Archive for Taxable Income
May 1, 2012
John R. Dundon II
Business Expense, Disallowed Expenses, IRS Appeal, IRS Audit, IRS Collections, IRS Enforcement, IRS Examination, Moving Expenses, Tax Guidance & Preparation, Tax Problems & Requests, Tax Records, Taxable Income
Recently the IRS’ Outreach Corner published an article stating that if you’re searching for a job, “you may be able to deduct some of your expenses, such as attending career fairs, moving expenses and submitting resumes, on your tax return as long as you are looking for a new job in your current occupation.”
This is a true statement of fact however I worry for taxpayers because particular care needs to be had in understanding, substantiating as well as representing how long it has been since your last ‘job’ as well as whether the new ‘job’ in question is in the same ‘occupation’ as your previous ‘job’ and ultimately what the definition of a ‘job’ really is. These are the questions I am regularly faced with in IRS audits when job search expenses are being scrutinized and in Appeals if job search expenses have been disallowed.
For more information about job search expenses check out:
In Summary
• Job search expenses fall into the category of miscellaneous itemized deductions on Schedule A, Itemized Deductions. If your total itemized deductions are higher than the standard deduction, it’s generally better to choose to include your itemized deductions. Also, in most cases, these expenses must exceed your adjusted gross income by two percent to provide a tax benefit.
• Expenses incurred while searching for a job in your current occupation can be deductible. However, you may not deduct expenses incurred while looking for a job in a new occupation.
• Fees paid to employment and outplacement agencies are deductible. However, if your employer reimburses you for these fees in a later year, you must include the amount in your gross income up to the amount of your tax benefit in the earlier year.
• Costs for resume preparation and postage for mailing your resume to prospective employers is deductible.
• Travel expenses may be deductible if the primary purpose for the trip is to look for a new job. The amount of time you spend on personal activity compared to the amount of time you spend looking for work is important in determining whether or not the trip is primarily personal or primarily to look for a new job.
• Moving costs to a new job location may be deductible. However, you must meet certain criteria relating to distance moved and timing of the move. See IRS Publication 521, Moving Expenses.
• Job search expenses cannot be deducted if there was a substantial break between the end of your last job and the time you began looking for a new one.
• You cannot deduct job search expenses if you are looking for a job for the first time.
If you happen to be awarded a settlement you need to be careful in how the proceeds are reported to avoid scrutiny by the taxing authorities. I just closed a file today in IRS Examination the facts of which surrounded unintentional incorrect reporting of a settlement. While wrapping loose ends up with the taxpayer we came up with a list of10 facts about reporting a settlement that had he known in advance would have saved a LOT of (my) time and (his) money. They are as follows:
1. Whether your settlement or award is excluded from income depends on whether the nature or source of the claim was due to physical injury or physical sickness.
2. Non-excluded income from a lawsuit must be reported on an information document like IRS Form 1099-MISC sent to the plaintiff and/or the plaintiff ’s attorney as well as to the IRS.
3. Even if a portion of the settlement is for physical injuries, and therefore excluded from income, amounts paid for medical expenses that were previously deducted would need to be included in income.
4. Attorney fees are treated separately and may be partly excluded.
5. If a portion of the settlement amount was due to injury, it is excluded under IRC Sec. 104(a)(2). This includes not only medical expense reimbursement for the injury, but also any damages for lost wages or earnings, sickness due to complications from the physical injury, or emotional distress caused by the injury.
6. If any portion of your settlement is taxable, the attorney fees allocated to the taxable portion of the settlement are includible in income.
7. Generally, the taxable portion of the settlement is reported on line 21 of IRS Form 1040 - other income. Deductible attorney fees are reported as a miscellaneous itemized deduction, subject to the two-percent-of-AGI limitation, on IRS Form 1040 Schedule A.
8. If the accident involved an automobile used for business, any taxable settlement income and associated deductible fees should be reported on Schedule C or on a corporate tax return if appropriate.
9. If the taxable portion of the settlement does not match up to the net amount shown on Form 1099-MISC, it is likely that IRS’ automated under-reporter (AUR) program will pick up the discrepancy.
10. To avoid an IRS CP-2000 letter, it is helpful to attach a statement and appropriate portions of the settlement explaining the nature of the claim and settlement and how these items were reported.
Reporting back pay is not as straight forward as one imagines.
If you issued back pay you should report it on IRS Form W-2 (in boxes 1, 3, and 5) for the year payment is made.
If any punitive damages are involved in a settlement they should be reported by the company on IRS Form 1099-MISC because they are not payment for actual wages.
If the settlement included attorney fees, they are also reported on IRS Form 1099-MISC, whether they were paid directly to an attorney or not.
Interest associated with either the wages or the punitive damages is reported on IRS Form 1099-INT.
If you receive back pay you report the wage portion of the settlement on the tax return for the year in which the back pay is received. Note that only the part of the settlement that relates
to the back pay is subject to payroll taxes.
Interest paid on the settlement is taxable and likewise reported on the return for the year it is received.
IF you receive punitive damages they are reported as other income on line 21 of IRS Form 1040.
Finally, note that any attorney fees associated with the lawsuit may be deducted as a miscellaneous itemized deduction subject to the two-percent-of-AGI threshold.
A foreclosure on rental property technically involves the sale of the property back to the lender. Form 1099-A Acquisition or Abandonment of Secured Property reports that the lender has repossessed or foreclosed on the property. Box 2 is the amount of the outstanding mortgage debt, and box 4 is the fair market value of the property. If the value of the foreclosed property exceeds the amount of outstanding debt, the debt is considered fully satisfied because the value of the property exceeds the outstanding debt meaning that there would be no debt to cancel after the lender acquires the property.
However if the lender also cancels debt associated with the transaction, there may be income to report from the cancellation of debt on IRS Form 1099-C.
When a foreclosed property is ‘sold’ back to the lender the gain or loss on that transaction is realized by the property owner or taxpayer. The gain or loss is the difference between the amount realized when the property is sold and the taxpayer’s adjusted basis or cost in purchasing and upgrading the property. IRS Publication 551 Basis of Assets is a good source of information on how the basis in the property might be increased or decreased during ownership.
The realized amount is contingent on whether the debt is recourse debt or non-recourse debt. If the debt is non-recourse debt the lender essentially cannot claim assets of the debtor if the secured property does not fully satisfy the outstanding debt. If the debt is recourse debt the lender essentially claims assets of the debtor when the secured property does not fully satisfy the outstanding debt. When the foreclosure involves recourse debt the amount realized is the smaller of the outstanding debt immediately before the foreclosure reduced by any amount of recourse debt for which the taxpayer was liable, or the fair market value of the property.
It is important to remember that Sec. 1245 property in the rental unit may be subject to depreciation recapture which is taxed as ordinary income and also that Sec. 1250 property does not necessarily require depreciation recapture particularly if the straight-line method is used. Sec. 1231 basically says that if the property is foreclosed or ‘sold’ at a loss, the loss is categorized as an ordinary loss not a capital loss.
The sale of the property is reported on IRS Form 4797 Sales of Business Property. The sale of the building is reported in Part I of Form 4797 if sold at a loss and in Part III if sold at a gain. Report the sale of the land separately in Part I, whether sold at a gain or loss. Any non-recaptured Sec. 1250 gain is entered in Part III of Schedule D Form 1040 Capital Gains and Losses.
Now is a GREAT TIME OF YEAR TO MAKE A CHARITABLE DONATION if you are so fortunate. When you make a donation to a charity you may be able to take a deduction for it on your tax return as long as you secure the proper documentation substantiating the donation and its subsequent value. In route to making your charitable contribution decisions ….
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Make sure the organization qualifies Charitable contributions must be made to qualified organizations to be deductible. You can ask any organization whether it is a qualified organization or check IRS Publication 78, Cumulative List of Organizations.
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What you can deduct You generally can deduct your cash contributions and the fair market value of most property you donate to a qualified organization. Special rules apply to several types of donated property, including clothing or household items, cars and boats. This is done on page 2 of Schedule A of IRS Form 1040.
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When you receive something in return If your contribution entitles you to receive merchandise, goods, or services in return – such as admission to a charity banquet or sporting event – you can deduct only the amount that exceeds the fair market value of the benefit received.
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Record keeping Keep good records of any contribution you make, regardless of the amount. For any cash contribution, you must maintain a record of the contribution, such as a cancelled check, bank or credit card statement, payroll deduction record or a written statement from the charity containing the date and amount of the contribution and the name of the organization.
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Pledges and payments Only contributions actually made during the tax year are deductible. For example, if you pledged $500 in September but paid the charity only $200 by Dec. 31, you can only deduct $200.
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Donations made near the end of the year Include credit card charges and payments by check in the year you give them to the charity, even though you may not pay the credit card bill or have your bank account debited until the next year.
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Large donations For any contribution of $250 or more, you need more than a bank record. You must have a written acknowledgment from the organization. It must include the amount of cash and say whether the organization provided any goods or services in exchange for the gift. If you donated property, the acknowledgment must include a description of the items and a good faith estimate of its value. For items valued at $500 or more you must complete a Form 8283, Noncash Charitable Contributions, and attach the form to your return. If you claim a deduction for a contribution of noncash property worth more than $5,000, you generally must obtain an appraisal and complete Section B of Form 8283 with your return.
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Tax Exemption Revoked Approximately 275,000 organizations automatically lost their tax-exempt status recently because they did not file required annual reports for three consecutive years, as required by law. Donations made prior to an organization’s automatic revocation remain tax-deductible. Going forward, however, organizations that are on the auto-revocation list that do not receive reinstatement are no longer eligible to receive tax-deductible contributions.
Other Links Worth Checking Out:
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Publication 526, Charitable Contributions (PDF)
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Publication 561, Valuing of Donated Property (PDF)
Generally if payments are in exchange for partnership property, the amount received in excess of the partner’s outside basis in his/her partnership interest is taxed as capital gain. However if the payments represent a distributive share of partnership income or are deemed to be guaranteed payments, the payments are taxed as ordinary income.
According to Tax Court Memo 2009-243 Wallis v. Commissioner, retirement payments to a withdrawing partner as part of the liquidation of his/her partnership interest under §736 were considered essentially the equivalent of guaranteed payments and taxed as ordinary income. Yikes! So be careful to take the time to document.
In order to be allocated and taxed accordingly under Reg. §1.736-1(a) (2), payments for a partner’s interest should be clearly defined as distributions for partnership property or guaranteed payments.
This is a review of of tax court case John T. Bayse v. Commissioner TC Summary Opinion 2010-118. The bottom line is that if you are injured on the job be sure to think carefully about whether you wish to be relieved via worker’s compensation which is customarily not considered taxable income or some other method available to you through a union contract etc. Here is a brief synopsis of the case in question.
Firefighter John Bayse suffered a “hazardous duty injury.” From the date of his injury until his retirement from the fire department in December 2006, John was on hazardous duty injury status and paid pursuant the terms of the collective bargaining agreement (CBA) between the City of Cleveland and the Cleveland firefighters union.
John continued to receive payments for two years and was deemed permanently disabled effective January 1, 2007, allowing him to start receiving payments from his retirement plan. John timely filed his 2006 income tax return including gross wages earned from Rural Metro Corporation, interest income, and his state income tax refund.
Following an audit of John’s 2006 income tax return, the IRS sent him a notice of deficiency, stating that income received must be included as income in 2006 because it does not represent an amount received under a workmen’s compensation act as compensation for personal injury or sickness under §104(a)(1). The Tax Court agreed and ruled that the payments John received in 2006 while on hazardous duty injury status must be included in his gross income.
If you think you have a viable ongoing business with a profit motive be sure to maintain adequate financial records on a computer that you back up off site on a regular and consistent basis. Also be aware that in the tax court case of Chandler v. Commissioner (TC Memo 2010-92) the significance of inadequate hand kept records was a major determining factor in ruling that the tax payer’s horse breeding business was actually a hobby and not a business.
Even though the tax code states that handwritten records are an acceptable method for maintaining the accounting books as long as the records are accurate and provide substantial information for the taxpayer to prepare the tax return [Reg. §1.446-1(a)(4)], the tax court’s determination as drafted in TC Memo 2010-92 compels me to ALWAYS recommend the use of bookkeeping software.
In this case the IRS issued a deficiency notice citing lack of profit motive under §183 for horse breeding, training and racing activities. The IRS also determined Jo Anne, the tax payer, was liable for a §6662(a) accuracy related penalty in regard to maintaining adequate books and records for her horse breeding and training business.
The Tax Court determined the handwritten records Jo Anne kept
did not prove to be accurate or substantial. The Court also found
Jo Anne was able to reduce taxable income by approximately 40 percent for the years in question by claiming losses on her Schedule F relating to the horse breeding and training activities. Because the taxpayer did not provide the Court with adequate records and was unable to prove she was engaged in these activities for a profit otherwise, the dis-allowance of the deductions under §183(a) increased Jo Anne’s tax liability and she was held liable for the tax along with interest and penalties for the years under review.
