous Income, reporting the payment, but the taxpayer did not report it on her tax return because she believed it was excludable under Sec. 104.

The Tax Court held for the IRS that the damages were not excludable under Sec. 104(a)(2) even though the underlying action was based on a tort or tort-type right. The taxpayer was unable to show she received damages for physical injuries. A letter from her doctor did not note any physical symptoms. The flush language of Sec. 104(a) also did not help the taxpayer’s case because it states that “emotional distress shall not be treated as a physical injury or physical sickness.” She was also unable to benefit from Sec. 104(a) because she did not show that she used any of the damages for medical care for emotional distress.

Sec. 107: Rental Value of Parsonages

The Supreme Court declined to hear the taxpayer’s appeal in Driscoll (6).  This case involved how the word “a” in the Sec. 107 exclusion from gross income for the rental value of a parsonage should be interpreted when used in the phrase “a home.” Does that mean one home or could it mean two homes? The Tax Court held for the taxpayer, noting that “a home” could have a plural meaning. On appeal, the Eleventh Circuit held for the IRS, noting that “home” has a singular meaning and that income exclusions should be construed narrowly.

Sec. 108: Income From Discharge of Indebtedness

In a case decided by the U.S. Tax Court, the taxpayers did not qualify to exclude income from discharged credit card debt under the exclusion for insolvency in Sec. 108(a)(1)(B) due to a lack of credible evidence presented regarding the fair market value (FMV) of their assets immediately before the discharge (7).  The evidence they submitted was insufficient to establish FMV for federal tax purposes because the documents (tax bills and loan documents) did not describe the property or explain the methodology used to determine the value, and their testimony regarding comparable sales was uncorroborated and was not based on contemporaneous sales.

Rev. Rul. 2012-14 (8) amplifies Rev. Rul. 92-53 (9)  and explains how partners treat a partnership’s discharged excess non-recourse debt in measuring insolvency under Sec. 108(d)(3). To the extent discharged excess non-recourse debt generates cancellation of debt (COD) income that is allocated under Sec. 704(b) and its regulations, each partner treats its part of the discharged excess non-recourse debt related to the COD income as a liability in measuring insolvency under Sec. 108(d).

In Letter Ruling 201228023, (10) the IRS found that a parent corporation’s bankruptcy plan was considered a liquidation plan for tax purposes. None of the debtors will recognize COD income with respect to any of the allowed claims until all distributions are made or if the bankruptcy plan ceases to be a liquidation plan.

Sec. 162: Trade or Business Expenses

After the IRS denied a taxpayer’s deduction for moving expenses, the taxpayer agreed but then tried a uniquely different approach in Tax Court (11).  He tried to claim meals, lodging, and lease cancellation fees as business expenses related to his employment as a restaurant chef. The IRS and the court both agreed that he had changed his tax home when he moved himself and his family and therefore no deduction was allowed.

The IRS issued proposed regulations (12) that would allow a deduction under Sec. 162 for certain local lodging expenses incurred by employers or their employees. The deduction would be allowed under a facts-and-circumstances test. One factor considered in the test is whether the expense is incurred to satisfy a bonafide requirement imposed by the employer. In addition, the regulations contain a safe harbor allowing the deduction in the following circumstances: (1) The lodging is necessary for the person to fully participate or be available for a bonafide business function; (2) it does not exceed five calendar days or occur more frequently than once a quarter; (3) the individual is an employee, and his or her employer requires him or her to remain at the function overnight; and (4) the lodging is not lavish or extravagant and provides no significant personal pleasure or benefit. A simplified version of these rules was already in effect under Notice 2007-47 (13) [which was made obsolete by these regulations].

DeLima (14) could be used as a teaching tool for all the ways taxpayers can fail to substantiate their Schedule C, Profit or Loss From Business, trade or business expenses. The court went through a top 10 list of problems with the claimed expenses including:

• Failure to provide credible evidence on the relative amount of business vs. personal use of her vehicles;

• Failure to establish a business purpose for various expenses, including insurance costs, furniture rental, or lawn maintenance;

• Failure to provide receipts or other proof of equipment purchases and rentals;

• Admitting that her rented home and apartment were entirely mixed personal/business use; and

• Failure to meet the strict substantiation requirements of Sec. 274(d) for travel and entertainment or listed property expenses.

In addition, the taxpayer tried to claim that the IRS examination was barred by statute, even though she had signed a Form 872, Consent to Extend the Time to Assess Tax. This argument and her claim that she had signed the Form 872 under false pretenses were not raised until after the actual trial, and the court rejected them both.

Sec. 163: Interest

In Abarca, (15) the petitioner claimed mortgage interest expense deductions for various rental properties on Schedule E, Supplemental Income and Loss, some of which were purportedly owned in partnership with others. The petitioner was neither named as the borrower for any of the mortgages on these properties nor was he able to prove he was the properties’ legal or equitable owner. In addition, it was unclear whether the properties had been contributed to the various partnerships. It was also apparent that the partnership form was not respected as the petitioner reported the properties as if he owned them individually. In addition, the petitioner was unable to prove that he personally paid all of the interest that he claimed. The petitioner was denied the deductions for any of the mortgage interest claimed on Schedule E for the subject properties. The Tax Court held in Chrush (16) that the petitioner failed to substantiate payments of mortgage interest on Form 1098, Mortgage Interest Statement, and home mortgage interest not reported on Form 1098. The petitioner co-owned the house with a close friend, but the amount reported on the Form 1098 issued to them was far lower than the deduction the petitioner claimed on his tax return, and no bank statements, canceled checks, or other evidence was produced to substantiate that he paid the claimed interest that was not reported on the Form 1098. In addition, the petitioner was unable to prove that he, and not his co-borrower, paid the interest reported on the Form 1098.

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by Karl L. Fava, CPA; Jonathan Horn, CPA; Daniel T. Moore, CPA; Susanne Morrow, CPA; Annette Nellen, J.D., CPA; Teri E. Newman, CPA; S. Miguel Reyna, CPA; Kenneth L. Rubin, CPA; Amy M. Vega, CPA; Donald J. Zidik Jr., CPA.

Edited and posted by Harold Goedde, CPA, CMA, Ph.D. (taxation and accounting)

Footnotes

1 Massachusetts v. United States Dep’t of Health and Human Servs., 698 F. Supp. 2d 234 (1st Cir. 2012); Windsor, No. 12-2335-cv(L) (2d Cir. 10/18/12), cert. granted, Sup. Ct. Dkt. 12-307 (U.S. 12/7/12).

2 Carlebach, 139 T.C. No. 1 (2012).

3 Notice 2012-12, 2012-6 I.R.B. 365.

4 Added by Section 112(a) of Victims of Trafficking and Violence Protection Act of 2000, P.L. 106-386.

5 Blackwood, T.C. Memo. 2012-190.

6 Driscoll, 669 F.3d 1309 (11th Cir.), cert. denied, Sup. Ct. Dkt. 12-153 (U.S. 10/1/12).

7  Shepherd. Memo. 2012-212.

8 Rev. Rul. 2012-14, 2012-24 I.R.B. 1012.

9 Rev. Rul. 92-53, 1992-2 C.B. 48.

10 IRS Letter Ruling 201228023 (7/13/12).

11 Newell, T.C. Summ. 2012-57.

12 REG-137589-07.

13 Notice 2007-47, 2007-1 C.B. 1393.

14 DeLima, T.C. Memo. 2012-291.

15 Abarca, T.C. Memo. 2012-245.

16 Chrush, T.C. Memo. 2012-299.

Written by | Posted in Corporate • Estate Planning Tax • Federal • Individual • Property Tax • State And Local Tax (SALT) • Tax Policy

AICPA Letter Requests Extension For 2010 Decedent Tax Forms

In an August 8, 2011 letter to the Internal Revenue Service (IRS), the American Institute of Certified Public Accountants (AICPA) requested a blanket extension of time to file the 2010 Form 706, United States Estate (and Generation‑Skipping Transfer) Tax Return, and the 2010 Form 8939, Allocation of Increase in Basis for Property Acquired from a Decedent, for the estates of persons who died in 2010. The AICPA letter also asked the IRS to extend the time to pay any estate tax for 2010 as well as to extend the due date of the 2011 Form 706 for estates of 2011 decedents.

The AICPA asked for the extensions “because of the lateness of the issuance of the not yet finalized 2010 Form 706 and 2010 Form 8939 and the unique situation faced by executors of 2010 estates. In addition, a draft of the 2011 Form 706 has not yet even been circulated.”

For estates of 2010 decedents, the due date for filing a Form 706 is September 19, 2011. The IRS released a draft of Form 706 on June 16. November 15, 2011, is the due date for filing Form 8939, but the form has not yet been released. The IRS said it expects to issue Form 8939 and the related instructions early this fall.

The AICPA letter pointed out that the November 15 deadline gives executors of estates less than the ninety days promised by the IRS between the date the form is released and the date the form is due. In its Notice 2011‑66, the IRS also stated that estates are not permitted any extension of time to file Form 8939.

In its letter, the AICPA said that executors need time to study the final versions of both Form 706 and Form 8939 to make “informed choices as to whether or not to elect out of the estate tax regime and use the modified carry‑over basis provisions of section 1022. . . .  In addition, many practitioners use tax software to complete their forms. It will take time once the final versions of the forms are released for the software companies to develop the programs for completing these forms.”

Regarding the estates of 2010 decedents, the AICPA suggested that the Treasury and the IRS announce the following:

– That the due date for Form 706 or Form 8939 will be ninety days after the issuance, in final form, of whichever of the two forms, together with its set of instructions, is issued last.

– That the due date for the payment of any estate tax is the same as the due date of Form 706. This would allow a reasonable period of time for the preparation and filing of either Form 706 or Form 8939, as promised by the Treasury Department and the IRS in IR‑2011‑33 with respect to Form 8939.

– That there be some procedure by which an estate can obtain an extension of time to file Form 8939 for a period of six months after its due date.

– That the due date for the 2011 Form 706 for 2011 decedents be no earlier than ninety days after the form and its instructions are released in final form.

The Economic Growth and Tax Relief Reconciliation Act of 2001 repealed the estate tax for persons who died in 2010, but the estate tax was reinstated for 2010 by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act. The recent law provided the option to file Form 8939, Allocation of Increase in Basis for Property Acquired from a Decedent as an alternative to the estate tax form. Filing of Form 706 or Form 8939 is required for estates with combined gross assets and prior taxable gifts exceeding $5 million or more for decedents dying in 2010 or later.

By:  Anne Rosivach

Edited and posted by:  Harold Goedde, CPA, CMA, Ph.D. (Taxation and Accounting)

Written by | Posted in Estate Planning Tax • Federal • Individual • Property Tax • Tax Policy

Tax Year End In South Africa

TaxConnections Picture - Africa Money and Flag XSmallTax year-end in South Africa, for smaller companies and all individuals, is on the last day of February 2013.

In terms of the collection process, South African Revenue Services (SARS or the equivalent of IRS and HMRC, the competent taxing authority in SA)  expects all provisional taxpayers to be either 80% or 90% correct in the end February provisional tax estimate, compared to the final assessment or IT34.

Irrelevant I hear the expats shout, as non-resident taxpayers face withholding taxes and are not required to pay provisional tax. True, I agree but non-resident for purpose of the provisional tax exemption, refers to a person that is either actually tax non-resident or was never tax resident and to a person exclusively tax resident of another country in terms of an applicable double tax treaty.

SA expats residing in the USA relying on anything less than a green card is probably exclusively tax resident in South Africa, as the SA Expats in Australia are exclusively SA tax resident (normally) until they receive a Permanent Residence (PR) Permit. The USA PR obviously is the green card and most others are not adequate to change the tax treaty tie breaker outcome. Read More

Written by | Posted in Africa • Estate Planning Tax • Expatriate • Indirect Tax • Individual • International • State And Local Tax (SALT) • Tax Policy • TaxConnections

IRS changes instructions for Forms 5471 and 8621

Form 5471:

  1. IRS now requires a creation of Refrence ID of the foreign corporation and this must be completed for all years ending on or after December 31, 2012.
  2. According to AICPA – “ The most notable change and one that the AICPA has recently addressed in a comment letter to the IRS, is the constructive ownership exception which was previously available to Category 3 and 4 filers only. The exception has now been extended to all Category 5 filers where ownership in the foreign corporation is solely through application of constructive ownership principles and the U.S. person through whom the U.S. shareholder constructively owns an interest in the foreign corporation files Form 5471 reporting all required information. “
  3. Other changes can be found in “What’s new” section of Form 5471.

Form 8621:

  1. In the filer identification section, a line has been added to request the reference ID number of the PFIC or QEF.
  2. New Part I, Summary of Annual Information was added to reflect the new annual filing requirement of section 1298(f) which was added by section 521 of the Hiring Incentives to Restore Employment Act of 2010. However, this new Part I is not required until the underlying regulations are published. For now, they have been marked as Reserved For Future Use. Form 8621 will be revised when Part I becomes effective.
  3. The elections in Part II of the form have been reordered and the filing requirements for new elections F, G, and H have been modified. Please complete Part II carefully with these changes in mind.
  4. See instructions for all changes very carefully.
Written by | Posted in Africa • Asia • Australia/Oceania • Corporate • Estate Planning Tax • Europe, Middle East • Expatriate • Federal • Individual • International • North America

The American Tax Relief Act of 2012 (The Fiscal Cliff Compromise)

Details of tentative deal that averts the fiscal crisis

Income tax rates:  Extends decade-old tax cuts on incomes up to $400,000 for individuals, ($450,000  married filing joint). Earnings above those amounts would be taxed at a rate of 39.6% up from the current 35 %.  Extends the Clinton-era caps on itemized deductions and the phase-out of the personal exemption for individuals making more than $250,000 and couples filing joint earning more than $300,000.

The estate and gift tax exclusion amount is retained at $5 million indexed for inflation ($5.12 million in 2012), but the top tax rate increases from 35% to 40%  effective Jan. 1, 2013. The estate tax “portability” election, under which, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount, was made permanent by the act.

Capital gains, dividends:  the tax rate on capital gains and dividend income for taxpayers with income exceeding $400,000 ($450,000 for married filing joint) increases from 15 % to 20 %.

Alternative minimum tax: permanently indexes it for inflation to prevent nearly 30 million middle-and upper-middle income taxpayers from being hit with higher tax bills averaging almost $3,000. The tax was originally designed to ensure that the wealthy did not avoid owing taxes by using loopholes.

Extends a tax credit for research and development costs and for renewable energy such as wind-generated electricity.

Unemployment benefits: Extends jobless benefits for the long-term unemployed for one year.

Cuts in Medicare reimbursements to doctors:  Blocks a 27 % cut in Medicare payments to doctors for one year.

Social Security payroll tax cut: Allows a 2 percentage point cut in the FICA tax, first enacted two years ago, to lapse, which restores the FICA tax to 6.2 %.

Across-the-board cuts:  delays for two months $109 billion worth of across-the-board spending cuts that were set to start striking the Pentagon and domestic agencies January 1. Cost of $24 billion is divided between spending cuts and new revenues from rules changes on converting traditional individual retirement accounts into Roth IRAs.  [Fox News, on-line ed.,  January 1, 2013, “Fiscal Cliff  Deal reached between Senate and White House- what’s inside the Senate’s ‘fiscal cliff’ solution?”  Fox News’ Ed Henry, Chad Pergram and Mike Emanuel contributed to this report].

OTHER PROVISIONS

Permanent extensions:

(1) Marriage penalty relief (i.e., the increased size of the 15% rate bracket (Sec. 1(f)(8)) and increased standard deduction for married taxpayers filing jointly (Sec. 63(c)(2))
(2) The child and dependent care credit rules (allowing the credit to be calculated based on up to  $3,000 of expenses for one dependent or up to $6,000 for more than one) (Sec. 21)
(3) The exclusion for National Health Services Corps and Armed Forces Health Professions  Scholarships (Sec. 117(c)(2))
(4) The exclusion for employer-provided educational assistance (Sec. 127)
(5) The enhanced rules for student loan deductions introduced by EGTRRA (Sec. 221)
(6) The higher contribution amount and other EGTRRA changes to Coverdell education savings accounts (Sec. 530)
(7) The employer-provided child care credit (Sec. 45F)
(8) Special treatment of tax-exempt bonds for education facilities (Sec 142(a)(13))
(9) Repeal of the collapsible corporation rules (Sec. 341)
(10) Special rates for accumulated earnings tax and personal holding company tax (Secs. 531 &  541)
(11) Modified tax treatment for electing Alaska Native Settlement Trusts (Sec. 646).

Extension of individual credits that were set to expire at the end of 2012:

(1) American Opportunity Tax Credit. Up to $2,500 tax credit for qualified tuition and other expenses of higher education was extended through 2018.
(2) Other credits and items from the American Recovery and Reinvestment Act of 2009, P.L. 111-5, that were extended for the same five-year period include
(3) enhanced provisions of the child tax credit under Sec. 24(d).
(4) earned income tax credit under Sec. 32(b). In addition, the bill permanently extends a rule excluding from taxable income refunds from certain federal and federally assisted programs (Sec. 6409).

Extension of individual provisions that expired at the end of 2011:

The act also extended through 2013 a number of temporary individual tax provisions, most of which expired at the end of 2011:

(1) $250 deduction for certain expenses of elementary and secondary school teachers (Sec. 62). This is per teacher. On a joint return, if both spouses are teachers, they may deduct only $250 EACH.  If one spouse-teacher does not have $250 in expenses, the other spouse-teacher cannot use the balance from the other spouse-teacher. Amounts in excess of $250 ($500) can be deducted as a employee business expense under miscellaneous itemized deductions-allowable to the extent they exceed 2% of AGI.
(2)  Exclusion from gross income of discharge of qualified principal residence indebtedness (Sec. 108)
(3) Parity for exclusion from income for employer-provided mass transit and parking benefits (Sec. 132(f))
(4) Mortgage insurance premiums treated as qualified residence interest (Sec. 163(h))
(5) Deduction of state and local general sales taxes (Sec. 164(b))
(6) Special rule for contributions of capital gain real property made for conservation purposes (Sec. 170(b))
(7) Above-the-line deduction (deduction for AGI) for qualified tuition and related education expenses for taxpayer and dependents (Sec. 222)
(8) Tax-free distributions from individual retirement plans for charitable purposes for taxpayers age 70½ or older (Sec. 408(d)).

Business tax extenders:

(1) Modified the Sec. 41 credit for increasing research and development activities, which expired  at the end of 2011. The credit is modified to allow partial inclusion in qualified research expenses and gross receipts for those of an acquired trade or business or major portion of one.  Extended  through 2013.
(2) The increased expensing amounts under Sec. 179 are extended through 2013.
(3) The availability of an additional 50% first-year bonus depreciation (Sec. 168(k)) was also  extended for one year by the act. It now generally applies to personal property placed in service  before January 1, 2014 (Jan. 1, 2015, for certain property with longer production periods).
(4)   Temporary minimum low-income tax credit rate for non-federally subsidized  new buildings (Sec. 42);
(5) Housing allowance exclusion for determining area median gross income for qualified residential rental project exempt facility bonds (Section 3005 of the Housing Assistance Tax Act of 2008)
(6) Indian employment tax credit (Sec. 45A)
(7) New markets tax credit (Sec. 45D)
(8) Railroad track maintenance credit (Sec. 45G)
(9)   Mine rescue team training credit (Sec. 45N)
(10)  Employer wage credit for employees who are active duty members of the uniformed services (Sec. 45P)
(11) Work opportunity tax credit (Sec. 51)
(12) Qualified zone academy bonds (Sec. 54E)
(13) Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified  restaurant buildings and improvements, and qualified retail improvements (Sec. 168(e))
(14) Accelerated depreciation for business property on an Indian reservation (Sec. 168(j))
(15) Enhanced charitable deduction for contributions of food inventory (Sec. 170(e))
(16) Election to expense mine safety equipment (Sec. 179E)
(17) Special expensing rules for certain film and television productions (Sec. 181)
(18) Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico (Sec. 199(d))
(19) Modification of tax treatment of certain payments to controlling exempt organizations (Sec. 512(b))
(20) Treatment of certain dividends of regulated investment companies (Sec. 871(k))
(21) Regulated investment company qualified investment entity treatment under the Foreign Investment in Real Property Act (Sec. 897(h))
(22) Extension of subpart F exception for active financing income (Sec. 953(e))
(23) Look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules (Sec. 954)
(24) Temporary exclusion of 100% of gain on certain small business stock (Sec. 1202)
(25) Basis adjustment to stock of S corporations making charitable contributions of property (Sec. 1367)
(26) Reduction in S corporation recognition period for built-in gains tax (Sec. 1374(d))
(27) Empowerment Zone tax incentives (Sec. 1391)
(28) Tax-exempt financing for New York Liberty Zone (Sec. 1400L)
(29) Temporary increase in limit on cover-over of rum excise taxes to Puerto Rico and the Virgin Islands (Sec. 7652(f))
(30) American Samoa economic development credit (Section 119 of the Tax Relief and Health Care Act of 2006, P.L. 109-432, as modified).

Energy Tax Extenders:

The act also extends through 2013, and in some cases modifies, a number of energy credits and provisions that expired at the end of 2011:

(1) Credit for energy-efficient existing homes (Sec. 25C)
(2) Credit for alternative fuel vehicle refueling property (Sec. 30C)
(3) Credit for two- or three-wheeled plug-in electric vehicles (Sec. 30D)
(4) Cellulosic biofuel producer credit (Sec. 40(b), as modified)
(5) Incentives for biodiesel and renewable diesel (Sec. 40A)
(6) Production credit for Indian coal facilities placed in service before 2009 (Sec. 45(e)) (extended to an eight-year period)
(7) Credits with respect to facilities producing energy from certain renewable resources
(Sec. 45(d), as modified)
(8) Credit for energy-efficient new homes (Sec. 45L)
(9) Credit for energy-efficient appliances (Sec. 45M)
(10) Special allowance for cellulosic biofuel plant property (Sec. 168(l), as modified)
(11) Special rule for sales or dispositions to implement Federal Energy
Regulatory Commission or state electric restructuring policy for qualified electric utilities (Sec. 451)
(12) Alternative fuels excise tax credits (Sec. 6426).

Foreign Provisions:

The IRS’s authority under Sec. 1445(e)(1) to apply a withholding tax to gains on the disposition of U.S. real property interests by partnerships, trusts, or estates that are passed through to partners or beneficiaries that are foreign persons is made permanent, and the amount is increased to 20%.

New Taxes:

These are effective January 1 as a result of 2010’s health care reform  (“Obama Care”) legislation:

(1) Additional hospital insurance tax on high income taxpayers. The employee portion of the hospital insurance tax part of FICA, normally 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer’s spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.
(2)  For self-employed taxpayers, the same additional hospital insurance tax applies to the hospital insurance portion of SECA tax on self-employment income in excess of the threshold amount.
(3)  Medicare tax on net-investment income. Starting  January 1, Sec. 1411 imposes a tax on individuals equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified adjusted gross income (MAGI) that exceeds a threshold amount.  For married individuals filing a joint return and surviving spouses, the threshold amount is $250,000; for married taxpayers filing separately, $125,000; for other individuals $200,000.  For estates and trusts, the tax equals 3.8% of the lesser of undistributed net investment income or AGI over the dollar amount at which the highest trust and estate tax bracket begins.  Net investment income means investment income reduced by deductions properly allocable to that income. Investment income includes income from interest, dividends, annuities, royalties, and rents, and net gain from disposition of property, other than such income derived in the ordinary course of a trade or business. However, income from a trade or business that is a passive activity and from a trade or business of trading in financial instruments or commodities is included in investment income. [Note: I have posted two articles on this topic on TaxConnections.com Tax Blog].
(4)  Medical care itemized deduction threshold. The threshold for the itemized deduction for unreimbursed medical expenses has increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is effective for all individuals, except, in the years 2013–2016, if either the taxpayer or the taxpayer’s spouse has turned 65 before the end of the tax year, the increased threshold does not apply and the threshold remains at 7.5% of AGI.
(5) Health flexible spending arrangement. Effective for cafeteria plan years beginning after December  31, 2012, the maximum amount of salary reduction contributions that an employee may elect to have made to a flexible spending arrangement for any plan year is $2,500.

[Paul Bonner and Alistair M. Nevius, Journal of Accountancy, on-line. ed., January 1, 2013]

REACTIONS  AND  COMMENTS

Edward Karl, Vice President–Tax for the AICPA said  “The AICPA is pleased that Congress has reached an agreement. The uncertainty of the tax law has unnecessarily impeded the long-term tax and cash flow planning for businesses and prevented taxpayers from making informed decisions. The agreement should also allow the IRS and commercial software vendors to revise or issue new tax forms and update software, and allow tax season to begin with minimal delay.”  [Paul Bonner and Alistair M. Nevius, Journal of Accountancy, on-line. ed., January 1, 2013]

There have been many critics of the legislation signed by the president, particularly due to its potential effect on the economy and not enough reduction in spending.  It did nothing to patch up the broken Social Security, Medicaid, and Medicare programs. The new congress convened on January 3 and the House reelected  John Boehner as Speaker. John Boehner and Mitch McConnell, Senate minority leader, said the GOP will use this legislation as a bargaining chip for more reductions in government spending (the debt limit has to be raised by February 28) that the Democrats are sure to resist. On March 1, automatic spending cuts, deferred by the act, will take place. Defense and domestic cuts will be hardest hit. In mid-March, congress must vote on a continuing resolution to fund government operations through September 30.

Self-employed and owners of S corporations will be faced with higher taxes since many of them will have income exceeding $400,000 where the tax rate increases from  35%  to 39.6%.  According to Vistage Polling, “29% of the chiefs of small firms planned to hire fewer workers. An additional  32%  expect lower investment spending, or fewer purchases of vehicles, property and equipment.” A small businessman said  “any added tax bill, which will be paid out of cash flow, would prevent him from offering employees raises and profit sharing.” [Emily Maltby and
Angus Loten, “Cliff  Fix Hits Small Business”, The Wall Street Journal, January 3, 2013].

David Limbaugh, a Fox News political analyst, appeared January 2 on Hannity. He was critical of the president saying  “the White House isn’t finished with revenue increases. He [the president] plans to put caps and phase-outs on deductions and go after the so called wealthy. The president refuses to reform entitlements and [wants to] tax and destroy the wealthy.”

Appearing on the same program, Charles Krauthammer, a syndicated columnist and Fox News analyst, said  “Obama only demanded increases in tax rates because it would accentuate the fractures, and that’s what happening on the House vote. If he [the president] can get the House GOP out of the way, he can be dominant in Washington for his entire term.”

Higher income taxes and the payroll tax increase is likely to stunt the growth of the economy. Joel Naroff, president of Naroff  Economic Advisors, said  “It’s [the new tax law] a huge hit.  It hits people whether they’re making $10,000 or they’re making $2 million.  It doesn’t matter who you are . . .the lower  your income, the more of your income you’re spending.  So, if your taxes go up, its going to come out of your spending. And that’s bad news for an economy that is 70 percent consumer spending.”  Mark Zandi, chief economist at Moody’s Analytics, stated  “. . . the higher payroll tax will reduce economic growth by .6 percent in 2013. . . higher taxes on household incomes above $400,000 a year will slice just  0.15 percentage point off economic growth.”  [Associated Press, “Economy likely loser in any deal”, The Albany Times Union, January  2, 2013].

The long drawn out political standoff between the president and the GOP added uncertainty that discouraged consumers from spending and businesses from hiring and investing. Mark Vitner, senior economist at Wells Fargo, predicts the economy will expand only 1.5 percent in 2013, down from a lackluster 2.2 percent in 2012. Unemployment stands at  7.7 percent.  Many economists are disappointed that Congress and the White House couldn’t reach an agreement to significantly reduce the deficit over the next 10 years. That could have increased business and consumer confidence and accelerated growth. Another shortcoming in the legislation is the failure to reform the big entitlement programs, particularly Social Security and Medicare. Joseph Lavorgita, an economist at Deutsche bank, said  “Nothing really has been fixed. There are bigger philosophical issues that we aren’t addressing yet.”  [Associated Press, “Economy likely loser in any deal”, The Albany Times Union, January 2, 2013].

Another prominent businessman, Steve Forbes, chairman and editor-in-chief of Forbes Media, appeared January 3 on The Willis Report, and was very critical of the tax increase. He said the tax increases remove capital from the economy, substantially hurts small businesses, and  middle class taxpayers [due to the payroll tax increase]. The tax increase will hurt wage earners, capital creators, and risk takers. The complexity of the Internal Revenue Code has increased which will harm the economy.  He was also critical of the president’s position on tax increases.  “President Obama doesn’t want tax reform and simplicity in the tax code recommended by Simpson-Bowles. He only wants to raise tax rates, and take away exemptions and deductions.  He doesn’t want to raise revenue; he only wants “justice” and income redistribution. He thinks rich people shouldn’t be allowed to keep as much as they earn today. He doesn’t care if it [tax increases] hurts the economy.”

The Wall Street Journal, in an editorial, was very critical of the bill approved by Congress, due to a tax increase on what they call middle class taxpayers. Their editorial centered around why the new much ballyhooed $450,000 income threshold for the highest tax rate is largely fake and a political fiction.  The editor stated:

Under the new law, some of the steepest tax increases will fall on upper-middle class earners with incomes just above $250,000. During the negotiations, the White House won a concession from the Republicans to allow phaseouts for personal exemptions and limitations on itemized deductions, starting at an income level of $250,000 for individuals and $300,000 for joint filers…. the loss of the personal exemption, currently $3,800 per family member, can mean a 4.4 percent point rise in the marginal tax rate for a married couple with two kids and income above $250,000.  A family in that income range faces about a six percentage point marginal rate hike. The restored limitation on itemized deductions can raise the tax rate by another one percentage point. Add it together [phaseouts on exemptions and caps on deductions] and families in the 33%  tax bracket could see their marginal rate paid on each additional dollar earned rise to above 38%.  Add in the new ObamaCare investment taxes and the tax rare on interest income is close to 45% [Review and Outlook, “The Stealth Tax Hike”, January 5-6, 2013].

Carly Fiorina,, a Republican national strategist and former CEO of Hewlett Packard appeared on NBC’s Meet The Press January 6. Regarding the fiscal cliff compromise she said  “. . . the latest deal complicates the tax code and continues corporate welfare [she did not elaborate on what she meant by this]. We need to broaden and simplify the tax code. close the loopholes, lower the tax rates, deal with health care costs, stabilize Social Security, and get spending under control.”

Eugene Robinson, a nationally syndicated columnist was also very critical of the fiscal cliff deal.  He said:

To say that Congress looked like a clown show last week is an insult to self-respecting clowns. Our august legislature-aided and abetted by President Barak Obama-manufactured a fake crisis. They then proceeded to handle it so incompetently that they turned into a real one…. they could only manage to avoid hurtling to their doom, and ours, by deciding not to decide much of anything. Obama “won” this bloody battle, but what did he really gain, aside from bragging rights for the next few weeks?  More important, what did the nation gain? Practically zilch, except reprieve from hardships that its elected leaders were bizarrely threatening to impose on the citizens who elected them. The bill Congress passed and the President signed contains no significant new stimulus to boost the recovery. And while it raises taxes… the non-partisan Congressional Budget Office estimates the bill actually adds $4 trillion to the debt over the next decade, mostly by keeping the Bush middle class tax cuts in place.  [“Lets hand the clowns the script”, The Albany Times Union, January 6, 2012].

The next big crisis facing Congress is action on raising the national debt limit which we will hit at the end of February. Mr. Boehner and Mr. McConnell both said they will be holding out for spending cuts and will not stand for any tax increases on any agreement raising the debt limit. President Obama said he will not agree to spending cuts and wants more tax increases to raise revenue. If the GOP holds out on their insistence on spending cuts and no tax increases, the Democrats will likely resist spending cuts. This showdown could possibly shut down the government until an agreement is reached. The next big showdown will come in March when the delayed sequester on spending cuts expires.  At that date, unless a compromise is reached between the president and congress, there will be automatic large spending cuts in defense and other domestic programs. Another area that congress must deal with is entitlement cuts and reforms to Social Security Medicaid, and Medicare.

If a deal is not reached on spending cuts and raising the debt limit, Moody’s Investor Services and Standards and Poors said they may lower the U.S. credit rating unless there is more deficit reduction.

I will continue to monitor future tax legislation in Congress, particularly tax reform.  If anything significant takes place, I will post another article to discuss it.

CIRCULAR 230 DISCLOSURE:  Pursuant to regulations governing practice before the IRS, any tax  advice contained herein is not intended or written to be used and cannot be used by the taxpayer  for the purpose of avoiding tax penalties that may be imposed on the taxpayer.

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