News On The Tax Front--The latest tax news.
Military Family Tax Relief Act--The law changes provides benefits for servicemen.
In Brief:--Tax, business, and personal finance tips.
Previously Reported In Daily Update
The IRS has issued guidance (Notice 2003-75) simplifying the U.S. reporting rules that apply to U.S. persons with interests in two common types of Canadian retirement plans. The notice details the information that U.S. persons holding interests in Canadian Registered Retirement Savings Plans (RRSPs) and Canadian Registered Retirement Income Funds (RRIFs) are required to include on a statement attached to their U.S. tax returns. The IRS is developing a simple form for this information reporting. These new simplified reporting rules are designed to permit taxpayers holding interests in RRSPs and RRIFs to meet their information reporting obligations by using readily available information.
If you were due the advance child care credit and haven't received it, you have until Dec. 5 to claim any undelivered check. After that date, you cannot claim the money until you file your tax returns next year. Taxpayers need to update their addresses with the IRS by Dec. 5 so their check can be reissued. You can track your check by going to the IRS web site at www.irs.gov/individuals/article/0,,id=111546,00.html. You need to enter certain information including your Social Security number, filing status (such as single or married filing jointly) and the number of exemptions shown on your 2002 tax return. If you move or change your name, be sure to file Form 8822, Change of Address with the IRS.
The Energy Tax Policy Act of 2003 is dead, at least until after January 2004. The bill ran out of steam in the Senate on an issued that was clearly not going to be resolved. Two additional votes were needed to overcome a filibuster.
You have two options with respect to reporting the interest on U.S. savings bonds--you can either wait until redemption and report all the interest at once, or you can report the interest each year as you earn it. In Janet E. Landers (T.C. Memo. 2003-300) the IRS contended the taxpayer should have reported some $10,000 in interest on her return for the tax year. The taxpayer countered that the interest could have been reported on prior returns, but did not produce copies of those returns. The Court sided with the IRS. Without documentation supporting her contention that the interest was reported earlier, the Court held that all the accrued interest was taxable in the year at issue.
The Treasury has announced that the U.S. has signed an agreement that allows for tax information exchanges with Aruba.
The IRS has issued proposed regulations (REG-160330-02) relating to the tax treatment of installment obligations for partnerships and property acquired pursuant to a contract under Sections 704(c) and 737. The proposed regulations affect partners and partnerships. The proposed regulations amend Sec. 1.704-3(a)(8) to clarify that, if a partnership disposes of Section 704(c) property in exchange for an installment obligation, the installment obligation is treated as the Section 704(c) property. The proposed regulations also clarify that, if a partner contributes a contract that is Sec. 704(c) property to a partnership, and the partnership subsequently acquires property pursuant to that contract in a transaction in which less than all of the gain or loss is recognized, the acquired property is treated as the Sec. 704(c) property for purposes of Sections 704(c) and 737. For this purpose the term contract includes, but is not limited to, options, forward contracts, and futures contracts.
The IRS has recently released a number of updated publications for use in preparing 2003 returns:
In addition, the Service released the following publications for churches and tax-exempt organizations:
The IRS has issued (REG-110896-88) regulations on the ordering rules of section 664(b) of the Internal Revenue Code for characterizing distributions from charitable remainder trusts. The proposed regulations reflect changes made to income tax rates, including the rates applicable to capital gains and certain dividends, by the Taxpayer Relief Act of 1997, the Internal Revenue Service Restructuring and Reform Act of 1998, and the Jobs and Growth Tax Relief Reconciliation Act of 2003. The proposed regulations affect charitable remainder trusts and their beneficiaries.
The IRS has issued (REG-136890-02) temporary regulations relating to the transfer of indebtedness or stock of a taxpayer or related persons or of a promise to provide services or property in the future to provide for the satisfaction of an asserted liability that the taxpayer is contesting. The temporary regulations also relate to transfers of money or other property to a trust, an escrow account, or a court to provide for the satisfaction of a liability for which payment is economic performance. The text of those temporary regulations also serves as the text of these proposed regulations.
The IRS has released (Rev. Proc. 2003-85; IRB 2003-49) the inflation adjusted tax amounts for 2004. The indexed items include the tax rate tables for individuals and trusts, the standard deduction, personal exemption, Section 179 expense election (the amount rises to $102,000 from $100,000), the phaseout thresholds for itemized deductions and personal exemptions, and thresholds for the earned income tax credit, as well as a number of other items. We're currently updated our Corporate and Individual Tax Rates reference table. Portions will be posted later today. The full update will appear Monday.
The Senate has begun debate on the energy bill conference report. The full House approved the conference report by a 246 to 180 vote.
It's not unusual for commodity producers such as farmers and commodity customers such as food manufacturers to engage in hedging transactions to avoid catastrophic price swings. In Herman N. and Veronica Welter (T.C. Memo. 2003-299) the taxpayer's corporations engaged in farming operations. The taxpayers, as individuals, entered into commodity trades in soybeans, oats, and corn, claiming they did so to reduce the risk from the grain the business had to buy. The Court noted that in order to qualify as a hedging transaction where gains and losses are treated as ordinary, the transactions must be entered into by the same taxpayer whose risk is being hedged. That was not the case here. The corporation had the risk and the taxpayer, as an individual, entered into the hedges. The Court ruled the gains and losses (the losses were substantial here), were capital in nature.
The IRS may abate interest assessed on any deficiency or payment of tax to the extent that any error or delay in payment of the tax is attributable to erroneous or dilatory performance of a ministerial act by an officer or employee of the Service, and the taxpayer caused no significant aspect of the delay. Despite what you might think, taxpayers don't seem to win often on this issue. However, in Nicholas J. and Diane L. Palihnich (T.C. Memo. 2003-297) the Tax Court sided with the taxpayer in holding that the IRS abused its discretion in refusing to abate interest on the taxpayer's tax liability for one year. The Court noted the IRS lost the taxpayer's 1981-1982 amended returns for almost 11 years; that fits easily within the definition of a ministerial act. The Service's loss of a taxpayer's return is a procedural or mechanical act that does not involve the exercise of discretion or judgment by the IRS. The IRS contended that the taxpayers' delay in paying their 1980 tax from May 1987 to March 1998 was not attributable to the Service's loss of petitioners' 1981-82 amended returns. The Court disagreed. The Court also disagreed in the Service's argument that the taxpayers contributed to the delay. It noted the taxpayers had no role in losing their returns.
The energy bill is moving along in Congress and, while there are still many possibilities for a roadblock, passage looks promising. The Senate conferees agreed to close the now famous SUV loophole that allows some sport utility vehicles to escape the luxury car limitations and be written off in the year of purchase, but that was later stricken. But the issue of closing the loophole is far from dead. Look for it in another tax bill.
The Conference Committee has begun discussion on the Energy Policy Act of 2003. In addition to dealing with energy policy in general, incentives for energy conservation, renewal energy sources, petroleum reserves and production, etc. the bill contains provisions for:
The bill contains many other tax incentives, some of little interest to most individuals and business owners.
The IRS has recently released a number of updated publications for use in preparing 2003 returns:
While tax shelters of the type found in the 80's are much less prevalent today, a recent case that dates from that era (Donald L. Walford; T.C. Memo. 2003-296) still has relevance today. The Court noted that a hallmark of an economically distorted tax shelter is a purported transfer of ownership of an asset at a grossly inflated sale price. Generally, the purchaser makes a small cash payment and executes a nonrecourse note for the remaining purchase price. In this type of situation, the transaction is so economically infeasible or lacking in economic substance that the investor's primary or sole motivation for entering into the transaction is the tax benefits (e.g., artificially inflated depreciation deductions and investment tax credits). The fair market value of the underlying asset will not conceivably support the purchase price, and the nonrecourse debt practically ensures that the price will not be paid. That was clearly the case here. The equipment involved was purchased by the shelter promoter for some $337,000 and quickly sold to a partnership (in which the taxpayer was a partner) for $10,000,000. The Court also noted that based on a present value analysis, there was no reasonable possibility of a profit independent of tax considerations. The Court also used some of the factors in the hobby loss regulations (Sec. 1.183).
Military Family Tax Relief Act
Introduction
President Bush has signed the Military Family Tax Relief Act. The law provides income exclusions for death benefit payments and certain home sales. Both provisions are retroactive, so some qualifying taxpayers may be able to file amended returns and claim these tax breaks. If you do so, put the words "Military Family Tax Relief Act" in red at the top of such returns to speed processing.
Survivors' Benefits
The new law doubled the benefit paid to survivors of deceased Armed Forces members to $12,000, made the entire amount tax-free and made the changes effective for deaths occurring after Sept. 10, 2001. Previously, only $3,000 was tax-free. Recipients who already paid tax on benefits received for deaths after the effective date may file an amended return on Form 1040X, reducing their adjusted gross income by the $3,000 they had reported as taxable. Those who receive such "gratuity" benefits in 2003 and future years will not have to report them on their tax returns.
Home Sale Exclusion
Taxpayers may exclude gain on a home sale, provided they have owned and used the home as a principal residence for two of the five years before the sale. A reduced maximum exclusion may apply to those who satisfy part of the two-year rule. Military personnel often retain ownership of a home while away on duty but eventually sell it without returning to live in it, perhaps failing the use test completely.
The new law allows persons on qualified extended duty in the U.S. Armed Services or the Foreign Service to suspend this five-year test period for up to 10 years of such duty time. A taxpayer is on qualified extended duty when at a duty station that is at least 50 miles from the residence sold, or when residing under orders in government housing, for more than 90 days or for an indefinite period.
This change applies to home sales after May 6, 1997. A taxpayer may use this provision for only one property at a time and may exclude gain on only one home sale in any two-year period. Although an amended return must usually be filed within three years of the original return's due date, the law gives qualifying taxpayers who sold a home before 2001 until Nov. 10, 2004, to file an amended return claiming the exclusion.
A taxpayer may use Form 4506, "Request for Copy or Transcript of Return," to get an earlier year's tax return. This form and Form 1040X are available on the IRS Web site at www.irs.gov, or by calling 1-800-TAX-FORM (1-800-829-3676).
Here are four examples illustrating how the new home sale exclusion rule works:
Example 1--Lt. Green owned a house in Georgia and lived there from December 1988 until deployed overseas in January 1991. When he returned to the United States in July 1999, he was stationed 90 miles from the house. Preferring not to commute this distance, he sold the house four months later, realizing a gain of $150,000. Because he had not used the house as his principal residence during the 5 years preceding the sale, he reported this capital gain on his 1999 return. Under the new law, he can disregard both the 8= years he was overseas and the 4 months after his return to the States, since he was stationed more than 50 miles from old residence. His five-year test period for ownership and use now consists of the 5 years before January 1991, when he went overseas. Since he owned and lived in the house for more than two years during this test period, he may exclude the gain on the sale. He must file an amended return by Nov. 10, 2004, to recover the capital gain tax paid on the 1999 return.Other ProvisionsExample 2--Assume the same facts as Example 1, except that when Lt. Green returned to the U.S., his duty station was 40 miles from the house. Only the time overseas may be disregarded, because his duty station after returning to the U.S. was within 50 miles of the old residence. His five-year test period for ownership and use now consists of 4 months in 1999 and the 56 months before January 1991, when he went overseas. Since he lived in the house for more than two years during this test period, he may exclude the gain on the sale. He must file an amended return by Nov. 10, 2004, to recover the capital gain tax paid on the 1999 return.
Example 3--Col. White owned and lived in her Ohio house for three years before being stationed overseas in January 1988. She was still overseas when she sold the house in January 2003. She may disregard only 10 of her 15 years overseas, so her 5-year test period consists entirely of years in which she did not live in the house, leaving her not eligible for the home sale exclusion.
Example 4--Sgt. Brown owned and lived in a Virginia townhouse for 10 months before being deployed overseas in February 1991. She returned in 1995 and lived in the townhouse for 16 months before she was assigned to a Texas duty station in late August 1996. She married and when the couple returned to Virginia in July 1999, they bought a nearby house. In July 2001, they sold the townhouse. Having lived in the townhouse only one month in the five years preceding its sale, they reported the capital gain on their 2001 return. Under the new law, they may disregard the time spent overseas and in Texas when determining the 5-year test period, which would then consist of the two years from July 1999 to July 2001, when they lived nearby, the 16 months she lived in the townhouse in 1995-96, and the 20 months before the February 1991 overseas deployment. During this test period, Sgt. Brown owned and lived in the townhouse for 26 months, so she may exclude up to $250,000 of gain on its sale. Because her husband never lived in the townhouse, he does not qualify for any exclusion. The Browns have until Apr. 15, 2005, to file an amended return claiming a refund of the capital gain tax paid on the excludable amount.
The Act contains a number of other beneficial provisions for military personnel. The new law provides that the filing deadline and the time for payment of a tax liability for individuals serving in contingency operations as well as for those in combat operations.
The new law also provides that members of National Guard and reserve units can deduct travel expenses (including the per diem rate) while traveling as a member of a reserve component any time the individual is more than 100 miles away from home in connection with such services. This expense is deductible toward adjusted gross income (AGI) (an above-the-line deduction).
The Act also clarifies the treatment of certain dependent care assistance programs.
Previously Reported In Daily Update
Don't put off billing . . . You may think that you're doing customers a favor by delaying billing, particularly for those customers you know are having financial difficulty. That may be poor reasoning. Most customers want to get the bill so they know the amount and can budget, even if they won't be able to pay immediately. It's also important to you should the customer declare bankruptcy.
Hidden price increases . . . Many companies have found that it's still very difficult to raise prices. Many have taken a different approach. They've raising fees, changing the size of a package, reformulating a product, charging for service that was standard, raising the minimum order, etc. Often you'll have to check carefully. A package may have been 12 oz. but is now 11.5. If the price of the package hasn't changed, that's the same as a 4% increase in price. Increased or new fees may or may not represent a price increase for you. For example, when a bank raises the charge for a wire transfer from $15 to $25 that only makes a difference to you if you normally do wire transfers. Charges vary among banks. Look at the fee structure to see which bank will produce the lowest overall charge for you. There may be other ways to fight hidden price increases. If you're a good customer, you might be able to simply complain. It's often much easier for a company to waive a charge or fee than to offer a customer a discount on the product. Sometimes a vendor will offer waive a fee if you agree to certain conditions, for example, by agreeing to get your invoices on line instead of paper copies. Talk to vendors and service suppliers.
Switching annuities? . . . Does it make sense? Switching can be advantageous if your current annuity has had consistently poor performance. (Making a switch when an investment has one or two bad quarters probably doesn't make sense. Check with your investment advisor before taking any action.) What about redemption charges? Compare the redemption charge on your existing annuity and any sales charges on the new investment and the management fees and expenses on the existing and new investments. While redemption and sales charges will hurt more initially because they're up-front costs and could be significant, management and expense fees continue every year. For example, if the sell and buy charges total 4% and you'll save 1% per year in annual fees, your breakeven point is about 4 years, even if both funds have the same performance. There's no magic number. Do some analysis and talk to your investment advisor.
Contract for professional, not for company . . . If you're hiring a consulting firm, you generally do just that. If the professional leaves the company, you may be stuck with someone you don't have confidence in or, worse, can't work with. If you believe a certain individual is critical to the success of the job, consider a clause that allows you to back out of or otherwise modify the contract if he quits.
Hackers from within . . . Businesses (and individuals) are concerned about outsiders getting into their computers, stealing data, corrupting files, etc. But some studies have shown that almost as many problems arise from individuals inside the firewall either getting into data and corrupting files, accessing data that should not be available to them, etc. Not worried about insiders? How would you like it if an unauthorized employee get employment data, salary information, financial reports, special studies, etc. You may trust most of your employees like family, but all you need is one. Talk to an computer professional about what you can do to safeguard files. And, at the very least, use the password protection that's built into most current software. Disgruntled employees can be your worst nightmare.
Buy or lease business vehicle? . . . While there are a number of factors to consider, in the past it often made more sense to lease a car that was classified as a luxury auto for tax purposes. The reason was that, while both depreciation and lease payment deductions were limited, the lease payment limitation was more restrictive. For vehicles placed in service after May 5, 2003 and before January 1, 2005, the maximum first-year depreciation limit is $10,710. Work through the numbers before making a buy/lease decision.
Is your parent a dependent? . . . With more children taking care of their parents, there's a greater chance you or someone you know will be able to claim a parent as a dependent. There are a number of tests that have to be met (and there are exceptions), but the two toughest ones are that the dependent must have less than $3,050 in gross income (for 2003) and you must furnish over half of the dependent's total support. If you meet the test you can not only claim an exemption for the individual, you can deduct his or her medical expenses. That can be a substantial amount. In addition, you may be able to take the child and dependent care credit. This can be a complex area with a number of rules and exceptions; get good advice.
Add a contingency . . . If you're buying or selling a business, real estate, etc. consider adding a contingency to the contract, just in case you discover a problem before closing. Almost all contracts for the purchase of a home are contingent on the buyer finding a suitable mortgage within a certain time period. If you're the buyer it allows you back out of the contract with no consequences. Of course, you still have the option to do the deal using an alternate approach, such as getting financing through other means. If you're buying a business the deal could be contingent on financing, environmental approvals, meeting specific sales or asset amounts at the end of the month before the deal is scheduled to close, etc. Again, you still have the option to proceed, but this gives you a chance to back out. Why the clause? You may want to back out for other reasons (e.g., you found a similar property at a lower price, the market changed, etc.) but this may be the only way to do so in a contract. Talk to your attorney. He or she will advise you on the best approach.
Telecommuting deductions . . . If your business supplies equipment (e.g. computer, fax, etc.) and services (e.g. phone line, internet connection, etc.) to employees who work at home, you might want to be ready for an IRS challenge. Normally, such items would be nontaxable to employees as a working condition fringe benefit. But that exception would apply only if the employee is working from home for the convenience of the employer (the same rule that would permit the employee to deduct a portion of his house as a home office). The Service could argue that the employee is working from home for his, not your convenience. You can improve your position by detailing the savings (lower office rent, less support services at office, etc.) in a memo before letting employees work from home. You should also be aware that many of the items the employee would use at home (computer, etc.) are listed property and require special recordkeeping. Consider adopting a policy of no personal use on equipment supplied to the telecommuter. Make sure the employee knows of the rule and signs off on it. You don't want a big hassle that could be prevented by a minimum of documentation.
Copyright 2003 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