The most intriguing aspect of maintaining this tax blog is the pleasure of meeting and engaging a wide variety of successful people all with the courage to take the risk
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In 2013, the IRS will focus the significant majority of their enforcement budget and subsequent activity in my opinion on three specific areas: 1. Abusive transactions and under reported income
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This blog is my personal tax research tool. Pursuant to the rules of professional conduct set forth in US Treasury Circular 230 nothing contained in this blog was intended to be used
This blog is my personal tax research tool. Pursuant to the rules of professional conduct set forth in US Treasury Circular 230 nothing contained in this blog was intended to be used
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The most intriguing aspect of maintaining this tax blog is the pleasure of meeting and engaging a wide variety of successful people all with the courage to take the risk of venturing out on their own professionally in pursuit of dreams and aspirations. Sharing with me the lessons learned through experiences chalked up to enduring hard knock after hard knock I have learned from my readers and subscribers along the way of which I am profoundly thankful.
I couldn’t help but notice that many of my friends and clients alike, particularly those of you in the business of providing services to the community, have become successful beyond anyone’s wildest expectations and are now more prepared than ever to accept the significance of gifting in the greater scheme of life’s affairs. Because people that read my tax blog are smart however they want their gifts to both maximize a positive impact on the community but also offer the most tax advantages on the way. This is often referred to in my circles as intelligent gifting with purpose.
Most astute businesses are structured as Limited Liability Companies (LLC’s) and have elected to be treated as an S-Corporations for income tax purposes. Charitable contributions originating from S Corporations is nuanced and can appear at first somewhat complex to report but is fully legal and advisable. In order for expenses to be deductible as a charitable contributions they must be:
(1) un-reimbursed (aka not deducted elsewhere);
(2) directly connected with the services;
(3) incurred only because of the services provided; and
(4) not personal, living, or family expenses as defined under (Reg. Sec. 1.170A-1(g))
The Pension Protection Act of 2006 amended Internal Revenue Code Section 1367(a)(2) to provide that the decrease in shareholder basis under Internal Revenue Code Section 1367(a)(2)(B) by reason of a charitable contribution is equal to the shareholder’s pro rata share of the adjusted basis of the donation. This rule does not apply to contributions made in tax years beginning before January 1, 2006, and after December 31, 2013.
THIS IS WHERE THE RUBBER HITS THE ROAD!
For contributions made in tax years after December 31, 2013, the amount of the reduction is the shareholder’s pro rata share of the fair market value of the contributed property.
Example: Brian is the sole shareholder of Gymnastics Gym, Inc, an S corporation. Brian’s basis or investment in Gymnastics Gym’s stock is $1,000,000. In 2013, Gymnastics Gym made charitable contributions with a basis of $10,000 (basically the fixed and variable expenses of hosting gymnastics parties) and a fair market value of $20,000 (basically the usual or customary charge assessed to the general public or, more ideally, the amount acknowledged on the letter from the recipient charitable organization).
In this scenario Brian as a shareholder of Gymnastics Gym is treated as having made a 2013 charitable contribution equivalent to the cost basis ($10,000) of the donation. In 2014 on wards the donation value of the birthday parties will be the equivalent of the fair market value ($20,000) of the donation. Up until the end of tax year 2013 this charitable donation for income tax reporting purposes is generally treated as a cost of operating a business more so than a reduction in basis or investment in Gymnastics Gym stock.
If that same charitable contribution were to be made in 2014 however then Gymnastics Gym would deduct as ordinary operating expense the $10,000 cost of hosting gymnastics parties. Additionally Brian as the sole shareholder of Gymnastics Gym could choose to take up to the difference between the $10,000 deductible operating costs and the $20,000 Fair Market Value (FMV) of the gift (or $10,000) as a pass through charitable donation by reducing his basis in Gymnastics Gym stock dollar for dollar with the amount of claimed charitable donation.
How to report: Gymnastics Gym incurred usual and customary operating expenses to host birthday parties that happened to be donated to a charitable organization. These expenses are included on the income statement and offset gross receipts in arriving at net income. Separately and distinctly from that, Brian as a shareholder of Gymnastics Gym has a basis or investment in his shares of Gymnastics Gym.
The charitable donation amount of the parties (after accounting for operating expenses as you need to take care to not double dip on expenses) passes through Gymnastics Gym’s 1120-S via line 12.a. of Schedule K which carries over to box 16 schedule K1 labeled as ‘C’ (reduction in basis) and then carries to his personal 1040 Schedule A as part of his itemized deductions.
Caveat 1: Charitable contribution deductions on the 2013 1040 Schedule A (regardless of where they originate) begin to phase out when Adjusted Gross Income (AGI) exceeds $300,000 for married taxpayers filing joint returns so be sure to run the phase out calculation found in IRS Publication 526, Charitable Contributions.
Caveat 2: Special rules of Internal Revenue Code Section 170(e) should be considered in other files you take on in these regards but the application is narrowly specific.
It was difficult for me to wrap my arms around the concept at first and subsequently compiled the following facts.
Generally the value of a taxpayer’s time or services is not deductible as a charitable contribution according to Treasury Regulation Section 1.170A-a(g).
However, according to Parker Tax Publishing un-reimbursed expenditures made incident to rendering services, such as for example hosting a gymnastics party, the contributions to which are deductible, are indeed deductible contributions according to TC Saltzman v. Comm’r, 54T.C. 722,(1970); AND Babilonia v. Comm’r, T.C. Memo. 1980-207.
Most importantly though the expenses of rendering services are deductible because they constitute contributions “to” the charitable organization according to Rockefeller v. Comm’r, 676 F.2d 35,(2d Cir. 1982).
In conclusion in 2014 forward you can claim the Fair Market Value of of any charitable deduction out of your S-Corp as a pass through by offsetting it against basis after backing out the corporation’s cost of making the charitable donation.
Application for Automatic Extension of Time To File U.S. Individual Income Tax Return – IRS Form 4868
Everyone starts getting a little freaked out this time of year because of personal income tax reporting and paying obligations due on April 15th. I have found through the years that this kind of pressure causes people in all walks of life to make poor judgments and less than fully informed decisions just to hit a deadline.
The point of this post is to inform you that it is okay to file an application for a 6 month automatic extension of time to file your US individual income tax return and to NOT WORRY IF YOU ARE BEHIND THE CURVE THIS YEAR. There are many reasons why you may need an extension of time to file your taxes that are all fully legitimate including:
1. life changing events
2. partnerships or other pass through entities and trusts that are not prepared to report and even
3. lack of personal organization.
It is all okay. To file an extension request all you need to do is fill out and submit IRS Form 4868 and provide:
1. Your name and spouse’s name (if you’re filing jointly) and address;
2.Your Social Security number and spouse’s Social Security number (if you’re filing jointly);
3. An estimate of total tax liability for 2013;
4. Total of what you have already paid in 2013 (including withholding and estimated payments); and
5. The amount you’re paying with the extension, if anything.
Remember that an extension of the time to file is simply that. It is not an extension of time to pay as INCOME TAX PAYMENTS ARE DUE IN FULL ON APRIL 15TH.
What this means is if you think you might owe taxes and you’re filing for extension, you should make a payment with your extension request simply to avoid interest and penalty assessments later. The interest rate is currently 3% per year, compounded daily, and the late-payment penalty is normally 0.5% per month. In other words you should estimate what the taxes due are and if you over estimate rest assured you will be entitled to a tax refund.
This is super easy to do if you just take a minute to gather your thoughts and honestly estimate your liability. Once you’ve done this you can either mail in IRS Form 4868 with an estimated payment taking care to post mark the envelope by April 15th; use the IRS’ free file service or contact me and I’ll have one of my trusted lieutenants walk you through it or take care of this for you as you see fit.
Retirement Plan Recharacterization means according to Reg. Sec. 1.408A-5 that if you make a contribution to one type of IRA you may be able to treat the contribution as though it had been made to a different type of IRA. This is basically considered a correction if you will which can be significant for a wide variety of reasons.
One common reason that I’ve seen is if you converted a traditional IRA to a Roth IRA you may want to recharacterize the Roth IRA back to a traditional IRA if the value of the assets in the Roth IRA has declined between the conversion date and the due date for the tax return reporting the conversion.
This is because the amount you would have to include in income as a result of the conversion to a Roth IRA is based on the value of the account at the time of the conversion and does not take into account the decline in value between the conversion date and the due date of the return including extensions.
However a most common issue for recharacterization purposes occurs when you receive a distribution from a traditional IRA in one tax year and roll it over into a ROTH IRA in the next tax year but still within 60 days of the distribution from the traditional IRA. In this case you treat the contribution to the ROTH IRA as though it occurred in the year of the distribution from the traditional IRA.
You recharacterize a contribution or IRA conversion in either of two ways, a trustee-to-trustee transfer or simply by re-designating the first IRA as the second IRA, rather than transferring the account balance.
If you elect to recharacterize an IRA contribution you must report the recharacterization, and you must treat the contribution as having been made to the second IRA instead of the first IRA, on your income tax return for the tax year for which the recharacterized contribution was made to the first IRA. There are 2 types of recharacterizations that I’ll address.
1. You made a contribution to a traditional IRA and later recharacterized part or all of it to a Roth IRA.
If you recharacterizes only part of the contribution and the contribution included nondeductible amounts, you must report any nondeductible portion that remains in the traditional IRA on Part I of Form 8606, Nondeductible IRAs. If you recharacterize the entire contribution you do not report the contribution on Form 8606. See IRS Form 8606 Instructions for further information.
In either case, you must attach a statement to your tax return explaining the recharacterization.
For example if you contributed $4,000 to a new traditional IRA on May 27, 2013 and on February 24, 2014, you determined according to the active participant rules that your 2013 modified adjusted gross income will limit your traditional IRA deduction to $1,000. The value of your traditional IRA by that time grew to $4,400. You decided to recharacterize $3,000 of the traditional IRA contribution as a Roth IRA contribution, and have $3,300 ($3,000 contribution plus $300 related earnings) transferred from your traditional IRA to a Roth IRA in a trustee-to-trustee transfer and subsequently deduct the $1,000 traditional IRA contribution on Form 1040.
In this case you do not have to file Form 8606, but must attach a statement to your return explaining the recharacterization.
The statement indicates that you:
(a) contributed $4,000 to a traditional IRA on May 27, 2013;
(b) recharacterized $3,000 of that contribution on February 24, 2014, by transferring $3,000 plus $300 of related earnings from the traditional IRA to a Roth IRA in a trustee-to-trustee transfer; and
(c) that all $1,000 of the remaining traditional IRA contribution is deducted on Form 1040.
You do not report the $3,300 distribution from the traditional IRA on her 2013 Form 1040 because the distribution occurred in 2014. You do not report the distribution on your 2014 Form 1040 either, because the recharacterization related to 2013 and was explained in an attachment to her 2013 return.
2. You rolled over an amount from a qualified retirement plan to a Roth IRA in 2013 and later recharacterized all or part of the amount to a traditional IRA.
If you recharacterizes only part of the amount rolled over, you must report the amount not recharacterized on Form 8606, Nondeductible IRAs. If you recharacterizes the entire amount you do not report the recharacterization on Form 8606.
In either case, you must attach a statement to your tax return explaining the recharacterization and you must include the amount of the original rollover on the line for “pensions and annuities” on Form 1040, Form 1040A, or Form 1040NR. If the recharacterization occurred during the year for which the return is being filed, you must also include the amount transferred from the Roth IRA on the line for “IRA distributions” on Form 1040, Form 1040A, or Form 1040NR.
If the recharacterization occurred in the following year, you report the amount transferred only in the attached statement, and not on his or her return for the preceding year or for the year in which the recharacterization occurred.
For example you rolled over $50,000 from your 401(k) plan to a new Roth IRA on July 20, 2013. On March 25, 2014, you decided to recharacterize the rollover. The value of the Roth IRA on that date is $49,000. You recharacterize the rollover by transferring that entire amount to a traditional IRA in a trustee-to-trustee transfer and report $50,000 as an amount received from pensions and annuities on the line for “IRA distributions” on your 2013 Form 1040. You do not include the $49,000 as an IRA distribution on line 15a because it did not occur in 2013. You also do not report that amount on his 2014 return because it does not apply to the 2014 tax year. You do not have to file Form 8606, but you must attach a statement to his 2013 Form 1040 explaining that:
(a) you made a rollover of $50,000 from a Code Sec. 401(k) plan to a Roth IRA on July 20, 2013, and
(b) you recharacterized the entire amount, which was then valued at $49,000, to a traditional IRA on March 25, 2014.
Transfer of Allocable Earnings
One of the more difficult aspects of recharacterization for taxpayers to pick up on is the fact that if you recharacterizes a contribution or a Roth IRA conversion amount you must include in the transfer any earnings allocable to the contribution or conversion being recharacterized according to Reg. Sec. 1.408A-5.
If you recharacterize a contribution you must include in the transfer any earnings allocable to the contribution. If there was a loss, the amount transferred must be reduced by the amount of the loss. In most cases, the amount of the earnings that needs to be transferred is determined by the IRA trustee or custodian.
If you have a transfer agent as inept as Mass Mutual for example that lacks the professional acumen to calculate earnings on recharacterizations you may determine the amount of earnings allocable to an IRA contribution and the total amount to be recharacterized by following these steps:
Step 1: Determine the amount of the IRA contribution to be recharacterized.
Step 2: Determine the IRA’s adjusted closing balance which is the IRA’s fair market value at the end of the “computation period” plus the amount of any distributions, transfers, and recharacterizations made from the IRA during the computation period.
The computation period is the period beginning just before the time the particular contribution being recharacterized is made to the IRA and ending just before the recharacterizing transfer of the contribution.
Step 3: Determine the IRA’s adjusted opening balance.
The adjusted opening balance is the fair market value of the IRA at the beginning of the computation period plus the amount of any contributions or transfers (including the contribution that is being recharacterized under Code Sec. 408A(d)(6) and any other recharacterizations) made to the IRA during the computation period.
Step 4: Subtract the adjusted opening balance in Step 3 from the adjusted closing balance in Step 2.
Step 5: Divide the amount in Step 4 by the adjusted opening balance in Step 3, and enter the result as a decimal rounded to at least three places.
Step 6: Multiply the amount in Step 1 by the decimal determined in Step 5. This is the net income attributable to the contribution to be recharacterized.
Step 7: Add the amounts in Step 1 and Step 6. This is the amount of the IRA contribution, plus the net income attributable to it, to be recharacterized.
Lessons I’ve Learned
The following are some important lessons I’ve learned in defending (and preparing) tax returns for people who engaged this concept of recharacterization:
1. Generally, both the election to recharacterize and the transfer must take place on or before the due date for filing the tax return for the year for which the contribution or conversion was made to the first IRA.
2. To add even more salt to the water special procedures are available that allow someone who has already filed a timely tax return to recharacterize contributions for up to six months after his or her tax return’s due date exclusive of extensions.
3. If you elect to recharacterize an IRA contribution or Roth IRA conversion amount you must report the recharacterization, and must treat the contribution or conversion as having been made to the second IRA instead of the first IRA, on your income tax return for the tax year for which the recharacterized contribution was made to the first IRA
4. To recharacterize a contribution, you generally must have the contribution transferred from the first IRA to the second IRA in a trustee-to-trustee transfer. Generally, the transfer to the second IRA must be made by the due date of your tax return for the year during which the contribution to the first IRA was made.
5. Recharacterizations made with the same trustee can be made by re-designating the first IRA as the second IRA, rather than transferring the account balance.
6. After the transfer has taken place, the election to recharacterize is irrevocable. When you recharacterizes a contribution you must:
(a) include in the transfer any net income allocable to the contribution
(b) report the recharacterization on your tax return for the year during which the contribution was made; and
(c) treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA.
7. You must also notify both the trustee of the first IRA and the trustee of the second IRA that you elected to treat the contribution as having been made to the second IRA rather than the first by the date of the transfer.
Only one notification is required if both IRAs are maintained by the same trustee and include:
(a) the type and amount of the contribution to the first IRA that is to be recharacterized;
(b) the date on which the contribution was made to the first IRA and the year for which it was made;
(c) a direction to the trustee of the first IRA to transfer in a trustee-to-trustee transfer the amount of the contribution and any net income (or loss) allocable to the contribution to the trustee of the second IRA;
(d) the name of the trustee of the first IRA and the name of the trustee of the second IRA; and
(e) any additional information needed to make the transfer.
8. The election to recharacterize can be made on behalf of a deceased IRA owner by the executor, administrator, or other person responsible for filing the decedent’s final income tax return.
9. Generally, any amount that has been moved from one IRA to another in a tax-free transfer, such as a rollover, cannot be recharacterized. However, a taxpayer who mistakenly rolls over or transfers an amount from a traditional IRA to a SIMPLE IRA can later recharacterize that amount as a contribution to another traditional IRA.
10. If you receive a distribution from traditional IRA and contribute the entire amount to a different traditional IRA in a rollover contribution you cannot elect to recharacterize the contribution by transferring the contribution amount, plus net income, to a Roth IRA, because an amount contributed to an IRA in a tax-free transfer cannot be recharacterized. However, you can convert (other than by recharacterization) the amount in the second traditional IRA to a Roth IRA at any time, provided it satisfies the requirements for a qualified rollover contribution.
11. Employer contributions including elective deferrals under a SEP or SIMPLE plan cannot be recharacterized as contributions to another IRA. However, an amount converted from a SEP IRA or SIMPLE IRA to a Roth IRA can be recharacterized to a SEP IRA or SIMPLE IRA, including the original SEP IRA or SIMPLE IRA.
12. You cannot deduct any loss that occurred while the funds were in the first IRA. Also, no deduction is allowed for a contribution to a traditional IRA if the amount is later recharacterized.
13. The recharacterization of a contribution is never treated as a rollover for purposes of the one-year waiting period even if the contribution would have been treated as a rollover contribution by the second IRA if it had been made directly to the second IRA rather than as a result of a recharacterization of a contribution to the first IRA.
14. Timing of recharacterization. Generally, both the election to recharacterize and the transfer must take place on or before the due date (including extensions) for filing the tax return for the year for which the contribution to be recharacterized was made. If you miss the election deadline you can still elect to recharacterize a contribution if:
(1) your tax return was timely filed for the year the election should have been made; and
(2) you take appropriate corrective action within six months from the due date of the return, not including extensions consisting of: notifying the trustee of the taxpayer’s intent to recharacterize; providing the trustee with all necessary information; and having the trustee transfer the contribution.
After taking the necessary corrective action, you must amend your tax return to show the recharacterization. In addition to reporting the recharacterization, you must write on the amended return, “Filed pursuant to section 301.9100-2“
Excess contributions actually made for a prior year and deemed to be current-year contributions for purposes of the Code Sec. 4973 excise tax on excess contributions may be recharacterized only if recharacterization would still be timely with respect to the tax year for which the contributions were actually made. This rule applies to any excess contribution, whether made to a traditional or a Roth IRA.
For more information see IRS Publication 590 – Individual Retirement Arrangements.
As many of you know who follow this tax blog I enjoy dabbling in the uncharted waters of the US Tax Code. It helps keep me fresh. One of the many areas that this includes is the tax treatment of virtual currencies.
With the most recent run up in the price of Bitcoins there were a handful of very fortunate people that quite literally amassed multi-generational wealth over just a few short weeks cashing out their Bitcoins all the way to $1,000 per coin. You know who you are. May God bless you on your journey that you use this new found wealth for good.
Fortunately in your favor the IRS produced Notice 2014-21 explaining how existing general tax principles apply to transactions using virtual currencies, including Bitcoin. The following are some interesting points worth attention that I pulled from the Notice:
Q – What type of gain or loss does a taxpayer realize on the sale or exchange of virtual currency?
A – The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset. See IRS Publication 544 for more information about capital assets and the character of gain or loss.
What this means from my perspective generally speaking is that if you get paid in virtual currency you will need to record the value of the virtual currency on the date it is received as though it were a capital asset. Then when you go to convert the virtual currency you will be subject to a capital gain or (loss) depending on the value of the virtual currency at the time of the conversion.
Basically if you are going to accept payment in Virtual Currency you better keep detailed records of the value of the currency by day end closing prices each day the currency is received.
Q. Are there IRS information reporting requirements for a person who settles payments made in virtual currency on behalf of merchants that accept virtual currency from their customers?
A. Yes, if certain requirements are met. In general, a third party that contracts with a substantial number of unrelated merchants to settle payments between the merchants and their customers is a third party settlement organization (TPSO). A TPSO is required to report payments made to a merchant on a Form 1099-K, Payment Card and Third Party Network Transactions, if, for the calendar year, both (1) the number of transactions settled for the merchant exceeds 200, and (2) the gross amount of payments made to the merchant exceeds $20,000.
When completing Boxes 1, 3, and 5a-1 on the Form 1099-K, transactions where the TPSO settles payments made with virtual currency are aggregated with transactions where the TPSO settles payments made with real currency to determine the total amounts to be reported in those boxes. When determining whether the transactions are reportable, the value of the virtual currency is the fair market value of the virtual currency in U.S. dollars on the date of payment.
So don’t think that you can hid these gross receipts simply because they are virtually received.
The Business and Partnership Tax deadline is coming up fast.
Don’t sweat it. File IRS Form 7004 and apply for Automatic Extension of Time to File Certain Business Income Tax.
If you happen to be compelled feel welcome to check out the instructions for IRS Form 7004.
If you need help contact me and one of my trusted lieutenants will take care of this for you.
The best free US tax research sites in my opinion are:
1. For actually referencing the US Tax Code – Cornell University Law School as they seem to do the best job with updates and maintenance and at the end of the day the only thing you can seem to rely on is the actual tax code.
2. Of course there is the US Government Printing Office Code of Federal Regulations which most people tend to believe to be a little more difficult to navigate.
3. Legal Bitstream has been live on the internet since 2003, and is owned and operated by Mayfield Publishing Company, a privately held corporation based in Houston, Texas. Usually anything produced in Texas appears suspect in my reality nevertheless this is a wonderfully efficient first resource.
4. Tax Almanac is a website designed by Intuit, the makers of professional tax preparation and financial software. It is not necessarily a good consumer tax question site but provides a good first stop.
5. The IRS’ Taxmap that actually began in 2002 as an IRS prototype to address the business need for improved access to tax law technical information for IRS phone operators that has grown into a database designed to organize information around subjects of interest to taxpayers.
6. The IRS’ Electronic Reading Room where records are available for public inspection and copying under Subsection (a)(2) of the FOIA ( 5 U.S.C. § 552, as amended) including:
Final opinions, including concurring and dissenting opinions, as well as orders, made in the adjudication of cases;
Those statements of policy and interpretations which have been adopted by the IRS and are not published in the Federal Register;
Administrative staff manuals and instructions to staff that affect a member of the public;
Copies of records previously released under the FOIA, which the IRS determines may become or are likely to become the subject of future requests for substantially the same records.
7. The United States Tax Court site is always a hit. Be sure to have a stiff cocktail on the ready as the legal ease is enough to make the head spin.
8. Of course there is no way I’m going to let you go without plugging my own personal tax research site outlining some of my most memorable experiences.
So before you decide to hire a tax pro or simply want to know a little bit more about what you are up against start by checking out these sites.
Many taxpayers fear that aggressive deductions wave flags in front of IRS auditors and quite often I am asked what the chances are of being audited as if my opinion is some sort of a benchmark. The fact of the matter is that every tax return electronically filed is subject to some form of matching protocol, inspection, examination or audit.
Today’s historically connected engagement electronically between the US Government and its citizens has eroded privacy by subjecting us all to some form of unnoticed scrutiny. But at the same time incremental audit rates of substance seem to have proportionally decreased which mean that any particular taxpayer’s odds of attracting attention are slim unless you are a complete moron or behaving overtly fraudulent. Basically the simple answer is that if you properly documented legitimate deductions, you have little to fear.
If however you want to know how aggressive you can get I suggest referring to the IRS’ own audit techniques guides for over 50 specific industries from Alaskan commercial fishermen to pizza restaurants and coin-operated laundries.
Keep in mind that penalties are essentially assessed based on whether you have a “reasonable” basis for taking a position which is loosely defined as more than one chance in three of being accepted by the IRS. In fact if the audit technique guides and the Internal Revenue Code prove inconclusive and you remain concerned you can still file the claim and protect yourself somewhat by filing IRS Form 8275 or IRS Form 8275-R to disclose positions you believe to be contrary to law or regulations. Beware though as these forms tend to attract scrutiny.
Historically audits peaked in 1972 at one out of every 44 returns. As of 2012, the rate has dropped to one out of every 100.1 Roughly half focused on a single issue: the Earned Income Tax Credit claimed by roughly one in seven filers. The IRS focuses the rest of its efforts on three main targets:
Small businesses, particularly sole proprietors operating cash businesses, who underreport income and skim receipts. (These make up the bulk of audit targets.)
Individual taxpayers who fail to report pass-through income from partnerships, limited liability companies, S corporations, trusts, and estates. (In 2002, the IRS launched a program matching income from those sources to recipients.)
Phony trusts, churches, home-based businesses, and similar frauds and protests.2 (These account for most tax prosecutions — and while the IRS has lost a couple of high-profile criminal prosecutions, no court has upheld any of these theories.)
The table below, taken from the 2010-2012 IRS Data Books, summarizes audit data for those years:
Form 1040 (by “Total Positive Income”)
$0 – 199,999
$200,000 – 999,999
Schedule C (by Gross Receipts)
$0 – 24,999
$25,000 – 99,999
“C” Corp. (Form 1120)
“S” Corp. (Form 1120S)
Partnerships (Form 1065)
More and more taxpayers it seems are finding themselves compelled to engage in a structured installment sale of closely held business assets or rental real estate and I couldn’t help but notice that there are some common misconceptions about the associated tax implications, particularly if ‘related parties’ are involved in a transaction. So this is what I am telling people:
Report installment sales on IRS Form 6252
Report interest from installment sales on Schedule B
Report capital gains from installment sales on Schedule D.
For more details refer to IRS Publication 537 or IRC 453
Beware of some pitfalls. For example if you elect installment treatment on a sale to a relative (spouse, child, grandchild, parent, grandparent, sibling) and they resell the property within two years of the original sale date, you’ll owe tax on the entire remaining unpaid balance the year the relative sells the property.
Another pitfall to be aware of is if you like installment sale tax advantages, but you’re worried your buyer might default on payments, consider a “structured sale,” where you take part or all of your proceeds in the form of commercial annuity payments. Here’s how it works:
You negotiate a traditional installment sale with your buyer.
Your buyer assigns the right to make payments to an independent third-party and pays the purchase price, in cash, to that third party. (Using a third party avoids the “constructive receipt” which would make the sale immediately taxable.)
The third party uses the buyer’s cash to buy an immediate annuity from a top-rated life insurance company.
You pay taxes on your gain as you receive those annuity installments.
Installment sales where you receive payments in more than one tax year let you defer tax on sales until you actually receive those payments. Tax is divided among the actual installments and due as you receive them. Here’s how it works:
Calculate your gain on the sale.
Calculate the percentage of your total sale price consisting of basis and the percentage consisting of taxable gain.
Multiply each installment by your profit percentage to figure taxable gain from that installment.
You have to charge adequate interest on each installment. Otherwise the IRS can re-characterize part of each installment as interest, taxed at ordinary rates, instead of capital gain. The minimum rate is generally the “applicable federal rate” in effect at the time of the sale. Interest on unpaid installments is taxed as ordinary income.
For example, generally speaking, if you buy a building for $600,000 then sell it for $1 million. 40% of your sale price is gain, so 40% of each installment is taxed as capital gain.
Beware of these rules for special circumstances:
If you sell depreciated property, you’ll owe tax on recaptured depreciation at ordinary rates, and on “un-recaptured Section 1250 gain,” capped at 25%, in the year of sale.
You can’t elect installment sale treatment for depreciable property you sell to a business you control or a to trust with you or your spouse as a beneficiary.
If you sell property with no fixed price, such as an “earnout” sale of a business or property for a fixed percentage of sales or rent, divide the property’s basis into the term of the installments, then pay tax on any gain above that amount.
If the total of installment payments owed to you in any year tops $5 million, you’ll owe interest at the federal underpayment rate on the balance exceeding $5 million.
If your buyer assumes a mortgage, subtract that debt from the gross sale price before figuring gain on the sale.
If your buyer unexpectedly prepays installments, you’ll owe tax as soon as you receive them. Consider using a structured sale to avoid this unpleasant surprise.
Allowable Nontaxable IRA Rollovers Contributions Interpreted To Mean One Per Taxpayer Per Tax Year in US Tax Court Case – Bobrow v. Commissioner
In Bobrow v. Comm’r, T.C. Memo. 2014-21, the Tax Court relied on IRC 408(d)(3)(B) regarding the limits and frequency of nontaxable rollover contributions elected by the taxpayer noting that the one-year limitation addressed in this section of the US Tax Code applies to all IRAs maintained by the individual taxpayer.
So there you have it, as a result going forward I am now advising US Taxpayers to engage only one IRA rollover per tax year and to be the absolute safest one rollover every 366 days.