Archive for Deductible Expense
Tax Treatment of a Reverse Mortgage
A reverse mortgage is generally a loan where a lender pays a lump sum, a monthly advance, a line of credit, or a combination of all three to you while you continue to live in your home and retain title to it. Plans vary but for the most part a reverse mortgage becomes due with interest when you move, sell your home, reach the end of a loan period, or get baptized into eternal life.
According to the IRS “because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable. Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until you actually pay it.”
Where many taxpayers get confused or duped by aggressive salesmen is that the mortgage interest deduction may be limited because a reverse mortgage loan generally is subject to the limit on Home Equity Debt discussed in Part II of Publication 936, Home Mortgage Interest Deduction. Basically the IRS limits treatment of reverse mortgage loans by allowing as a deductible interest expense on IRS Form 1040 Schedule A the amount of interest paid on up to a $100,000 mortgage debt threshold.
If a reverse mortgage is repaid by a descendant’s estate, the principal and interest accrued to the date of death are deductible on the estate tax return IRS Form 706 as a debt of the estate according to IRC Sec. 2053(a)(4). It is not deductible on the estate’s IRS Form 1041, because it is not an administrative expense of the estate.
If taxpayers who acquire property subject to a liability from a decedent pay off the interest on a reverse mortgage after the borrower dies, they can claim the interest in the year that they pay it, as a “deduction in respect of a decedent” under §691(b).
Reporting Non-Reimbursed Partnership Expenses
In regards to the correct treatment of deductible expenses incurred by a partner essentially the partnership agreement, or the general practice of the partnership, should clearly represent that the partners are responsible for certain expenses and that the partners are not eligible for reimbursement from the partnership, even upon request. This has been critical in several court cases.
According to IRS Private Letter Rulings the correct method for deducting partnership expenses that are not reimbursed by the partnership is to report the amount on IRS Form 1040 Schedule E, page 2, with a description of “UPE” (unreimbursed partnership expense). Reporting in this fashion allows a direct deduction of the expenses against partnership income.
If you report the deductions on IRS Form 2106, Employee Business Expenses, you are subjecting the deduction to the 2% Adjusted Gross Income limitation.
Self Employed Health Insurance Insurance Deduction: Worksheet v. IRS Publication 535
If you qualify to take the deduction, use the Self-Employed Health Insurance Deduction Worksheet to figure the amount you can deduct. However use IRS Publication 535 instead if any of the following applies.
You had more than one source of income subject to self-employment tax.
You file Form 2555 or 2555-EZ.
You are using amounts paid for qualified long-term care insurance to figure the deduction.
According to IRS INSTRUCTIONS you may be able to deduct the amount you paid for health insurance for yourself, your spouse, and your dependents. The insurance can also cover your child who was under age 27 at the end of 2011, even if the child was not your dependent. A child includes your son, daughter, stepchild, adopted child, or foster child.
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1. | Enter the total amount paid in 2011 for health insurance coverage established under your business | |||
(or the S corporation in which you were a more-than-2% shareholder) for 2011 for you, your spouse, and your dependents. Your insurance can also cover your child who was under age 27 at the end of 2011, even if the child was not your dependent. But do not include amounts for any month you were eligible to participate in an employer-sponsored health plan or amounts paid from retirement plan distributions that were nontaxable because you are a retired public safety officer | 1. | |||
2. | Enter your net profit* and any other earned income** from the business under which the insurance plan is established, minus any deductions on Form 1040, lines 27 and 28. Do not include Conservation Reserve Program payments exempt from self-employment tax | 2. | ||
3. | Self-employed health insurance deduction. Enter the smaller of line 1 or line 2 here and onForm 1040, line 29. Do not include this amount in figuring any medical expense deduction on Schedule A | 3. | ||
*If you used either optional method to figure your net earnings from self-employment, do not enter your net profit. Instead, enter the amount from Schedule SE, Section B, line 4b. | ||||
**Earned income includes net earnings and gains from the sale, transfer, or licensing of property you created. However, it does not include capital gain income. If you were a more-than-2% shareholder in the S corporation under which the insurance plan is established, earned income is your Medicare wages (box 5 of Form W-2) from that corporation. | ||||
One of the following statements must be true.
You were self-employed and had a net profit for the year.
You were a partner with net earnings from self-employment.
You used one of the optional methods to figure your net earnings from self-employment on Schedule SE.
You received wages in 2011 from an S corporation in which you were a more-than-2% shareholder. Health insurance premiums paid or reimbursed by the S corporation are shown as wages on Form W-2.
The insurance plan must be established under your business. Your personal services must have been a material income-producing factor in the business. If you are filing Schedule C, C-EZ, or F, the policy can be either in your name or in the name of the business.
If you are a partner, the policy can be either in your name or in the name of the partnership. You can either pay the premiums yourself or your partnership can pay them and report them as guaranteed payments. If the policy is in your name and you pay the premiums yourself, the partnership must reimburse you and report the premiums as guaranteed payments.
If you are a more-than-2% shareholder in an S corporation, the policy can be either in your name or in the name of the S corporation. You can either pay the premiums yourself or the S corporation can pay them and report them as wages. If the policy is in your name and you pay the premiums yourself, the S corporation must reimburse you. You can deduct the premiums only if the S corporation reports the premiums paid or reimbursed as wages in box 1 of your Form W-2 in 2011 and you also report the premium payments or reimbursements as wages on Form 1040, line 7.
But if you were also eligible to participate in any subsidized health plan maintained by your or your spouse’s employer for any month or part of a month in 2011, amounts paid for health insurance coverage for that month cannot be used to figure the deduction. Also, if you were eligible for any month or part of a month to participate in any subsidized health plan maintained by the employer of either your dependent or your child who was under age 27 at the end of 2011, do not use amounts paid for coverage for that month to figure the deduction.
If you were eligible to participate in a subsidized health plan maintained by your spouse’s employer from September 30 through December 31, you cannot use amounts paid for health insurance coverage for September through December to figure your deduction.
Medicare premiums you voluntarily pay to obtain insurance that is similar to qualifying private health insurance can be used to figure the deduction. Amounts paid for health insurance coverage from retirement plan distributions that were nontaxable because you are a retired public safety officer cannot be used to figure the deduction.
If you qualify to take the deduction, use the Self-Employed Health Insurance Deduction Worksheet to figure the amount you can deduct. However use IRS Publication 535 instead of the Self-Employed Health Insurance Deduction Worksheet in these instructions to figure your deduction if any of the following applies.
You had more than one source of income subject to self-employment tax.
You file Form 2555 or 2555-EZ.
You are using amounts paid for qualified long-term care insurance to figure the deduction.
Dependent Care Credit IRC 21
According to Internal Revenue Code Section 21, the maximum tax credit as of this posting date remains at $1,050 (35% of $3,000) for one qualifying individual and $2,100 (35% of $6,000) for two or more. This credit is for expenses paid for the care of your qualifying children under age thirteen, or for a disabled spouse or dependent, to enable you or your spouse (if Married Filing Jointly) to work or look for work.
A qualifying person is a dependent child, age twelve or younger and/or your spouse or other certain individuals who are physically or mentally incapable of self-care.
In order to qualify you (or your spouse if MFJ) must have earned income from wages, salaries, tips, other taxable employee compensation, or net earnings from self-employment.
Additionally:
1. Payments for care can not be made to a spouse or dependent.
2. You are precluded from the credit if your filing status is Married/separate.
3. The qualifying person must have lived in the home with you for more than 6 months.
4. You may use up to $3,000 of expenses paid in a year for one qualifying individual or $6,000 for two or more qualifying individuals to figure the credit.
5. Qualifying expenses must be reduced by the amount of any dependent care benefits provided by your employer that are excluded from income.
Most importantly:
If an individual is paid to come to your home and care for your dependent or spouse, you pretty much by default become a household employer liable for employment tax reporting and payment obligations. Check out IRS Publication 926.
Is Your Activity For Profit Allowing for Business Deductions – Rundlett v. Commissioner
You are allowed deductions for ordinary and necessary expenses incurred in the course of business under §162, but you must also keep adequate records to substantiate expenses which can at times seem esoteric if not convoluted. Deductible travel expenses for example under §274(d) are based on whether or not the travel relates to a business activity or is for pleasure, while §162(a)(2) specifically states the amounts cannot be lavish or extravagant under the circumstances.
No single factor or set of factors can determine if you are engaged in a business activity for profit, but all facts and circumstances must be taken into account §183-2(b). Three common questions are considered when determining whether or not the activity is for profit or a hobby subject to the hobby loss rules under §183.
• Did you conduct the activity in a manner similar to comparable activities that are profitable?
• Did you maintain complete and accurate books and records for the activity?
• Did you change operating procedures, adopt new techniques or abandon unprofitable methods to ensure profitability of the activity?
According to Douglas Rundlett, et ux. v. Commissioner TC Memo 2011-22, even though you may conducted an activity in a businesslike manner you should also demonstrate that you adopt new techniques or strategies to limit future losses or risk being viewed as being engaged in a not for profit activity or hobby.
Interest Deduction Determined Based on Use of Loan Proceeds – Ellington v. Commissioner
If you incur interest expense on loans you should use the tracing rules of Reg. §1.163-8T to determine whether the interest expense is for:
1. business
2. investment
3. passive activities. or is
4. personal in nature
The regulation focuses on the use of the loan proceeds, not the item or items used as collateral for the loan.
Reg. §1.163-8T(c)(1) even sets forth an example of a taxpayer pledging his corporate stock as security for a car loan. In the example, the conclusion is that the loan interest is personal based on its use to purchase a personal use vehicle. In order to properly deduct the interest, it is essential to determine and document the use of the loan proceeds received as evidenced in James Ellington, et ux. v. Commissioner TC Memo 2011-193.
Employee Tool and Equipment Plans
Tool and Equipment Plans generally require employees to provide their own tools. Some plans purport to receive tax-favored treatment as “accountable plans” under the definition of adjusted gross income in Internal Revenue Code § 62(c). If you are expected to use your own tools and equipment on the job and get reimbursed be very careful in understanding the definition of an “accountable plan” because the Internal Revenue Service has established a compliance team to address significant concerns with certain Employee Tool and Equipment Plans that purport to receive tax-favored treatment as accountable plans. It’s all spelled out in the Alert. Here’s the facts as I understand.
1. According to ILM 201120021 a reimbursement or other expense allowance arrangement that pays an amount regardless of whether an expense is paid or incurred or reasonably expected to be paid or incurred by the employee in performing services for the employer violates the business connection requirement of an accountable plan under Treas. Reg. § 1.62-2(d)(3)(i). Accordingly, payments made under the arrangement are treated as made under a nonaccountable plan. Amounts treated as paid under a nonaccountable plan must be included in the employee’s gross income for the taxable year, are subject to withholding and payment of employment taxes, and must be reported as wages or other compensation on the employee’s Form W-2.
2. The IRS’ Chief Counsel issued the following Advice – ILM 200745018 concluding that an employer’s tool reimbursement plan does not satisfy the requirements of an accountable plan.
3. IRS Revenue Ruling 2005-52 holds that tool allowances paid to employees are not paid under an accountable plan because the substantiation and return of excess requirements are not met.
4. A Coordinated Issue Paper Revised on July 2,2008 concludes that Employee Tool and Equipment Plans under which amounts are paid to employees for the use of their tools and equipment, do not meet the accountable plan requirements.
5. An IRS Private Letter Ruling (200930029) states that an employer’s expense reimbursement plan satisfies the business connection, substantiation, and return of excess requirements of an accountable plan. Payments made under the Plan were allowed exclusion from the Technician’s income and not considered wages subject to the withholding and payment of employment taxes because the Plan only reimbursed covered costs that the Technician substantiated.
If you are an employer that requires your employees to provide their own tools you may want to review and understand this private letter ruling and only provide reimbursement for tool expense upon written substantiation (aka receipt). It is best practice to understand the nuances of accountable and nonaccountable tool and equipment plans. A blanket payment made to an employee on a regular and consistent basis is usually considered income subject to employment tax regardless of what it is called.
Mortgage Refinancing Tax Deductible Expenses
With mortgage rates at levels not seen in generations and the banks finally starting to lend again many people have been calling with questions about the tax implications of refinancing. It can be a little confusing and this is my best attempt at explaining it in general terms without hitting line item detail of a HUD statement.
Mortgage interest is treated separately and distinctly from mortgage fees, charges and taxes. When loan proceeds are used for business or investment the charges are generally deductible over the life of the loan under Internal Revenue Code §162(a) or §212 and include among other items:
Overnight/courier fees
Underwriting fees
Credit report fees
Appraisal fees
Notary fees
Escrow fees
Title insurance fees
Document preparation fees
Flood certificate fees
Modification endorsement fees
