News On The Tax Front--The latest tax news.
In Brief:--Tax, business, and personal finance tips.
Previously Reported In Daily Update
In Internal Revenue News Release IR-2004-15 the Service is reminding taxpayers claiming the Child Tax Credit that they cannot claim the full $1,000 per child if they received an advance payment check last year. When figuring the credit, they must subtract any amount they got in advance. Failure to do so will reduce and could delay the tax refund claimed. You can get the amount of your advance Child Tax Credit payment by visiting IRS.gov. Information is available by clicking on "1040 Central" or "Your 2003 Advance Child Tax Credit." You must put the amount of their advance payment check on line 2 of their Child Tax Credit Worksheet. If you're claiming the Child Tax Credit but did not receive an advance payment you will get their entire benefit from the credit on your return. If your advance payment was larger than the amount of your credit you will not have to repay the difference and will not claim any Child Tax Credit on your return. If the advance payment was reduced because of past-due taxes or certain non-tax debts, you must use the full advance amount, before offset, in the worksheet. This is because you received the benefit of the advance payment amount that was used to pay the past-due amount.
If you don't engage in a venture with the objective of making a profit, any net losses that you might have been able to use to offset your other income aren't deductible. Generally, when considering these hobby loss rules, most taxpayers and professionals only think about the consequences of the operating losses. In Csaba L. Magassy and Frances H. Magassy (T. C. Memo. 2004-4) that was only part of the issue. The taxpayers purchased a 1963 108' Feadship boat with the intention of restoring it and reselling it for a profit. The cost of the repairs exceeded expectations. The taxpayers organized an S corporation and chartered the boat, then later sold it for a loss. If the loss on the sale of the boat were incurred in a trade or business, it would be an ordinary loss, fully deductible. The Tax Court held that the taxpayers did not have a good faith profit objective relating either to the charter of the Feadship or to the sale of the Feadship, and disallowed the operating losses and the $1.93 million loss on the sale of the boat.
Paying personal expenses with company funds and then deducting the expenses on the business and not reporting the income on your personal return will result in unreported income. That was essentially the situation in Howard H. Thompson (T.C. Memo. 2004-2). Since this was not a fraud case, the taxpayer had the burden of proof. That is, he had to show the IRS was wrong in its determination. In support of his position that he did not have the unreported income, the taxpayer relied on his testimony. The Court had advised the taxpayer that he may not introduce at the trial any evidence that was inconsistent with or contrary to the deemed admissions and the deemed stipulations. The IRS objected to certain of the taxpayer's testimony on the ground that it was inconsistent with or contrary to certain of the deemed admissions and deemed stipulations in this case. The Court agreed with the IRS. The Court found that the taxpayer did have additional funds from his embezzlement and that income was not reported on his tax returns for the years at issue.
You may be able to settle your tax liability for less than the full amount if you file an Offer in Compromise and it's accepted by the IRS. But the Service doesn't have to accept an offer. In Randall G. Van Vlaenderen (T.C. Memo. 2003-346) the IRS rejected the taxpayer's offer and the taxpayer asked the Court to find that the rejection was an abuse of discretion. The Court noted the taxpayer's liabilities exceeded $78,000, but he offered to pay only $3,763. The IRS countered with an offer of $59,676. The IRS noted that the taxpayer's monthly bank deposits less his projected living expenses allowed him to pay much more than his offer. The taxpayer raised his offer to $9,756. In addition, the taxpayer had not filed one of his tax returns, a prerequisite to an acceptance of an offer by the IRS. The Court sided with the IRS, noting that while it was possible that the revenue officer's financial analysis, based on the information that petitioner had provided, was flawed. Nonetheless, the Court found it could not conclude that the information that the taxpayer provided was reliable or that consideration of his amended offer in compromise of $9,756 would have changed the determination.
ThThe IRS has issued a ruling (Rev. Rul. 2004-4; IRB 2004-6) to shut down abusive transactions involving S corporation ESOPs. The ruling makes these listed transactions for tax-shelter disclosure purposes. An employee stock ownership plan, or ESOP, is a type of retirement plan that invests primarily in employer stock. Congress has allowed an S corporation to be owned by an ESOP, but only if the ESOP gives rank-and-file employees a meaningful stake in the S corporation. When an ESOP owns an S Corporation, the profits of that corporation generally are not taxed until the ESOP makes distributions to the company's employees when they retire or leave the job. This is an important tax break which allows the company to reinvest profits on a tax-deferred basis, for the ultimate benefit of employees who are ESOP participants. The ruling shuts down transactions that move business profits of the S corporation away from the ESOP, so that rank-and- file employees do not benefit from the arrangement. For example, the ruling prohibits using stock options on a subsidiary to drain value out of the ESOP for the benefit of the S corporation's former owners or key employees. This notice does just that, imposing a 50% excise tax on the option holders in cases where rank-and-file ESOP participants are deprived of the business profits.
The determination of your principal residence can be important for a number of tax and nontax reasons. In Louis Fusaro (T.C. Memo. 2003-345) the Tax Court found that the taxpayer was a resident of Florida at the time the IRS filed tax liens on the taxpayer's interest in a pension plan, not a resident of California as the taxpayer contended. Thus, the IRS liens were valid.
In Notice 2004-10 (IRB 2004-6) the IRS is providing guidance to sponsors or administrators of retirement plans or qualified tuition programs (QTPs), or trustees, custodians, or issuers of traditional Individual Retirement Arrangements (IRAs), Roth IRAs, Coverdell education savings accounts (CESAs), or Archer Medical Savings Accounts (Archer MSAs) regarding the electronic delivery of payee statements to recipients. Specifically, this notice provides that a furnisher of a Form 1099 or a Form 5498 relating to the reporting of contributions and distributions of pensions, traditional IRAs, Roth IRAs, QTPs, CESAs, and Archer MSAs may provide the payee statements electronically beginning after December 31, 2003.
In his State of the Union address, President Bush called on Congress to extend the tax reductions that are set to expire and make the tax cuts permanent. He also asked for personal retirement accounts that would enable individuals to save part of their social security funds outside the system and a refundable tax credit that would allow millions of lower-income Americans to buy their own basic health insurance. The President also proposed that individuals who buy catastrophic health care coverage, as part of our new health savings accounts, be allowed to deduct 100 percent of the premiums from their taxes.
It has not escaped the IRS that a significant number of sole proprietorships are not filing a Schedule C and thus avoiding tax on their self-employment income. It appears that the IRS may soon attack this problem. An open meeting of the Small Business/Self Employed--Schedule C Non-Filers Committee of the Taxpayer Advocacy Panel will be held February 10, 2004.
The IRS his reminding (IR-2004-11) taxpayers in Alabama, Arkansas, Delaware, Michigan, Montana, Tennessee, Rhode Island, Utah and Wyoming, as well as those in parts of New York, will file tax returns with a different center in 2004 than they did during 2003. Taxpayers in these states should be aware of this change only if they did not receive an instruction booklet in the mail and plan on mailing a paper tax return.
Taxpayers enclosing a check should add "-0102" to the zip code listed above if mailing a Form 1040, "-0115" for Form 1040A or "-0114" for Form 1040EZ. Those not enclosing a check should add "- 0002" if mailing a Form 1040, "-0015" for Form 1040A, or "-0014" for Form 1040EZ.
Both businesses and individuals are entitled to claim a net operating loss (NOL). Net operating losses of individuals are usually generated by businesses losses such as from a sole proprietorship, S corporation, etc. In Herschel H. and Robert S. Hoopengarner (T.C. Memo. 2003-343) the taxpayers claimed an NOL which they carried forward to offset income in later years. The IRS disallowed the losses, arguing that the taxpayers did not prove the losses existed. The Court sided with the IRS. The Court noted that the tax returns did not prove the existence of the NOLs. The Court found the taxpayer's testimony to be general, vague, conclusory, and/or questionable in certain material respects. The taxpayers provided no financial documentation to substantiate the NOLs, producing no books or records for the years of the alleged loss. The Court also noted that taxpayer did not call key witnesses. The Court inferred that their testimony would not have been favorable to the taxpayers. Finally, the Court refused to estimate the amount of the NOLs because it had no reasonable evidentiary basis to make an approximation as to the amount of net operating losses.
Individuals can deduct investment interest (interest used to purchase or carry stocks, bonds, etc.) up to the amount of their investment interest. Investment interest is now basically interest income and short-term capital gains. Dividends used to qualify as investment income, but no longer do so because they're now taxed at the same rate as long-term capital gains. In Paul S. and Sharon E. Talchik (T.C. Memo. 2003-342) On Schedule D of their 1999 return, the taxpayers reported $47,555 in short-term capital gains. That amount was offset, however, by a short-term capital loss carryover from 1998 of $74,836, leaving a $27,281 net short-term capital loss carryover to future years. The Court held that the taxpayers had only $225 of investment income from dividends and disallowed all the remaining investment interest deduction.
If you use the accrual method of accounting you record the income when it's earned, not when you receive payment. In Perry Funeral Home (T.C. Memo. 2003-340) a funeral home operating in Massachusetts entered into preneed funeral contracts and received payments in advance of death for goods and services to be provided later at the contract beneficiary's death. These payments were refundable at the contract purchaser's request, pursuant to State law, at any time until the goods and services were furnished. The taxpayer was on the accrual method and included these payments in income not in the year of receipt but in the year in which the goods and services were provided. The Court noted that such contracts were rarely canceled, but under state law the amounts were refundable. Thus, the Court held that the amounts received by the taxpayer under the contracts was includable in income only upon the provision of the goods and services.
There are two ways for individuals to compute their estimated taxes. One is to "annualize" your income for each period. The second, and most commonly used, is to pay in at least as much as your liability for the prior year. This "safe harbor" is quick, easy, and foolproof. You might think there's an easy way to avoid paying estimated taxes--just don't file or claim a zero liability for one year and you won't have to make estimated payments the next. But it's not that easy. In Fortunato J. Mendes (121 TC--, No. 19) the Court held that, since the taxpayer never filed a return for one year, he was liable for the estimated tax penalty for underpayment in the next year.
The IRS announced (IR-2004-10) a new program for new business taxpayers designed to boost electronic payment of taxes. This development offers some taxpayers new, quicker access to an electronic payment system. This initiative will be available using the Electronic Federal Tax Payment System (EFTPS). EFTPS enables taxpayers and tax professionals to make federal tax payments electronically online, by phone, or with batch provider software for professionals. EFTPS Express Enrollment for New Businesses will affect all businesses receiving a new Employer Identification Number (EIN). Business taxpayers with a federal tax obligation will be automatically pre-enrolled in EFTPS to make all their Federal Tax Deposits. In addition to receiving their EIN, taxpayers will also receive a separate mailing containing an EFTPS Personal Identification Number (PIN) and instructions for activating their enrollment. New business taxpayers will activate their enrollment by calling an 800-number, entering their banking information and completing an authorization for EFTPS to transfer funds from their account to Treasury's account for tax payments per their instructions. Taxpayers can enroll in EFTPS by visiting EFTPS-OnLine at www.eftps.gov, or by calling EFTPS Customer Service at 1-800-555-4477 or 1-800-945-8400 to receive an enrollment form by mail. Taxpayers can make payments 24 hours a day, 7 days a week from home or office; schedule payments up to 120 days in advance (for businesses) or 365 days in advance (for individuals); review the last 16 months of tax payment history online or by calling Customer Service. In addition, taxpayers receive an immediate acknowledgement number for every EFTPS transaction for easy record keeping and as proof of the transaction. EFTPS is ideal for all business taxpayers and for individual taxpayers that make Form 1040 ES quarterly estimated payments.
No gain or loss is recognized on transfers of property between spouses or former spouses if incident to a divorce. A transfer of property is considered incident to the divorce if the transfer occurs within 1 year after the date on which the marriage ceases, or is related to the cessation of the marriage. If the transfer meets the above requirements, your spouse takes over your basis. For example, as part of a divorce settlement you transfer a vacation home worth $500,000 but where your basis is only $100,000. There's no gain on the sale. Your spouse takes your $100,000 basis. If he or she sells the property for $505,000, they'll have to report a $405,000 gain on the sale. In Claudia F. Walker (T.C. Memo. 2003-335) the Court found the taxpayer did indeed take over her husband's basis in the property as a result of a settlement of an obligation within one year of the divorce. The later sale of that property to a third party, however, was fully taxable to the taxpayer. The taxpayer also argued that she had an agreement with her former spouse that he would report one-half of the gain resulting from the sale of taxpayer's undivided 50-percent interest in the property. The Court found that a former case (Friscone, T.C. Memo. 1996-193) was not controlling here since the taxpayer accepted her ex-spouse's 25- percent interest in the property in consideration for a credit against the $500,000 equalizing money judgment. The ex-husband then transferred his 25-percent interest in the property to the taxpayer pursuant to a quitclaim deed. This transfer extinguished his ownership interest in the property. Consequently, the divorce decree no longer controlled the apportionment of the property.
Previously Reported In Daily Update
Shopping for price? . . . Don't assume that internet source, the warehouse club, etc. has the lowest price. They may be low on most items, but don't make the grade on others. It's rare that one source will be lowest at all times. If they are, they'll usually have ways to boost their profits. For example, a warehouse club could have the best prices, but they'll also have many house brands where they have a bigger margin. Nothing wrong with that. You could pay less for the house brand, get good quality, and the store can make a large enough profit to hold down prices on name brands. Just shop carefully.
Doing some capital improvements on your home? . . . Don't forget to tell your insurance company when you're done. Many improvements are costly and add significantly to the value of your home. You don't want to be underinsured after going through all the work of getting the improvement done right. You may have to inform the local tax assessor. While it'd be nice to get away without paying tax on the improvement, but some localities have penalties for failing to report additions.
HH bonds due for extinction . . . HH savings bonds have been a good way to continue deferring interest on EE (or E) savings bonds. In fact, the only way to buy HH bonds is by exchanging your EE bonds. But the Treasury has decided to phase them out by midyear. While existing bonds will still earn interest, you won't be able to get new ones after that time. If you exchange your EE bonds for HH bonds now, you'll be able to postpone tax on the interest for another 20 years. But the rates on HH bonds are low. Once HH bonds are no longer issued, you won't have any way to defer the interest on the EE bonds. That could be a blow for taxpayers who have a substantial holding. That's especially true if the bulk of the bonds mature in one year. In that case consider cashing some bonds before final maturity in those years when your taxable income is low. If the final maturity is spread over a number of years, you might just want to sit tight. Remember, EE bonds reach final maturity in 30 years. All accrued interest is taxable in the year of final maturity, even if you don't redeem the bonds. In addition, the bonds stop earning interest.
Home sale exclusion for unforseen circumstances . . . You can exclude up to $500,000 of the gain on the sale of your principal residence, but only once every two years. There's a exception to the general rule. The law provides for a reduced maximum exclusion if the primary reason for sale or exchange is a change in place of employment, health, or unforeseen circumstances. What's an unforseen circumstance? The law broadly defines that as the occurrence of an event that the taxpayer does not anticipate before purchasing and occupying the residence. Some of the safe harbor events are the involuntary conversion of the residence, death or divorce. In a recent letter ruling (LTR 200403049) a family member of the taxpayer was placed on probation and spent one year at a rehabilitation facility. The Court ordered the individual to live at the home under house arrest. The neighbors protested the individual's presence, made threats, and interfered with his attempts to find employment. The IRS held that events leading up to the sale of the house were unforseen circumstances and the sale qualified for a partial exclusion. While you may not find yourself in an identical situation, you could end up in one with similar circumstances. Check with your tax advisor. You may be entitled to a partial exclusion.
File your return for free . . . The IRS has announced (IR-2004-13) that it's Free File program is available and contains a number of changes to and improvements over last year's version. You access Free File by going to the IRS web site. While you're going to the IRS site, you'll be accessing one of a number of private companies such as Intuit, Inc., CCH, etc. to enter data, perform the calculations, etc. Free File is not available to all taxpayers. Different providers have different requirements. In most cases your AGI (adjusted gross income) has to be under a certain level, typically around $30,000. While the program might not suit you, it could be valuable to your employees, children, or relatives.
Advance child tax credit . . . If you claimed the child tax credit in 2002, you probably received a check over the summer for your advance child tax credit. For 2003, the child tax credit is $1,000, but you've got to reduce that amount by the amount of the advance credit you received. Thus, if you received a check for $400 over the summer and you're entitled to claim a credit of $1,000 (one qualifying child) for 2003, you can take a credit of $600 on line 49 of Form 1040. Confused? You're probably not alone. The Child Tax Credit Worksheet on page 40 of the Form 1040 instructions should make it easier. If you use a tax program to do your return, just go through the program carefully--don't try to shortcut it. Don't know if you got a check from the IRS? Or how much the check was for? Go to the 1040 Central at the IRS web site. Put in your social security number, filing status and the number of exemptions claimed last year and you'll get an immediate response as to the amount of the advance credit you received. Or just click here 2003 Advance Child Tax Credit.
Copies of your filed returns . . . Taxpayers have two options for getting copies of their federal tax return information--tax return transcripts and tax account transcripts. A tax return transcript shows most line items from the tax return (Form 1040, 1040A or 1040EZ) as it was originally filed, including any accompanying forms and schedules. It does not reflect any changes made after the return was filed. In many cases, a return transcript will meet the requirements of lending institutions such as those offering mortgages and student loans. A tax account transcript shows any later adjustments either you or the IRS made after the tax return was filed. This transcript shows basic data, including marital status, type of return filed, adjusted gross income and taxable income. Request transcripts by calling 1-800-829-1040, or order by mail using IRS Form 4506-T, "Request for Transcript of Tax Form." Specify the type of transcript you are requesting. The IRS does not charge a fee for transcripts, which are available for the current and three prior calendar years. Allow two weeks for delivery. If you need a photocopy of a previously processed tax return and attachments, complete Form 4506, "Request for Copy of Tax Form" and mail it to the IRS address listed on the form for your area. There is a fee of $39.00 for each tax period requested. Copies are generally available for the current and past 6 years.
1099 filing tips . . . You'll need to give any independent contractors to whom you paid $600 or more during 2003 a 1099-MISC. You probably know that already. But here are some other points to keep in mind:
There are more rules. See the General Instructions for Forms 1099, 1098, 5498 and W-2G and Instructions for Form 1099-MISC on the IRS web page. There are inexpensive software programs that make this job much easier and will help you avoid problems.
It's the message, stupid . . . Some ads are so cute or imaginative we love seeing them on TV, in print, etc. It's nice that they're entertaining, but that's not the ultimate purpose. You spend big money on ads to sell products or services. That flashy, award-winning web site or ad isn't worth it if you don't get viewers and, eventually, sales.
Don't assume your future tax bracket . . . Everyone assumes they'll be in a lower tax bracket when they retire. That may not be true. If you're married now and your spouse dies or you get divorced after beginning retirement, you could find yourself in a higher bracket. While you generally can't factor all eventualities into your financial plan, you do want to avoid backing yourself into a corner from which you can't escape. Just consider what you'd do if you do end up in a higher bracket.
Investment interest deduction more restricted . . . You can deduct investment interest (e.g., margin interest) up to the amount of your investment income. Interest expense that exceeds that amount can be carried forward and used in future years with the same restriction. In the past investment income was interest, dividends and short-term capital gains. But, beginning with 2003, most dividends will be taxed at capital rates. And that means dividends will no longer qualify as investment income. That could put additional restrictions on your investment interest deduction. You can make an election to have the dividends taxed at ordinary income rates, but it's unlikely that will save tax dollars. You might want to run the numbers both ways, just to be sure.
Which form--1040, 1040A or 1040EZ? . . . The IRS wants you to use the simplest one you can. If you've got a business that's organized as a sole proprietorship, S corporation, partnership, or LLC, you'll need to use a full 1040. That's also true if you've got taxable income of $50,000 or more, capital gains or losses, itemize your deductions, etc. But your children may be able to file Form 1040EZ or 1040A. You can use a 1040EZ if:
You have taxable income below $50,000
Are single or married, filing jointly
Are under age 65
Have no dependents
Have interest income of $1,500 or less
You can use 1040A if:
You have taxable income below $50,000
Have capital gain distributions, but no other capital gains or losses
Your only tax credits for child tax, education, earned income, child and dependent care expenses, adoption and retirement savings contributions
Your only deductions are for IRA contributions, student loan interest, educator expenses or higher education tuition and fees
You don't itemize deductions
Just because you received a Form 1040EZ or 1040A in the mail or used one last year doesn't mean you have to the same form this year.
Copyright 2003-2004 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536