Archive for Cancelled Debt
January 16, 2013 John R. Dundon II Adoption, Alternative Minimum Tax (AMT), Cancelled Debt, Capital Gain, Charitable Contribution, Child Tax, Employment Tax, Estate Tax, Excise Tax, Generation Ski[[ing Transfer Tax, Social Security Tax, Tax Credit, Tax Guidance & Preparation, Tax Relief The American Taxpayer Relief Act of 2012 makes permanent many otherwise expiring tax provisions. The following is my summary of what I believe to be relevant provisions:
Ordinary income above a certain threshold is taxed at a higher rate. The thresholds are: taxable income of $400,000 (for an unmarried taxpayer), $425,000 (for a head of household), and $450,000 (for a taxpayer who is married and filing jointly).
The current maximum 15% tax rate on long-term capital gains and qualified dividends is extended for individuals who have taxable income up to $400,000 (for a unmarried taxpayer), $425,000 (for a head of household), and $450,000 (for a taxpayer who is married and filing jointly). For capital gain and dividend income above the applicable threshold, the rate increases to 20%. With the new 3.8% Medicare surtax for unmarried and head of household taxpayers with modified adjusted gross income (“MAGI”) over $200,000 and married taxpayers with MAGI over $250,000, the capital gain and qualified dividend rate has become more complex.
The 3.8% “Medicare surtax” effective January 1, 2013, under the health care reform law passed in 2010 is still being deployed. This new tax applies to certain types of investment income for unmarried taxpayers with MAGI above $200,000 and married couples above $250,000. The tax applies to the lesser of the individual’s net investment income or MAGI in excess of the threshold amounts. In addition, high-income earners will be subject to an additional payroll tax of 0.9% on wages received in excess of those threshold amounts.
The $5 million estate, gift and generation-skipping transfer (GST) tax exemptions are now permanent and adjusted for inflation from 2011. It also makes permanent the “portability” provision between spouses, which allows a surviving spouse to use a deceased spouse’s unused exemption on lifetime gifts and/or transfers at death. GST exemption, however, is not portable. For 2013, the exemption amount is projected to be $5.25 million. The Act sets the rate for all transfers in excess of the exemption amount (for all three taxes) at 40%. The federal credit for state death taxes is now permanently repealed. However, an estate may continue to deduct state estate or inheritance taxes for purposes of computing the federal estate tax. A variety of beneficial GST tax provisions that were scheduled to expire have been made permanent, including the automatic allocation of a taxpayer’s GST exemption to certain transfers, provisions permitting the “qualified severance” of a trust into two trusts, one of which is exempt from the GST tax and one of which is not; and relief for a late allocation of GST exemption.
The alternative minimum tax (AMT) patch, which historically had been passed each year by Congress to lessen the burden of AMT on millions of middle-income households is now permanent and will be adjusted for inflation. Under the Act, the AMT exemption amount for 2012 is $50,600 for unmarried taxpayers and heads of household, $78,750 for taxpayers who are married and filing jointly, and it is indexed for inflation going forward. The 2013 exemption amounts are projected to be $51,900 for unmarried taxpayers and heads of household, and $80,750 for married taxpayers filing jointly.
The personal exemption phase-out (“PEP”) provision, which had been suspended under prior law, returns. It phases out the personal exemption for taxpayers with adjusted gross income (“AGI”) over $250,000 (for an unmarried taxpayer), $275,000 (for a head of household), and $300,000 (for a taxpayer who is married and filing jointly).
A past law often referred to as the “Pease provision” which limited itemized deductions for high-income taxpayers is reinstated. The Pease provision was suspended for 2010 through 2012 allowing taxpayers to deduct 100% of their itemized deductions regardless of their income subject to other applicable restrictions. The Pease provision applies to AGI above the following thresholds: $250,000 (for an unmarried taxpayer), $275,000 (for a head of household), and $300,000 (for a taxpayer who is married and filing jointly). The Pease provision phases out itemized deductions by the lesser of (i) 3% of the excess of AGI over the threshold or (ii) 80% of the otherwise allowable deductions. While the Act did not directly address the mortgage interest or charitable deductions, the Pease provision has the effect of limiting the amount of these deductions that a taxpayer may take if his or her income exceeds the applicable threshold.
The payroll tax “holiday” enacted in 2010 expired. Under the payroll tax holiday, the 6.2% social security tax paid by all wage earners was temporarily cut to 4.2%. The expiration of the holiday will cause wage earners to pay 2% more in social security taxes on all wages up to $113,700.
The ability to exclude from income gain on the sale of certain qualified small business stock (QSBS) is extended, as long as the stock was held for more than five years before sale. The exclusion is generally 50%, but was increased to 75% for QSBS acquired after February 17, 2009, and before September 28, 2010; and to 100% for QSBS acquired after September 27, 2010, and before January 1, 2012. The Act extends the 100% gain exclusion to QSBS acquired after September 27, 2010 and before January 1, 2014. Note that the QSBS exclusions are generally limited to the greater of (i) $10 million of gain or (ii) ten times the taxpayer’s cost basis in the stock sold in that year. In addition, gain subject to the 100% exclusion rule is not a preference item for alternative minimum tax purposes.
The ability of a taxpayer age 70½ or older to exclude up to $100,000 from gross income for distributions made directly from a traditional or Roth IRA to a qualified charity is extended. This provision expired after 2011; it is now extended for 2012 and 2013. The Act contains two time-sensitive provisions giving taxpayers flexibility with respect to the 2012 tax year. First, if a taxpayer took a required minimum distribution (“RMD”) in December of 2012, he or she can elect to treat some or all of that RMD as a qualified charitable contribution to the extent that the distribution (up to $100,000) is transferred in cash to a qualifying charitable organization before February 1, 2013, and meets the other charitable rollover requirements. Second, a qualified charitable contribution made in January of 2013 may be treated as having been made on December 31, 2012.
A deduction for a charitable gift of long-term capital gain property is generally limited to 30% of the donor’s adjusted gross income (AGI). However, for the years 2006 through 2011, a special provision allowed a deduction of up to 50% of the donor’s AGI for contributions of “qualified conservation property.” The Act extends this provision through December 31, 2013.
There are various other individual and business tax provisions that were set to expire including: earned income credit; adoption credit and assistance; child and dependent care credit; mortgage debt cancellation relief; mortgage insurance premiums deduction; marriage penalty relief; and bonus depreciation.
First off regarding income, do not include a canceled debt in gross income if any of the following situations apply:
The cancellation takes place in a bankruptcy case under the U.S. Bankruptcy Code.
The cancellation takes place when the debtor is insolvent, and the amount excluded is not more than the amount by which the debtor is insolvent.
The canceled debt is qualified principal residence indebtedness (applies to debt canceled between January 1, 2007, and December 31, 2009). IRC section 108(a)(1)(E).
Remember that you must reduce tax attributes in other assets by the amount of debt that is cancelled. This is something that I’ve blogged about before and will blog about again as it can be very confusing to calculate.
Some other things I’ve learned include:
1. A tax lien attached to a bankruptcy estate’s property generally takes effect after property or proceeds transfers back to the debtor presuming the tax is not discharged.
2. The IRS may file a proof of claim in the bankruptcy court the same way as other creditors even if the taxes have not yet been assessed or are subject to a Tax Court proceeding.
3. If the IRS filed a notice of federal tax lien before the bankruptcy petition was filed, the IRS will have a secured claim to the extent the lien attached to equity in the debtor’s assets and will be treated as such in the bankruptcy case.
4. Relief from the failure-to-pay or timely file penalties are generally not available for a failure to submit tax withheld from others under obligation to the U.S. Treasury exists such as employer ‘trust fund’ employment tax obligations.
5. The period of time for collection of tax is generally 10 years from the date of assessment. This is extended for the period during which the IRS is prohibited from collecting due to bankruptcy plus 6 months.
6. The same exceptions to discharge that apply to individuals in chapter 7 cases apply to individuals in chapter 11 cases. A corporation in chapter 11 may receive a broad discharge when the plan is confirmed but secured and priority claims must be satisfied under the plan.
7. If a tax is discharged, the discharged tax may still be collected from the debtor’s previous bankruptcy property if the IRS filed a Notice of Federal Tax Lien before the bankruptcy petition was filed mostly because perfected liens generally pass through bankruptcy unaffected, even if the debtor’s personal liability for the debt is discharged.
8. Keep in perspective that not all tax debts may be discharged via bankruptcy. In fact many tax debts are excepted from the bankruptcy discharge. According to the IRS in chapter 7 taxes entitled to “eighth priority” treatment include;
a. taxes assessed when no return was filed,
b. taxes for which a return was filed after 2 years before the bankruptcy petition was filed,
c. taxes for which a fraudulent return was filed.
9. Ultimately taxes associated with a willful attempt to evade are not discharged. Penalties however can be discharged if a reasonable cause threshold is achieved – unless of course the penalty relates to a tax that is not discharged.
According to IRS Publication 908, Bankruptcy Tax Guide, generally the automatic stay rules prevent a creditor from taking actions to collect debts incurred before a bankruptcy petition is filed. However automatic stay rules do not universally apply. Exceptions include an IRS exam to determine tax liability, a demand for tax returns, IRS notice of deficiency issuance, assessing tax or sending a demand for payment of assessed tax.
Taxes incurred during administration by the bankruptcy estate are given second priority treatment as administrative expenses.
Taxes arising in the ordinary course of your business or financial affairs in an involuntary bankruptcy case, after the filing of the bankruptcy petition but before the earlier of the appointment of a trustee or the order for relief, are included in the third priority payment category.
If you have employees, your employees’ portion of employment taxes on the first $10,950 (this amount adjusted every 3 years) of wages that they earned during the 180-day period before the date of your bankruptcy filing or the cessation of your business (whichever occurs first) is given fourth priority treatment. Your portion of the employment taxes on these wages, as the employer, is given eighth priority treatment.
Also some tax debts that arose before a bankruptcy case is filed are classified as eighth priority claims including:
Income taxes on gross receipts for a tax year ending on or before the date of the filing of the petition plus the previous 3 years for which a return, if required, is last due, including extensions.
Income taxes on gross receipts assessed within 240 days of the filing of the petition exclusive of any time during which an offer in compromise is pending plus 30 days.
Income taxes that were not assessed before the bankruptcy petition date, but were assessable as of the petition date, unless these taxes were still assessable solely because no return was filed, a late return was filed within 2 years of the filing of the bankruptcy petition, a fraudulent return was filed, or because the debtor willfully attempted to evade or defeat the tax.
Withholding taxes.
Employer’s share of employment taxes on wages, salaries, or commissions including vacation, severance, and sick leave pay last due within 3 years of the filing of the bankruptcy petition, including a return for which an extension of the filing date was obtained.
Excise taxes on transactions occurring before the date of filing the bankruptcy petition, for which a return, if required, is last due including extensions within 3 years of the filing of the bankruptcy petition.
When a rental home secured by a recourse loan is sold short you incur a loss on the disposition of the rental properties requiring the report of a sale as well as any income from the cancellation of debt. The cancellation of debt income is excluded from gross income to the extent you demonstrate insolvency. If for example you demonstrate insolvency in excess of the debt cancelled, none of the cancellation of debt income is included in gross income. Instead, IRS Form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness but not below zero.
If you do not qualify for cancellation of debt income exclusion, the cancelled debt that is included in gross income is reported on IRS Form 1040, Schedule E, line 3. Attach a statement that explains that the entry reported includes both regular rental income as well as cancellation of debt income.
September 30, 2011 John R. Dundon II Appeals & Audit Resolution, Cancelled Debt, IRS Appeal, IRS Audit, IRS Collections, IRS Enforcement, IRS Examination, IRS Levy, IRS Lien, IRS Mediation, IRS Penalties, IRS Penalty and Interest Abatement The IRS as many of you are painfully aware is often looked upon as accusing first without due process requiring the tax payer to shoulder the burden of proof in regards to his or her innocence relevant to the Internal Revenue Code. In other words there is no such concept as ‘innocent until proven guilty’ when it comes to IRS audits. Systematically the IRS conducts correspondence exams routinely requiring tax payers to defend themselves. That is how the United States Treasury rolls, deal with it. Shifting the burden of proof back onto the IRS is almost always an effective means of navigating through the process in route to a favorable resolution. How does one do that?
Under §6201(d) the taxpayer can shift the burden of proof to the IRS if he or she asserts a reasonable dispute with respect to the income reported on an information return like say for example a 1099-C Cancellation of Debt.
According to §7491(a) (1) the burden of proof is switched from the taxpayer’s responsibility to the IRS if the taxpayer submits
factual evidence contrary to the information return.
June 26, 2011 John R. Dundon II Appeals & Audit Resolution, Back Taxes Owed, Bankruptcy, Cancelled Debt, Self Employ, Small Business, Statutory Notice of Deficiency, Sub-chapter S, Tax Abuse, Tax Court, Tax Guidance & Preparation, Tax Problems & Requests, Tax Relief By law, the IRS has the authority to collect outstanding Federal taxes for 10 years from the date your tax liability was assessed. The 10-year collection period is suspended:
● while the IRS and the Ofice of Appeals consider a request for an installment agreement or an offer in compromise.
● from the date you request a CDP hearing until Appeals issues a CDP Notice of Determination or, if you seek review in the Tax Court, until the Tax Court’s decision becomes final, including appeals to a United States Court of Appeals.
● from the date you request innocent spouse relief until a final Notice of Determination is issued or, if you seek review in the Tax Court, the date the Tax Court decision becomes final and for 60 days thereafter. If, however, you appeal the Tax Court’s decision regarding your right to innocent spouse relief to a United States Court of Appeals, the collection period will begin to run 60 days after the filing of the appeal unless a bond is posted with the appeal.
● for tax periods included in a bankruptcy while the automatic stay is in effect, plus an additional six months.
● while you are residing outside the United States, if you are absent for a continuous period of at least six months. The amount of time the suspension is in effect will be added to the time remaining in the 10year period. For example, if the 10-year period is suspended for six months, the time left in the period we have to collect will increase by six months.
I’ve been asked 3 times in the last 24 hours or so about how and why an IRS 1099-C form was received when one was not expected because no debts were cancelled. The IRS 1099-C form is used by qualified lenders to report to the IRS as Income the Cancellation of a tax payer’s debt, presuming debt was cancelled. Unfortunately I’m sad to report that this is the time of the year when many taxpayers find out through mysterious ways such as unsuspecting arrivals in the mail of IRS form 1099-C from a collection agency that they have been a victim of identity theft. If this happens to you this is what I recommend.
First contact the issuer of the 1099-C and explain that you suspect that you are a victim of identity theft because the 1099-C was issued incorrectly. Depending upon the agency you can expect a wide range of responses from radio silence to actually offering assistance and direction in seeking relief.
If you get an uncooperative or reticent response then insist in writing that a ‘corrected 1099-C’ be issued by a specific date. If you find the issuer still uncooperative then you should submit a copy, not the original documents, of your valid Federal or State issued identification, such as a social security card, driver’s license, or passport, etc, along with a copy of a police report and/or a completed IRS Identity Theft Affidavit – Form 14039 . Send these documents to the IRS using one of the following options: Mailing address: Internal Revenue Service P.O. Box 9039 Andover, MA 01810-0939. FAX: Note that this is not a toll-free FAX number 1-978-247-9965. You should also contact the IRS Identity Protection Specialized Unit, toll-free 1-800-908-4490 for guidance. Hours of Operation: Monday – Friday, 8:00 a.m. – 8:00 p.m. your local time
If you suspect fraud on behalf of the issuer of the 1099-C complete IRS Form 3949-A. You may fill out IRS Fraud Info Referral Form 3949-A online, print it and mail it to: Internal Revenue Service Fresno, CA 93888. Although you are not required to identify yourself, it is helpful to do so. Your identity can be kept confidential.
You should also contact the Federal Trade Commission (FTC) at www.ftc.gov/bcp/edu/microsites/idtheft. Or, you can call 1-877-IDTHEFT (1-877-438-4338); TTY 1-866-653-4261. The FTC website is a one-stop national resource to learn about the crime of identity theft. It provides detailed information to help you deter, detect and defend against identity theft. Also, you should see if the crime you are a victim of is related to any cyber crime as well and consider filing an online complaint with the Internet Crime Complaint Center (IC3) at www.ic3.gov . The IC3 gives victims of cyber crime a convenient and easy-to-use reporting mechanism that alerts authorities of suspected criminal or civil violations. IC3 sends every complaint to one or more law enforcement or regulatory agencies that have jurisdiction over the matter. IC3’s mission is to receive, develop and refer criminal complaints regarding the rapidly expanding arena of cyber crime. For law enforcement and regulatory agencies at the federal, state, local and international level, IC3 provides a central referral mechanism for complaints involving Internet related crimes.The IC3 reflects a partnership between the Federal Bureau of Investigation, the National White Collar Crime Center and the Bureau of Justice Assistance. I would research all of these sites. You also should monitor your credit report periodically. Free credit reports are available online at www.annualcreditreport.com.
If you are forgiven debt and that forgiven debt is not considered income then you should prepare and file IRS Form 982 - Reduction of Tax Attributes Due to Discharge of Indebtedness.
Generally, the amount by which you benefit from the discharge of indebtedness is included in your gross income. However, under certain circumstances described in section 108 such as bankruptcy and insolvency, you can exclude the amount of discharged indebtedness from your gross income. You must however according to the form’s instructions file IRS Form 982 to report the amount excluded from income and the reduction of certain tax attributes dollar for dollar of the related investment in plant, property and equipment, etc.
If it is other business related debt that is forgiven or discharged for example then use Part I of Form 982 to indicate why any amount received from the discharge of indebtedness should be excluded from gross income and the amount excluded. Use Part II to report your reduction of tax attributes. The reduction must be made in the following order unless you check the box on line 1d for qualified real property business indebtedness or make the election on line 5 to reduce basis of depreciable property first. If you are a small business owner with a basis in a building that was repossessed that you ran your operations out of AND you had a Net Operating Loss (including carry forwards) the underlined preceding sentence is the most important thing to remember from this post. There are many reasons to consider foregoing basis in advance of NOL. Respond to me directly for more insight if you wish. Nevertheless unless you elect otherwise the oder with which you are to reduce your tax attributes are as follows:
Any net operating loss (NOL) for the tax year of the discharge (and any NOL carryover to that year (dollar for dollar);
Any general business credit carryover to or from the tax year of the discharge (33 1⁄3 cents per dollar);
Any minimum tax credit as of the beginning of the tax year immediately after the tax year of the discharge (33 1⁄3 cents per dollar);
Any net capital loss for the tax year of the discharge (and any capital loss carryover to that tax year) (dollar for dollar);
The basis of property (dollar for dollar);
Any passive activity loss (dollar for dollar) and credit (33 1⁄3 cents per dollar) carryovers from the tax year of the discharge; and
Any foreign tax credit carryover to or from the tax year of the discharge (33 1⁄3 cents per dollar).
Use Part III to exclude from gross income under section 1081(b) any amounts of income attributable to the transfer of property described in that section.
Debt that is forgiven is considered income for taxes purposes and is reportable to the IRS. The debt forgiven is reported by the lender to the IRS on form 1099-C. The debt forgiven is reported by the taxpayer as other income on Form 1040, Line 21. Taxpayers can exclude the debt forgiveness if it qualifies as qualified principal residence indebtedness before January 1, 2013 [§108(a)(1)]. The exclusion is taken on Form 982 – Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1802 Basis Adjustment)
Interesting side note…… The new significantly modified debt will generate debt forgiveness income if the new debt is less than the balance of the old debt under §108(e). The basis of the taxpayer’s principal residence is then reduced by the amount of the income excluded using Form 982 [§108(h)(1)].
During 2002 and 2003, Mary allowed her daughter Susan and son-in-law Robert to charge $30,238 on her American Express account. Dumb Ass! As predicted and on queue, the couple divorced and could no longer make payments for their charges to the account.
At Mary’s request, an understanding was arrived at whereby she would make payments on the card and pay the balance in full and Robert would pay her back. Mary repeatedly tried to collect the unpaid debt allegedly owed to her by Robert, but to no avail. Thus, in December 2006 she canceled the uncollectible debt and filed a Form 1099-C, Cancellation of Debt, with her 2006 tax return. She imputed the entire debt to Robert, reported nothing to her daughter, and claimed a nonbusiness bad debt deduction in the form of a short-term capital loss on her Schedule D (Form 1040).
Robert filed suit claiming that the Form 1099-C issued by Mary for the alleged charges is false and fraudulent because she is not an “applicable entity” that is required to file an information return. Therefore, she is prohibited from filing Form 1099-C, and the fraudulent filing is actionable per se under §7434.
An information return must be filed under §6050P when any applicable entity discharges $600 or more of indebtedness. An applicable entity is a governmental agency, a financial institution, or other organization in the business of lending money. Hayes is not an applicable entity, so she is not required to file Form 1099-C.
However, the limited issue for decision in this case is whether a non-applicable entity is permitted or forbidden to file Form 1099-C. There is no binding, on-point legal authority. However, Service Center Advice 1998-020 concludes that “individuals or entities not required by §6050P to file Form 1099-C may nevertheless voluntarily file such forms in appropriate circumstances.” Nothing specifically prohibits an individual from filing Form 1099-C if such individual cancels a bona fide, uncollectible debt and takes a bad debt deduction under §166(d).
It is hard to say such an individual willfully filed a fraudulent information return. In addition, there is no reason to prohibit a non-applicable entity from filing a Form 1099-C, provided it is truthful and accurate. In fact, this may encourage debtors to properly include it in gross income.
Lastly, Mary testified that her daughter told her that she was required to issue a IRS Form 1099-C in order to take a bad debt deduction. This tends to indicate that she filed a Form 1099-C in error, not fraudulently.
Thus, the Court ruled that the filing of a Form 1099-C by someone other than an applicable entity is not fraudulent or actionable per se under §7434. Robert cannot prove fraud merely by providing that Mary filed a Form 1099-C in which she claimed to discharge Robert’s alleged debt. Whether Hayes filed an intentionally false, erroneous, or fraudulent return in any other respect is left for a jury to decide.
