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Gregg Butler
cpa/pfs
Rondal Jones
cpa/abv,cva,cff
Paul Hansen
cpa


Serving the Valley Since 1969

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Tax FAQs


** All Tax FAQ Content on This Page Copyright © BNA 2010, All Rights Reserved **

Child & Dependent Care Credit

This letter explains the requirements for the credit for child and dependent care expenses.  Also included is an example setting forth the computation of the credit.

There are several requirements that you must meet to be able to claim a credit for child or dependent care expenses:

  1. The expenses must be incurred for the care of a qualified person.
  2. You [and your spouse] must share the home that you live in (”principal place of abode”) with the qualifying persons.
  3. You must pay dependent care expenses so that you [and your spouse] can work, and you [and your spouse] must have income from work during the year.
  4. Your dependent care payments must be to someone other than a person you [or your spouse] claim as a dependent.
  5. You must identify the care provider on your income tax return.
  6. If you are married, you must file a joint return.

 

These requirements are explained in more detail below.

It is also important to note that for tax years beginning in 2009 or later, another requirement applies, which is that in order to claim the child tax credit, the qualifying child must be one for whom you are allowed to claim an exemption deduction on your tax return.

To be eligible for the child and dependent care credit, the expenses must be for the care of: (1) a dependent under age 13 for whom you can claim an exemption; (2) your spouse who is physically or mentally unable to care for himself or herself; or (3) a dependent who is physically or mentally unable to care for himself or herself even if you cannot claim an exemption for the person.  A person's qualifying status is determined each day. [If you are divorced or separated, your child is a qualifying person if you are the custodial parent (you have custody during the year longer than your child's other parent has custody) and your child is under age 13 or is not capable of self-care, is in the custody of one or both parents for more than half of the year, and receives more than half of his or her support from one or both parents.  You generally must claim an exemption for your child unless you waived your right to claim the exemption.]

Additionally, you must work to be eligible for the credit.  [Your spouse also must work, be a full-time student or be incapable of self-care.]  Volunteer work does not constitute qualified work, but actively looking for work does qualify.  The expenses you incur for dependent care must be work-related to qualify for the credit.  In other words, the expenses must have been incurred to allow you [and your spouse] to work.  The care provided must be for a qualifying person's well-being and protection.  Amounts you pay for food, clothing, schooling and entertainment do not qualify unless these amounts are incident to, and cannot be separated from, the cost of caring for the qualifying person.  Expenses for household services may qualify, if part

 


of the services are for the care of qualifying persons.  The cost of getting a qualifying person to  and from your home and the care location is not a work-related expense, unless provided by the dependent care provider.  The same is true for transportation costs you pay for the care provider to come to your home.  Some expenses may also qualify as medical expenses.  These expenses can be used either way, but the same expenses cannot be used to claim both the credit and the medical expense deduction.

Payments made to a care provider who is a relative will not qualify, if the relative is a dependent for whom you [or your spouse] can claim an exemption or is your child who is under age 19 at the end of the year, even if he or she is not your dependent.

To claim the credit, you must identify all persons or organizations who provide care on your tax return.  [If you are married at the end of the tax year, you must file a joint return to claim the credit.  If your spouse died during the year and you do not remarry, you must file a joint return.]

There are two limits on the credit for child care expenses: an earned income limit and a dollar limit.  The amount of work-related expenses cannot be more than your earned income for the year [if married at the end of the year, the smaller of your or your spouse's earned income for the year].  Earned income includes wages, salaries, tips, and net earnings from self-employment but does not include pensions, annuities, social security payments, workers’ compensation, or interest and dividends.  [If your spouse is a full-time student or incapable of self-care, he or she is deemed to have earned income of $250 (or $500 if more than one qualifying person) for each month.]

The dollar limit on the amount of your work-related expenses you can use to figure the credit for 2003 and beyond is $3,000 for one qualifying person and $6,000 for two or more qualifying persons.  If you have more than one qualifying person in your household, you do not need to divide the $6,000 equally among them.  The dollar limit is a yearly limit, which means that you do not need to prorate it based on how long the person was a qualifying person during the year.  However, if the dependent was a qualifying person for only the first six months of the year, you can claim expenses only for those six months.  The dollar limit is reduced by any child and dependent care benefits received from your employer under an employer-provided dependent care assistance plan.

As an example, assume that in 2008, you and your spouse have two children, ages 4 and 13.  Your earned income is $35,000, your spouse's earned income is $35,000 and your adjusted gross income is $70,000.  The 13-year old child turned 13 on October 1.  You paid $5,000 in child care at a nursery school for the 4-year old child and $1,500 (for 9 months, i.e., Jan.−Sept.) for after school and summer care for the 13-year old child, for a total of $6,500 paid in child care expenses for the year.  Because you have two qualifying persons, the dollar limit is $6,000.  The applicable percentage for AGI of $70,000 is 20%.  The amount of credit that can be taken is $1,200 ($6,000 times 20%).

A portion of the child credit may be refundable, meaning that you may be able to collect it even if you have no tax liability to be reduced by the credit.  This refundable amount varies and is based on several factors.

Please call our offices if you have any further questions.

Discharge of Indebtedness

As a general rule, the cancellation of a debt creates taxable income to the debtor in an amount equal to the difference between the amount due on the obligation and the amount paid by the debtor.  If the debt is discharged without any payment by the debtor, the entire amount of the obligation is treated as taxable gain.  The realization of discharge-of-indebtedness income assumes an economic gain to the debtor from the discharge.
 
I. Transactions That May Be Subject to Discharge of Indebtedness Income

A variety of transactions may produce discharge-of-indebtedness income.  A common example is the purchase by a debtor of his own indebtedness at a discount from face value (although relief is provided in 2009 and 2010, as we explain below).  In such a transaction, the amount of discharge-of-indebtedness income is determined by reference to the adjusted issue price of the obligation, rather than the face amount, if the debt instrument is issued at a premium or a discount.  In addition to purchases by the debtor, certain purchases of indebtedness by a person related to the debtor may result in discharge-of-indebtedness income.  Another example might be the discharge of a loan pursuant to the settlement of a business dispute.

A sale of property that is encumbered by liabilities can result in a capital gain or loss, or it may result in discharge-of-indebtedness income.  Generally, the amount realized from the sale or disposition of property includes the amount of any liability from which the taxpayer is discharged and depending on the nature of the liability, a portion of the amount realized from the sale may be characterized as discharge-of-indebtedness income, with attendant income tax consequences.

If a debt of an employee to the employer is forgiven in consideration of the performance of services by the employee, the employee realizes compensation income to the extent of the debt forgiveness.  A corporation that issues stock in exchange for debt realizes discharge-of-indebtedness income to the extent of the difference between the amount of the obligation and the value of the stock.
 
Not all debt discharges result in discharge-of-indebtedness income.  A debt cancellation that is a gift or a reduction in the purchase price of property does not give rise to discharge-of-indebtedness income.

For cash method taxpayers, the discharge of an obligation that would have been deductible if paid, does not result in discharge-of-indebtedness income.  Generally, the discharge of an indebtedness attributable to a previously deducted expense of an accrual method taxpayer will generally give rise to discharge-of-indebtedness income.

The issuance of new debt in exchange for pre-existing debt will result in discharge of indebtedness income to the extent of any difference between the issue price of the old debt and the value of the new debt, again subject to relief in 2009 and 2010.


II. Exclusions of Discharge-of-Indebtedness Income

Taxpayers can exclude discharge-of-indebtedness income if: (1) the discharge occurs in a bankruptcy or insolvency case; (2) the indebtedness is qualified farm indebtedness; (3) the indebtedness is qualified real property business indebtedness; or (4) the discharge is qualified principal residence indebtedness discharged after 2006 and before 2013.  In return for the exclusions, taxpayers must reduce specific tax attributes, including the adjusted bases of property, to the extent that the discharged indebtedness is excluded from gross income.  The Code provides certain rules regarding the basis reduction required by or elected under these provisions.

When indebtedness of a partnership is discharged, the Code requires that both the exclusions and the reduction of tax attributes associated with the exclusions be applied at the partner level.  Each partner then separately reports his or her distributive share of the income in accordance with the partnership agreement.  The partners must include in income their pro rata share of the discharged debt, without a net basis increase that normally accompanies an item of partnership income.

In the case of a discharge of indebtedness of an S corporation, the statutory exclusions and the reduction of attributes are applied at the corporate, rather than the shareholder, level.  Due to the limitations imposed on the deduction of losses by S corporation shareholders, however, special attribute reduction rules apply.

III. Deferral of Discharge-of-Indebtedness Income

Responding to the continuing economic crisis in 2009, Congress enacted the American Recovery and Reinvestment Act of 2009 (2009 ARRA).  Among the ARRA's provisions is one that allows taxpayers to elect to defer cancellation of indebtedness income arising from a reacquisition of an applicable debt instrument after December 31, 2008, and before January 1, 2011.  This irrevocable election is made on an instrument-by-instrument basis.  Income deferred pursuant to the election must be included in the gross income of the taxpayer ratably in the five taxable years beginning with (1) for repurchases in 2009, the fifth taxable year following the taxable year in which the repurchase occurs or (2) for repurchases in 2010, the fourth taxable year following the taxable year in which the repurchase occurs.

Please note that there are exceptions and limitations to many of the rules, so we will need to carefully review the specific facts in your case before taking any action.  If you have any questions, do not hesitate to contact us.

Education Credits

This letter explains the tax strategies available to assist you with the cost of education.  There are several tax provisions that deal with the cost of education.  There are costs involved with funding your children's primary and secondary education, and post-secondary education.  There are ongoing educational costs for those in the work force, and for those interested in continuing their education beyond technical requirements.

The tax law provides for savings vehicles and tax credits and deductions for expenses that qualify under the specific provisions.
 
To assist with primary and secondary education, there are the Coverdell education savings accounts.  The contributions into these accounts are not deductible, but the dollars grow tax free and the distributions are tax free to the extent that they are used for qualified expenses.

You can also fund §529 plans with contributions that enjoy an exception to the general rules regarding the annual exclusion for gift tax purposes.  The amounts grow tax free and the distributions are also tax free to the extent used for qualified post-secondary education expenses. These expenses include tuition and a modest amount of room, board and supplies.  These plans are set up by each state and, therefore, careful planning is necessary to ensure that you select the best plan for your needs.

The Hope credit can reduce your tax for expenses associated with the first two years of college. The amount of the Hope credit is a maximum of $1,500 (adjusted annually for inflation) for each student for a maximum of two years for tuition and other required expenses of the first two years of college education.  For 2008, the inflation-adjusted maximum amount was $1,800.  For 2009 and 2010, special rules apply to the Hope credit.  This modified credit is known as the American Opportunity Tax credit.  The allowable modified credit is a maximum of $2,500 per eligible student per year for qualified tuition and related expenses paid for each of the first four years, instead of just the first two years, of the student's post-secondary education.  Under the modified rules, the definition of qualified tuition and related expenses is expanded to include related course materials.

The Lifetime Learning credit is available for ongoing post-secondary expenses.  The Lifetime Learning credit is allowed against the first $10,000 of expenses for tuition and related costs for any course of post-secondary instruction.  The maximum credit amount is 20% of all qualifying expenses (up to $2,000), or 40% of all qualifying expenses (up to $4,000) if they were incurred in certain disaster areas.

The Hope and Lifetime Learning credits have overlap between the type of expenses that qualify and the application of income limitations, so they should be evaluated carefully.  Expenses that are used for the credits cannot have been paid for by scholarships or other tax-free distributions.


Finally, to the extent that your educational expenses are incurred to improve or maintain your existing skills, they are deductible as trade or business expenses or as miscellaneous itemized deductions.  However, it is important to note that the same expenses cannot be claimed for both a deduction and a credit.

Please contact our office for assistance in optimizing the tax benefits from your educational expenses.

Employee Reimbursement Plans

This letter explains the tax consequences of an employee reimbursement either under an employer's accountable plan or nonaccountable plan.
 
In general, employee expenses reimbursed under an employer's accountable plan are not considered income to the employee for federal income tax purposes.  In contrast, employee expenses reimbursed under a nonaccountable plan are considered income to the employee and are subject to withholding.

An accountable plan is a reimbursement or other expense allowance arrangement that satisfies three basic requirements: a business connection; substantiation; and return of excess amounts. The requirements of an accountable plan are applied on an employee-by-employee basis.

To satisfy the business connection component, the business expenses covered by the plan: (1) must satisfy the requirements for deduction as business expenses; and (2) must be paid or incurred by the employee in connection with the performance of services as an employee. Allowances under the plan may include per diem allowances, allowances for meals and incidental expenses, and mileage allowances.
 
To satisfy the substantiation component, an accountable plan must require employees to furnish adequate substantiation of reimbursed expenses to the employer or other payor.  The specific type of substantiation required under an accountable plan depends on the nature of the reimbursed expense, but in any case must be done in a reasonable amount of time.  Certain types of expenditures are covered by other special rules.  Such expenditures include: (1) traveling expenses, including meals and lodging while away from home; (2) any item with respect to an activity that is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity; (3) gifts; and (4) expenses with respect to any “listed property.”   Other than the aforementioned expenses, substantiation is adequate if the information furnished to the employer is sufficient to identify the specific nature of each expense and to show that the expense is attributable to the employer's business activities.

To satisfy the return of excess amounts component, the arrangement must require an employee to return to the employer, within a reasonable period of time, any amount that exceeds the employee's properly substantiated expenses.  If the arrangement contains the requisite provision for return of excess amounts, but an employee fails to return amounts received in excess of substantiated expenses, within a reasonable period, the amounts paid to the employee that exceed the properly substantiated expenses are treated as paid from a nonaccountable plan.  Special rules apply when an arrangement provides per diem allowances for ordinary and necessary business expenses of traveling away from home (excluding transportation costs to and from the destination) or mileage allowances for ordinary and necessary expenses of local transportation or travel away from home.


An arrangement between an employer and employee for advances, allowances, or reimbursement of business expenses that does not satisfy one or more of the three basic requirements of an accountable plan is treated as a nonaccountable plan

For tax purposes, amounts treated as paid under an accountable plan are excluded from the employee's gross income, are not reported as wages or other compensation on the employee's Form W-2 , and are exempt from the withholding and payment of employment taxes (Federal Insurance Contributions Act (“FICA”), Federal Unemployment Tax Act (“FUTA”), Railroad Retirement Tax Act (“RRTA”), and Railroad Unemployment Repayment Tax (“RURT”)), and income tax.  They are instead deductible as business expenses by the employer, subject to any limitations on the deduction of the particular type of expense.  Note that there are exceptions to this rule for expenses that are either more or less than the reimbursed amounts.
 
When an employee's expenses are allowed or reimbursed under a nonaccountable plan, the employer must report the amounts paid under the plan as wages on the employee's W-2 Form. Moreover, such amounts are subject to withholding and to the payment of employment taxes, such as FICA, FUTA, RRTA, and RURT.  Amounts paid under a nonaccountable plan are included in the employee's gross income.  Expenses attributable to amounts included in gross income are deductible by the employee, subject to all applicable limitations.
 

If you have any questions concerning the matters discussed in this letter or wish to discuss the specifics of your situation further, please give us a call.

CLAIMING THE PERSONAL EXEMPTION FOR THE CHILD OF DIVORCED OR SEPARATED PARENTS

As a taxpayer, you are generally entitled to a personal exemption of any of your children for whom you provide more than 50% of the support during the tax year.  However, if you and the child's other parent are divorced or separated, different rules apply.  In general, in such a case, if the parents together provide more than 50% of the child's support, then the parent who had custody of the child for the greater part of the year is entitled to the exemption for the child.  This is true even if the noncustodial parent provided the greater part of the support.  This rule applies where at year-end the parents are either divorced, legally separated, separated under a written separation agreement, or have been living apart at all times during the last six months of the year.

There are several ways in which you can avoid this general rule, if you are the noncustodial parent, but each requires the cooperation of the custodial parent.  First, the custodial parent may waive his or her right to the exemption by attaching a required form to his or her tax return each year.  In that case, the noncustodial parent may claim the exemption.  Second, you may enter into a multiple support agreement with the custodial parent, which can assign the exemption to the noncustodial parent.  In such cases, the noncustodial parent must still provide at least 10% of the child's support.  Such agreements are useful where the parents have joint custody of the child and it is unclear who is entitled to the deduction under the regular rules. Finally, there is an exception for certain divorce and separation agreements entered into before 1985.  To the extent that they assign the exemption to the noncustodial parent, they will be respected by the IRS.
 

Because these rules may deny the personal exemption to a noncustodial parent who is providing the major part of a child's support, the allocation of a child's personal exemption must be carefully considered in preparing any divorce or separation agreement.  We would be glad to discuss how the rules may be advantageously used in your case.

First-Time Homebuyer Credit

The first-time homebuyer who, on or after April 9, 2008, and before January 1, 2009, purchased a home that he or she uses as a principal residence could claim a credit of up to $7,500 to offset his or her federal income tax.  A married taxpayer who filed a separate return could claim a credit of $3,750.  The credit was gradually phased out for a married taxpayer filing jointly with a modified adjusted gross income of $150,000 or more.  For other taxpayers, the phase out began at $75,000.  Any taxpayer who claimed this credit must pay it back — similar to an interest-free loan — over a 15-year period beginning in the second tax year after the tax year the credit was claimed.  An accelerated recapture provision applied if the residence is divested before the end of this period.

The first-time homebuyer who purchased a home in 2009, but before December 1, benefited from more taxpayer-friendly provisions.  Although the income limits remained the same, the amount of the credit increased to $8,000 ($4,000 for a married taxpayer filing a separate return).  The repayment provision no longer applies and the accelerated recapture provision only applied to the three-year period following the year of purchase.  In addition, the 2009 purchaser who would realize a better tax result by claiming the credit in 2008 could elect to treat the purchase as occurring in 2008.

If you did not make a home purchase by the prior December 1, 2009 deadline, the credit was extended through April 30, 2010 by the 2009 WHBAA.  Moreover, taxpayers who entered into a written binding contract by this date and closed on the purchase by June 30, 2010 remain credit-eligible.  Significantly, long-time homeowners who have used the same principal residence for a consecutive five-year period over the last eight years are also eligible for a $6,500 credit ($3,250 if married and filing separately) upon the purchase of another principal residence.  Also, while the credit amounts discussed above remain unchanged, the income limits are increased to $125,000 to $145,000 and $225,000 to $245,000 (for joint returns).  Taxpayers may continue to treat the purchase as having occurred in a prior year, depending on which tax year is most advantageous.

Under the 2009 WHBAA, however, the credit is subject to an $800,000 purchase price limitation and is not allowable to taxpayers under age 18 or dependents.  Also, purchases from a related person remain ineligible and this now includes purchases from a family member of the taxpayer's spouse.  In addition, taxpayers must attach a copy of the settlement statement to their applicable return, or the credit will be disallowed.

Health Savings Accounts - HSA's

This letter provides basic information concerning a means of saving for medical expenses on a tax-favored basis: health savings accounts (HSAs).

What Is an HSA?

In general, HSAs are modeled after Archer MSAs.  Thus, an HSA is a trust or custodial account created exclusively for the benefit of the account holder and is subject to rules similar to those that apply to individual retirement arrangements (IRAs).  As discussed below, contributions to and distributions from HSAs receive favorable federal income tax treatment, and the funds in an HSA are not subject to federal income tax.

Who Is Eligible to Benefit Under HSAs?

HSAs are available to individuals under age 65 who are covered by a “high deductible” (see below) health plan and no other health plan, other than one providing certain permitted coverage.  Such persons are referred to as “eligible individuals.”
Contributions can be made to an HSA either by the eligible individual or by someone else on his or her behalf, including an employer.  Unlike Archer MSAs, HSA contributions may be made available as an option under a cafeteria plan.

What Is a “High Deductible” Plan?

In general, a “high deductible” plan is a health plan with an annual deductible of at least $1,000 for individual coverage, or an annual deductible of at least $2,000 for family coverage.  Also, the maximum out-of-pocket expenses with respect to allowed costs, including the deductible, cannot exceed $5,000 for individual coverage and $10,000 for family coverage.  These amounts are increased annually for cost-of-living adjustments (COLAs). For 2011 and 2010, these amounts are $1,200, $2,400, $5,950, and $11,900, respectively.

How Are Contributions to an HSA Taxed?

Contributions to an HSA are deductible, within limits, “above the line;” i.e., in computing adjusted gross income (AGI) for federal income tax purposes.  Employer contributions are excludible from employees’ gross income within the same limits.  Earnings on amounts in an HSA are not currently taxable, nor are distributions from an HSA that are used to pay qualified medical expenses.  Beginning in 2011, expenses for medicines and drugs are qualified medical expenses only if they are for prescribed drugs or insulin.  Thus, over-the-counter medicines do not qualify unless obtained using a prescription.

What Are the Limits on Deductibility of HSA Contributions?

The maximum annual contribution to an HSA is $2,850 for an eligible individual with self-only coverage, or $5,650 for an eligible individual with family coverage.  These amounts also are increased annually for COLAs.  For 2011 and 2010, these amounts are $3,050 and $6,150, respectively.  For individuals who have attained age 55 by the end of the taxable year, the annual contribution limit is increased by $1,000.  The maximum deductible contribution is not limited to the eligible individual's annual deductible under the high deductible health plan.

Full-Year Contributions for Part-Year Account Holders

In computing the annual HSA contribution amount, an individual who is eligible during the last month of a taxable year is treated as having been eligible for all prior months during the taxable year and, thus, is allowed to make contributions for months before the individual was enrolled in a high deductible health plan.  If the individual does not remain eligible for a full year, a portion of HSA contributions is includible in gross income and is subject to a 10% (20% beginning in 2011) additional tax unless the individual dies or becomes disabled.  All contributions to an Archer MSA and HSA are aggregated for purposes of the maximum annual limit.

How Are Distributions from an HSA Taxed?

Distributions from an HSA to pay the medical expenses of the individual and his or her spouse, dependents, or adult children under the age of 27 at the end of the year are excludible from income.  Distributions that are not used to pay medical expenses are subject to income tax.  Such distributions also are subject to an additional 10% penalty tax, unless the distribution is made after age 65 or on account of death or disability.

Rollovers into HSAs

From Archer MSAs and Other HSAs. Rollover contributions may be made to an HSA from an Archer MSA or another HSA.  Such rollover contributions need not be in cash and are not subject to the annual contribution limits.
 
From health flexible spending accounts (FSAs) and health reimbursement accounts (HRAs). Certain amounts in a health FSA or HRA may be rolled over directly to an HSA.  Contributions must be transferred to the HSA before January 1, 2012.  Such rollovers may not exceed the lesser of (1) the balance in the FSA or HRA as of September 21, 2006, or (2) the balance in the FSA or HRA as of the date of the rollover, determined on a cash basis in both cases.  These rollover amounts are excludible from gross income and from wages for employment tax purposes, are not counted in applying the maximum deduction limitation for other HSA contributions, and are not deductible.

The rollover is limited to one distribution from each FSA or HRA of an eligible individual and is designed to assist individuals in transferring from another type of health plan to a high deductible health plan.  If the individual does not remain an eligible individual for a full year after the contribution, the rollover contribution amount is includible in gross income and is subject to a 10% additional tax unless the individual dies or becomes disabled.
 
An employer that permits any employee to make these rollovers must allow all employees who are covered under the employer's high deductible plan to make such rollovers, subject to an excise tax if this requirement is not met.
From IRAs. The tax code allows a one-time rollover to an HSA from an IRA.  The rollover must be made in a direct trustee-to-trustee transfer.  The rule does not allow rollovers from simplified employee pensions (SEPs) or SIMPLE retirement accounts.

Amounts rolled over from an IRA are not includible in income if they are not otherwise includible in income and are not subject to the 10% additional tax on early distributions for taxpayers under age 59½.  In determining the extent to which amounts distributed from the IRA would otherwise be includible in income, the aggregate amount distributed from the IRA is treated as includible in income to the extent of the aggregate amount which would have been includible if all amounts were distributed from all IRAs of the same type (i.e., in the case of a traditional IRA, there is no pro rata distribution of basis).  This rule is applied separately to Roth IRAs and other IRAs.

The amount that can be rolled over from an IRA to an HSA is the maximum deductible HSA contribution amount.  The rollover amount reduces the maximum HSA contribution amount that would otherwise be allowed.  No deduction is allowed for the amount contributed from an IRA to an HSA.

Only one IRA-to-HSA rollover may be made during the individual's lifetime, except that if a distribution and contribution are made during a month in which an individual has self-only coverage as of the first day of the month, an additional distribution and contribution may be made during a subsequent month within the taxable year in which the individual has family coverage.  The limit applies to the combination of both contributions.

If the individual does not remain an eligible individual for a full year after the contribution, the rollover contribution amount is includible in the individual's gross income and is subject to a 10% additional tax unless the individual dies or becomes disabled.

If you have further questions regarding HSAs, please call us.

Home Office Deductions

The general rule for home office deductions for individual taxpayers is that no deduction is allowed for the use of a dwelling unit, which is used by you as a residence.  However, there are several exceptions to this rule.

This rule does not apply to any deduction to the extent that it is allocable to a portion of the dwelling unit which is exclusively used on a regular basis in one of the following ways:
 

  1. as the principal place of business for your trade or business;
  2. as a place of business that you use for meeting patients, clients, or customers; or
  3. in connection with your trade or business (for a structure that is separate from the main dwelling unit).

The term “principal place of business” includes a place of business used for administration or management activities of any trade or business, if there is no other fixed location from which substantial administration or management activities are conducted.

Under the second test, above, expenses are deductible if they are allocable to a portion of a dwelling unit used exclusively and on a regular basis as a place of business in which you regularly meet or deal with customers in the normal course of your business. The meetings must be substantial and integral to the conduct of your business. The customers must be physically on the premises; phone calls are not enough.

The application of the “principal place of business” exception can be complex in cases where the business is conducted at more than one location.  In such a case, the one location that is the “most important, consequential, or influential” will be the principal place of business.  The most important factors used to answer this question are:

  1. the relative importance of the activities performed at each location, and
  2. the time spent at each location.

 

The “relative importance” test is applied first.  This test compares the activities performed at each business location.  If this test provides no definitive answer, then the “time” test is applied. The “time” test looks at the amount of time spent on business at home with the time spent on business at other locations.

There are limitations on the amount you can deduct each year. Your deduction cannot be more than the gross income derived from the business use of the dwelling, less deductions allocable to the business portion of the unit, whether or not it was used in a business (real estate taxes and mortgage interest) and deductions allocable to the business, but not allocable to the qualifying business use of the unit itself (such as expenses for supplies and compensation).

 

Also, the business deductions are allowable in the following order:
 

  1. deductions allocable to the business use, without regard to whether the unit is used for business (mortgage interest and real estate taxes),
  2. deductions allocable to the business, but not allocable to the business use of the unit, and
  3. deductions allocable to the business in which the qualifying business use occurs, which are allocable to the use of the unit (depreciation, utilities, etc.).

For example, assume that you earned $45,000 from the qualifying business use of your home and you had the following expenses:
 

  • $10,000 (business percentage of mortgage interest and real estate taxes),
  • $20,000 (salary expenses), and
  • $20,000 (depreciation and utilities expenses).

In this scenario, even though your total expenses were $50,000, only $45,000 is deductible this year.  The remaining $5,000 (the depreciation and utilities expenses - deductions allocable to the use of the home itself) is carried over to the next year (subject to next year's income limitation).

The expenses allocable to the portion of the unit used for business purposes may be determined by any reasonable method under the circumstances, such as the number of rooms or square footage.

This letter provides only a basic overview of the rules regarding home office deductions.  However, because every taxpayer's situation is unique, I encourage you to call us to discuss your situation in more depth.

Individual Charitable Giving

In General

Taxpayers who itemize their deductions are allowed an income tax deduction for charitable contributions which are actually paid during the taxable year.  For tax purposes, a charitable contribution is a contribution to a qualified charitable organization made without expectation of commensurate benefit.  

Capital Gain Property

Gifts of appreciated property often prove advantageous from a tax standpoint because capital gain is usually not required to be recognized when the property is contributed, and you receive a charitable contributions deduction for the entire value of the property.  These comments will be limited to the impact of gifts of long-term capital gain property (property held more than one year). If you subsequently decide to contribute any property that would not generate a long-term capital gain if sold rather than donated (i.e., held for less than one year), there are additional considerations.  The starting point for determining the amount deductible for a contribution of appreciated capital gain property is the fair market value of the property.  There are, however, two significant limitations on the amount that a donor may deduct:

Capital Gain Reduction: Certain contributions must be reduced by the amount that would have been long-term capital gain if the property had been sold instead of contributed.  Such a reduction is required for: (1) gifts of tangible personal property with a use unrelated to the exempt purposes of the recipient organization; (2) most gifts to private foundations; (3) gifts of patents, copyrights, trademarks, and similar property.

Applicable Percentage Limitation: The maximum charitable contributions deduction for any taxable year is limited to a certain percentage of a donor's adjusted gross income.  The applicable limitation depends on the identity of the donee, the form of the gift, and the type of property contributed.  For most charitable contributions, the percentage limitation is 50%.  For an outright contribution to a public charity of capital gain property, which is not required to be reduced, as discussed above, the controlling percentage limitation is 30%.   Amounts in excess of the limitation may be carried forward and used in the succeeding five tax years.

Election to Reduce Deductible Amount

A donor who contributes capital gain property which is not required to be reduced by the capital gain component, may nevertheless elect to reduce the contribution.  If the election is made, the applicable percentage limitation is increased to 50%.  In other words, by electing to reduce the total amount deductible with respect to a contribution, a taxpayer may increase the maximum amount deductible in the year of contribution.  The election is generally advantageous only if the amount of appreciation is insubstantial.

Substantiation Requirements

Charitable contributions are not deductible unless they are substantiated in the manner prescribed by the IRS.  The extent of substantiation required depends on the type and claimed value of the property donated.

All contributions of less than $250 must be substantiated by either (1) a bank record (i.e., a cancelled check or account statement) or (2) written acknowledgment from the charity documenting the contribution’s amount and date.  All contributions of $250 or more must be substantiated by a written acknowledgment from the donee organization before a deduction is allowed. The acknowledgment must state the amount of money or description of property and whether any consideration was given in exchange for the contribution.

For property, other than publicly traded securities, with a claimed value exceeding $5,000, a donor must obtain a qualified appraisal to substantiate the value of the property.  A qualified appraisal is an appraisal prepared by an independent appraiser that contains specific information about the property, the value of the property, the valuation method and the qualifications of the appraiser.  A summary of the qualified appraisal, which must be signed by the appraiser and the donee, is required to be attached to the donor's tax return.  Less stringent substantiation requirements are imposed in the case of gifts of publicly traded securities and gifts of property not exceeding $5,000 in value.

The question of valuation of contributed property should not be taken lightly.  If the claimed value is excessive, a donor may be subject to an overvaluation penalty as well as other sanctions.

Summary

The foregoing discussion was designed to apprise you of the principal issues that arise in connection with a charitable contribution.  Once you have decided which properties are available for contribution, we can advise you of some specific conclusions about the selection of property and the timing of contributions, with the goal of maximizing the benefit of your charitable contributions deduction.  Please let us know if you have any questions about any of the matters discussed in this letter

IRA-Roth Conversions

Effective in 2010, the modified adjusted gross income (AGI) limit that restricted the ability of higher income taxpayers to convert a traditional individual retirement account (IRA) into a Roth IRA is repealed.  Also effective in 2010, taxpayers may convert a traditional IRA to a Roth IRA regardless of filing status.  Previously, married taxpayers filing separately were not permitted to make a Roth conversion.  In order to decide whether a Roth conversion is appropriate for you, you need to understand the differences between these types of IRAs.

The major difference between traditional IRAs and Roth IRAs is the tax treatment of contributions and distributions.  Qualified contributions to traditional IRAs are fully or partially deductible, and the contributions and earnings are not taxed until distributed.  Contributions to a Roth IRA, although nondeductible when made, grow tax free and IRA assets (including earnings) are not taxed when distributed.

The deadline for setting up an IRA, whether traditional or Roth, is the due date for filing your tax return (not including extensions).  This also is the contribution deadline.  You may not set up or make contributions to a traditional IRA in the year you attain age 70½ or later.  This restriction does not apply to Roth IRAs.

The maximum amount that can be contributed to a traditional or Roth IRA is the lesser of your compensation or $5,000 for 2008, 2009 and 2010.  Individuals who have attained age 50 may make additional catch-up contributions.  The otherwise maximum contribution limit for an individual who has attained age 50 before the end of the taxable year is increased by $1,000 for a total of $6,000 for 2008, 2009 and 2010.  The annual contribution limit is reduced for any contributions made to other traditional or Roth IRAs; thus, contributions to all of your traditional IRAs and Roth IRAs, for a taxable year, may not exceed the above annual contribution limits.

Phase-out rules reduce the annual contribution limit (and deduction limit, in the case of traditional IRAs), based on your modified AGI and filing status.  The traditional and Roth IRA contribution limit (determined without taking into account deductions for traditional IRA contributions) is phased out for 2010 for taxpayers with a modified AGI between $105,000 and $120,000 for single taxpayers; between $167,000 and $177,000 for married taxpayers filing joint returns; and between $0 and $10,000 for married taxpayers filing separate returns.

For traditional IRAs, the phase-out rules further reduce your contribution and deduction limits if you are an active participant in your employer's retirement plan.  The 2010 phase-out limits for active participants are between $56,000 and $66,000 for a single individual; between $89,000 and $109,000 for married couples filing jointly; and between $0 and $10,000 if you are married but filing separately.  The active participant rules do not apply to Roth IRAs.

Another important difference between traditional and Roth IRAs involves the required minimum distribution rules, which require individuals to begin receiving distributions from traditional IRAs in the year following the year in which the individual attains age 70½.  In contrast, no minimum distributions are required to be made from a Roth IRA while the owner is alive.


The post-death minimum distribution rules that apply to traditional IRAs generally also apply to Roth IRAs.

If you have any further questions, please don’t hesitate to call our office.

Moving Expense Reimbursements

This letter addresses the income tax effects of moving expense reimbursements received from your employer.

You do not have to include in income reimbursements for certain “qualified” moving expenses—that is, for moving expenses that would be deductible by you.  Deductible expenses are expenditures for moving household goods and personal effects and traveling (including lodging) from the former residence to the new residence.  Expenses for meals are not included. Nondeductible moving expenses include: (1) meals and lodging in temporary quarters; (2) expenditures incurred in searching for a new residence; and (3) qualified residence sale, purchase, and lease expenses and reimbursements for these expenses would be taxable.

As noted, you must also include in gross income all reimbursements of nonqualified moving expenses in the year you receive them.  The amounts are reported to the employee in box 12 of the Form W-2 with the code P and are reported as income by you on your Form 1040.

If your employer reimburses you in a year after the year you moved, the reimbursement is included in income in the year received.  For example, assume you moved in 2007 and deducted your moving expenses on your 2007 tax return, but your employer did not reimburse you until 2008.  The reimbursement must be included in income in 2008.  Note, however, that you can choose to deduct moving expenses in the year you are reimbursed by your employer in certain instances.

Please call us if you have any further questions regarding these rules

DEDUCTIBILITY OF MOVING EXPENSES

In General

The Internal Revenue Code [§ 217] allows individuals to deduct reasonable moving expenses paid or incurred during the taxable year in connection with the commencement of work at a new principal place of work.  Moving expenses incurred that are not paid or reimbursed by your employer are allowable as a deduction in computing adjusted gross income and are not subject to the 2% floor limitation on itemized deductions.  You must be able to substantiate all deducted expenses, so be certain to keep adequate records, receipts, bills, and canceled checks.  The specific requirements that you must satisfy to qualify for this deduction are discussed below.

Closely related to start of work

Deductible moving expenses must be closely related in time and place to the commencement of work at a new location.  The requirement that the move be closely related in time is satisfied if the expenses deducted are incurred within one year of the date you report to the new job.  Under limited circumstances, deductions are allowed for expenses incurred beyond the first year.  The requirement that the move be closely related in place is satisfied if the distance from your new home to your new job is less than the distance from your former (i.e., current) home to the new job.  Please note, however, that even if these requirements are met, you must still satisfy the distance and duration requirements discussed below.

Distance requirement

In order for moving expenses to be deductible, your new job must be at least 50 miles farther from your old residence than was your former job.  In the case of a salesman who is required to be on the road daily meeting with customers in an assigned region, the “job location” that applies to this requirement is your main job location, e.g., the place where you report for work, where you base your work, or where you spend most of your working time.

Duration of employment

The moving expense deduction is also conditioned upon you remaining a full-time employee for at least 39 weeks during the 12-month period right after you move.  In order to meet the duration requirement, you should know that you need not work 39 consecutive weeks, and also that employees in a seasonal trade or business are considered to be working full-time if the off-season is less than six months and the employee works full-time before and after the off-season.  If you and your spouse file a joint return and you are both employed, if both of you change jobs, either of you can satisfy the full-time work test, but you cannot add the weeks your spouse works to those you work.  The employment requirements for the self-employed are slightly different.  A self-employed individual must perform services on a full-time basis for at least 78 weeks during the 24-month period following arrival in a new location, 39 of which must be in the first 12-month period.


You may generally claim the moving expense deduction in the year in which the expenses are incurred, even if you have not satisfied the duration requirement by the deadline for filing your return, as long as there is time in the 12-month period to satisfy the requirement.  For example, assume you begin your new employment in December 2005 and pay your moving expenses in 2005.  On April 17, 2006, when you file your income tax return for 2005, it will not be necessary for you to have met the 39-week requirement.  You, however, may elect to claim the 2005 moving expenses on your 2005 income tax return in any case, as there is still sufficient time remaining before December 2006 to satisfy such condition.  Alternatively, if you incurred the expenses in 2005, but decided to claim the deduction in 2006 after satisfying the duration test, you must file an amended return for 2005 to take the deduction.  You must claim the deduction in the year the expenses are paid or incurred, so you would not be able to claim them on your return for 2006.  If your employer reimburses your expenses in a later year, however, you may wait until that year to claim the deduction.

Moving Expenses Defined

Moving expenses paid or incurred are limited in scope.  Moving expenses means only the reasonable expenses of (1) moving household goods and personal effects from your former residence to the new residence, and (2) traveling (including lodging, but not meals) from the former residence to the new place of residence.  You are allowed to take into account another person's (i.e. your spouse) moving expenses when that person has both the former residence and the new residence as their principal place of abode and is a member of your household.

Specific types of deductible expenses for moving “household goods and personal effects” include: packing and crating charges; the costs of connecting or disconnecting utilities; and the in-transit storage charges (within any consecutive 30-day period after your things are moved from your former home and before they are delivered to your new home) and insurance for the household goods and personal effects you or a member of your household own.  Also included are costs associated with moving your car for use at the new home, and the reasonable costs of moving your pets.  You may also deduct the cost of one trip for you and each of the members of your household from your former home to your new home, including travel and lodging.  You do not need to all travel together or at the same time.  If you use your automobile to travel to your new home, you may deduct either the actual out-of-pocket expenses, for which you have adequate records, or you may take the standard mileage deduction, if you can prove the mileage traveled.

Moving expenses that are not deductible include the cost of: house-hunting trips; living expenses after you arrive at the new location; trips to sell property; storage other than in-transit storage; mortgage penalties; loss on the sale of your home, etc.  Also not allowed are pre-departure expenses at the former residence, any allowance for depreciation, or expenses of trips back to the former residence because family members are still there.

Please contact us if you have further questions regarding this matter

Nanny Tax

This letter explains the Social Security tax rules for employers of domestic workers; the so-called “Nanny Tax.”

Individuals who hire domestic employees (including those for domestic service on a farm) must withhold and pay Social Security taxes (commonly referred to as “FICA” tax) when the wages paid to such employee exceed the dollar threshold (adjusted for inflation) under the Internal Revenue Code.  Employers also must withhold and pay federal unemployment insurance tax (commonly referred to as “FUTA” tax) on wages of $1,000 or more paid to a domestic employee in any calendar quarter.

Domestic employees include workers such as nannies, baby-sitters, housekeepers, gardeners, cooks, valets, caretakers, and chauffeurs.  Wages paid to a worker under the age of 18 for domestic service in a private home are exempt from Social Security taxes, as long as domestic service is not the employee's principal occupation.  Thus, for example, the wages of a 16 year-old student who also baby-sits is exempt from the reporting and payment requirements, regardless of whether the amount of wages paid is above the threshold.  On the other hand, the wages of a 17 year-old single mother, who leaves school and goes to work as a domestic worker to support her family, is subject to the reporting and payment requirements, and such earnings above the threshold amount also are wages covered by Social Security.

You must report on a calendar-year basis any FICA and/or FUTA tax obligations for wages paid to domestic employees on Schedule H of Form 1040 .  Any FICA and/or FUTA tax must be paid by April 15 of the year following the year in which the wages were paid, and are included in determining whether the estimated tax penalty may apply.  Therefore, to avoid any penalty, you should pay such taxes during the year through withholding from your wages, estimated tax payments, or a combination of both.  Further information is available in the IRS Instructions to Schedule H and IRS Publication 926, Household Employer's Tax Guide.
 

If you would like to discuss this matter further, please call for an appointment.

DETERMINATION OF WHO QUALIFIES AS A DEPENDENT FOR PURPOSES OF THE PERSONAL EXEMPTION

As a taxpayer, you are allowed a personal exemption for yourself, your spouse, if you file a joint return, and for any person who meets the technical definition of a dependent.  The determination of who is your dependent can have important tax consequences, because the personal exemption amount is $3,650 for 2009 and 2010.

A “dependent” can be (i) a qualifying child or (ii) a qualifying relative.

A person cannot be considered a dependent if that person (i) filed a joint income tax return with his or her spouse (other than solely to claim a refund), or (ii) is neither a citizen or national of the United States nor a resident of the United States, Canada or Mexico.

A qualifying child is a child of the taxpayer or a descendant of the child (that is, a grandchild or great-grandchild) or a brother, sister, stepbrother or stepsister of the taxpayer or a descendant of any such relative (that is, a niece, nephew, grandniece or grandnephew).  The individual must not have reached the age of 19 as of the end of the year or must be a student under the age of 24 who has not provided more than half of his or her own support.  Beginning in 2009, the child must be younger than the person claiming the exemption.  There are special rules if more than one person can claim the same child.

A qualifying relative is a child or a descendant of a child, a brother, sister, stepbrother, or stepsister, the father or mother, or an ancestor of either, a stepfather or stepmother, a son or daughter of a brother or sister of the taxpayer, a brother or sister of the father or mother of the taxpayer, a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.

A qualifying relative must also have the same principal place of abode as the taxpayer and be a member of the taxpayer's household for the year in question.

A qualifying relative must also meet a gross income test ― that is, his gross income cannot exceed the exemption amount.  Further, the taxpayer seeking to claim the exemption must have provided more than one half of the relatives support for the year.

Support generally includes the fair rental value of housing provided to the dependent, food and clothing, payments for child care, the cost of private education, medical insurance and medical care, and transportation expenses.  Although support includes more than the mere necessities of life, it is often unclear whether a particular expenditure is an element of support.

Once you have determined the total amount of support received by a qualifying relative in the year in question, it is necessary to measure the amount of support contributed by the taxpayer seeking the exemption.  You must contribute more than half of total support to claim the exemption.  Several special rules apply.


Finally, an important exception to the rules governing personal exemptions is that anyone who may be claimed as a dependent by another taxpayer is not entitled to an exemption on his or her own tax return.  For example, if you claim your daughter as your dependent, you may take an exemption for her on your tax return.  If she, however, files a tax return based on her own income, she may not take a personal exemption.

As you can see, the tax laws governing the use of the personal exemption, especially where the exemption is claimed for a dependent, are very complex and fact-specific.  If you have any questions about your right to a personal exemption for a dependent, we would be glad to discuss them with you.

Personal Expenses

Below is a summary of the tax treatment of common personal, living and family expenses on your income tax return.

Generally, expenses are deductible only if incurred in a trade or business or in connection with the production of income. In some cases, Congress has specifically authorized the deductibility of certain personal expenses such as medical expenses, charitable contributions, and taxes. Interest on home mortgages, home equity and student loans may be wholly or partially deductible, while interest incurred on other types of personal obligations are not.  Most other nonbusiness personal living and family expenses are not deductible.

The cost of a meal is not deductible, unless the meal has a business purpose and the taxpayer can satisfy the other restrictions regarding deductibility of such expenses.  Furthermore, the amount of such deduction is limited.

Clothing expenses are generally considered nondeductible personal expenses.  However, there is an exception allowing the deduction of clothing expenses where the clothing is appropriate only for the taxpayer's place of employment.  Accordingly, the cost of a policeman's uniform is deductible, while cost of a business suit is not.
 
Daily commuting expenses are nondeductible.  Therefore, travel costs to and from the taxpayer's regular place or business are considered nondeductible, but the cost of going from your regular place of business to a client's office or another place of business is considered a deductible expense.

In general, education expenses are personal nondeductible expenses.  However, the cost of education may be deductible if such expense is incurred because of a requirement of an employer or the education is intended to maintain or improve skills required in a trade or business. Additionally, tax credits are available for the higher education expenses of certain taxpayers.
 
In addition to education credits, Congress has also authorized tax credits for other personal expenditures that would otherwise be nondeductible.  Unlike deductions, which reduce the amount of income being taxed, credits provide a direct reduction of the taxpayer's tax liability. Some of the available credits are for: household and dependent care that enable the taxpayer to be gainfully employed; adoption; the cost of specific home energy conservation improvements and residential energy efficient property; and the cost of some hybrid, electric, and alternative fuel vehicles.

Please contact us with any questions you may have.

SALE/EXCHANGE OF RESIDENCE (GENERAL SUMMARY)

Under the home-sale exclusion rule, you may be able to exclude a portion, or possibly all, of the gain realized from the sale of your home, if your home met the principal residence rules.  During the five-year period ending on the date of the sale you must have owned and used the property as your principal residence for a period aggregating two or more years.  You need not have lived there continuously to qualify.  You may use the exclusion provided the eligibility requirements are met, but generally no more frequently than once every two years.
 
The amount of the exclusion is generally limited to $250,000 for single individuals and married individuals filing separately.  The exclusion is increased to $500,000 in the case of married couples filing a joint return, where at least one spouse meets the ownership requirement, both spouses meet the use requirement, and neither spouse is ineligible for the benefits because he or she excluded gain on the sale or exchange of a home under the new provision within the past two years.  The $500,000 exclusion amount also applies to a sale by a surviving spouse within two years of the death of the deceased spouse, provided the ownership and use requirements are otherwise met.  If a taxpayer marries someone who is ineligible, the taxpayer generally remains eligible for a maximum exclusion of $250,000.
 
If you fail to meet the ownership and use requirements due to a change in place of employment, health, or other unforeseen circumstances, you may exclude a fraction of the $250,000 ($500,000) amount.
 
Special rules apply in determining ownership and use if you are receiving out-of-residence care, inheriting property from a spouse, transferring property pursuant to a divorce, or disposing of property where the rollover rules applied.

The exclusion rule also generally applies to the sale of a remainder interest in a principal residence, if all the other requirements are met.  Thus, you may retain a life estate in your home while selling the remainder interest.

The exclusion rule requires gain recognition to the extent of any depreciation taken after May 6, 1997, for the rental or business use of your home.

The home-sale gain exclusion provision generally applies to sales of a principal residence occurring after May 6, 1997.  You may elect, however, not to have the new exclusion provision apply to any sale or exchange (in such cases, gain recognition generally is required, and the prior law rollover and one-time exclusion provisions cannot be applied).

If you have a gain in excess of $250,000 ($500,000 if married filing jointly) when you sell your home, you will now be liable for income tax on the excess gain in the year of sale.

No deduction is allowed if your home is sold at a loss.

We would be happy to meet with you to discuss the application of these provisions to your particular situation.

Self-Employment Tax

Self-employed individuals whose net self-employment income is $400 or more are subject to the Self-Employment Contributions Act (SECA) tax, in addition to federal income tax.  If net self-employment income is $400 or more, then all self-employment income is subject to the tax.  The SECA tax rate is 15.3%.  This rate is equal to the rate that the employer and employee jointly pay.  Self-employed individuals must pay the full amount based on their earnings from self-employment.  However, self-employed individuals may deduct one half of the combined rate times their net earnings from self-employment in computing the SECA tax.  Alternatively, for income tax purposes, such taxpayers may deduct one half of the SECA tax imposed for the tax year as a business expense in computing adjusted gross income.

Beginning in 2013, the employee half of the hospital insurance tax portion (i.e., 1.45%) of this tax is increased by an additional tax of 0.9% on employment wages over $250,000 for married taxpayers who file jointly and surviving spouses, $125,000 for married taxpayers who file separately, and $200,000 for other individuals.  These threshold amounts are reduced, but not below zero, by the amount of wages that are subject to FICA taxes.

The tax Code exempts from SECA tax net self-employment income in excess of the old-age, survivors, and disability insurance (OASDI) wage base (adjusted annually), minus the amount of wages paid to you by your employer that are subject to FICA taxes.  If the income on which you paid SECA tax exceeds the OASDI wage base, the income beyond the base is not subject to the OASDI portion of the SECA tax.  All earned income is subject to the hospital insurance portion of the SECA tax.  However, beginning in 2013, the additional tax mentioned above is not factored into the computation of the amount that self-employed individuals may deduct.

Your “net earnings from self-employment” are your gross income derived from your trade or business less allowable deductions attributable that trade or business.  You also must add guaranteed payments for any services that you performed for a partnership of which you are a member.  Generally, amounts that are excludible from gross income are not taken into account in determining net earnings from self-employment.

The SECA tax is computed on Schedule SE of Form 1040.  The amounts reported on Schedule SE are in most cases taken from Schedule C of Form 1040.  The amount of the SECA tax computed on the Schedule SE is reported on the Form 1040.

If you have any questions, please don’t hesitate to call.

Unemployment Benefits

This letter explains the taxation of unemployment benefits.  Until recently, unemployment compensation payments were often not subject to tax.  However, current law provides that all unemployment compensation paid under federal or state law, including those payments that are in the nature of unemployment benefits, generally are fully includible in the recipient's gross income. There is, however, a special $2,400 exclusion from gross income for unemployment benefits received in tax year 2009.

Payments from a private unemployment compensation plan are not made under federal or state law, and so are not unemployment benefits eligible for the 2009 exclusion.  Instead, payments  received from a private employment compensation plan are fully includible in gross income as income from a private nongovernmental unemployment compensation plan.

Please call us if you have any additional questions

YOUR OPTIONS WHEN YOU OWE THE IRS BUT CAN’T FULLY PAY

This letter explains the procedures that the IRS generally follows when you are unable to pay your tax liability and what your payment options are.  The IRS generally attempts to collect unpaid taxes first through voluntary payment arrangements.  If this fails, the IRS may then turn to enforced collection methods such as liens, levies, and seizures.  Thus, it is important that you take the appropriate steps if you cannot fully pay your tax liability.
 
Initially, if you believe that your tax bill is in error, you should immediately call or write to the IRS office that sent the bill.  Copies of any records, tax returns, cancelled checks, etc., that may help in correcting the error should be included.  If the IRS concludes that you are correct, it will adjust your account and issue a corrected bill.

If you are not disputing the amount of the liability, but simply are unable to pay your bill in full, you have several options to consider.  As outlined below, the IRS has strong powers that it can use to enforce collection of the debt, including seizing your personal or business assets.  To avoid this, you should first attempt to work with the IRS to come to a mutually satisfactory payment arrangement through an extension of time to pay, borrowing from sources such as loans, credit cards, 401(k) plans, life insurance, and/or home equity, paying over time under an installment agreement, or submitting an offer in compromise.  Under limited circumstances, the IRS will temporarily stop collection actions if this causes a hardship to you or your family. Lastly, you may consider filing for bankruptcy protection.

Short-Term Payment Extension. If you are temporarily unable to pay your tax liability, you may be eligible for a short-term extension of time to pay of up to 120 days.  There is no fee, you can make the request online through the IRS's website, and you usually will receive written confirmation within 10 days.

Installment Agreements. If you cannot fully pay within 120 days, you may be able to pay in monthly installments.  First, the IRS must accept an installment agreement if you: owe $10,000 or less; have filed and paid all tax returns during the five years prior to the year of liability; can fully pay the tax liability within three years; file and pay all tax returns during the agreement; and have not had an installment agreement within the last five years preceding the year of liability.  Importantly, you can qualify for this “guaranteed” agreement so long as the tax alone does not exceed $10,000 (i.e., your actual tax bill may exceed $10,000 including penalties and interest).  Also, the IRS's policy is to grant such agreements even if you could otherwise fully pay.  You can apply online through the IRS's website or authorize us to prepare the application for you.

Second, you can apply for a “streamlined” installment agreement online through the IRS's website, without having to contact the IRS or provide extensive financial disclosure if your unpaid liability (including tax, assessed penalties, and interest) is $25,000 or less and you can fully pay the liability within 60 months.  Again, you can authorize us to prepare the application for you.


Lastly, you can apply for the more traditional type of installment agreement, but you will need to provide extensive financial disclosure and the IRS will conduct a fairly detailed financial analysis to determine the amount and duration of any payment plan.

Offer in Compromise. You also have the right to submit an “offer in compromise” (OIC).  The IRS may compromise your tax liability, i.e, accept less than full payment, on one of several grounds: (1) doubt as to liability for the amount owed; (2) doubt as to ability to make full payment of the amount owed; or (3) if there is no doubt as to liability or collectibility, promoting effective tax administration in exceptional circumstances or to avoid economic hardship.

The doubt as to the liability for the amount owed must be supported by evidence and the amount acceptable to the IRS depends upon the degree of doubt found in the particular case.  In the case of inability to pay, the amount offered must exceed the total value of your equity in all your assets, and must give sufficient consideration to present and future earning capacity.  If an offer is accepted, the IRS also may require you to agree to pay a percentage of future earnings as part of the offer and to relinquish certain present or potential tax benefits.

There is a $150 nonrefundable filing fee (unless you meet certain low-income guidelines) and you must: (1) submit 20% of the offer amount as a lump-sum payment (or make such payment in five or fewer installments); (2) agree to pay the offer amount within 24 months (and submit the first payment with the application); or (3) agree to pay the offer amount over the remaining statutory period for collecting the tax (and submit the first payment with the application).

Suspending Collection Due to Economic and Other Hardships. If you can show that collection of the tax debt would cause a financial or other hardship for you or your family, such as preventing you from meeting necessary living expenses, the IRS may temporarily delay collection until your financial condition improves (i.e., classify the account as “currently not collectible”).  After approximately one year, the IRS will review your case to determine if the hardship still exists.  (Note, however, that penalties and interest will continue to accrue during such period).  The IRS may also enter into a compromise agreement with you.

Bankruptcy. You may also consider bankruptcy.  The filing of a bankruptcy petition serves to place a “stay” on further IRS collection actions.  The IRS may then file a claim for the unpaid taxes with the bankruptcy court.  The court can determine whether and when these taxes are to be paid.  In addition, certain taxes that cannot be paid from the bankruptcy estate may be discharged.  Discharge generally is limited to taxes incurred more than three years before the bankruptcy petition is filed.  Before filing for bankruptcy, however, you should first consider all of the consequences that such filing may have on your overall financial situation.

Enforced Collection Action—Liens, Levies, and Seizures. When voluntary means fail, the IRS has a formidable array of powers to enforce collection.  The IRS's authority to take enforcement action arises 10 days after the first notice and demand for payment of the unpaid tax.  Enforced collection action includes the filing of a Notice of Federal Tax Lien, the serving of a Final Notice of Intent to Levy, and/or the seizure and sale of your property.

Normally, the IRS sends several notices asking for voluntary payment of the tax before any enforcement actions are taken.  If you have not contacted the IRS by this time, the IRS sends a notice of intent to levy by certified mail.  Thirty days later, if you have not requested an Appeals office Collection Due Process hearing to consider collection alternatives, the IRS may begin enforcement actions.

The IRS may place a lien for the unpaid tax on your property.  The IRS may also seize (levy on) your property.  Levy can be made on property in the hands of third parties (employers, banks, etc.) or property in your possession (automobile, house, etc.).  Certain property cannot be levied upon: a limited amount of personal belongings, clothing, furniture, and business or professional books and tools; unemployment, worker's compensation, certain welfare benefits, and certain pension benefits; court-ordered child support payments; undelivered mail; and a small portion of wages.  The IRS must obtain court approval to seize your personal residence.

After seizure, the IRS can sell the property to satisfy the tax bill.  The IRS will give you notice before the sale of the property.  The sale is canceled if you redeem the property before the sale, or make other arrangements to pay the tax bill.
 

Please call us to discuss the options outlined in this letter.  We would be glad to assist you in arriving at the best solution possible in your circumstances.

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