Archive for Taxable Income
In 1913, the collection of income tax was not intended to be collected from the masses, only from the rich, only those making $20,000 or more. How much did the average American family make in 1913? I would suspect that, just as today, it would depend upon where in the country you live. Some resources claim average salaries as low as $750/year and some as high as around $3,000/ yr. In either case, back in 1913 the average family in the United States was living far, far below the threat of paying income tax. And that was the intent of the government back then. The government was very concerned that the ‘little people’ be able to feed their families, pay their bills and save for their retirement.
The Internal Revenue Service now processes more than 145 million tax returns each year. The Internal Revenue Code is now more than 3.4 million words. If printed 60 lines to a page, it would fill more than 7,500 letter size pages.
So perhaps while we fill out our tax returns this year, we should fill our glass with our favorite drink and ponder what it will take to get back to the intent of the 16th amendment
A taxpayer came to me today for verification on dependent care expenses. Their basic profile may be similar to yours. A husband and wife with two children in day care. The wife is a full time student that does not work outside of the house. The husband was laid off from his former job and has been regularly seeking gainful employment throughout the duration of the tax year in question.
These good people were told by a cog in a tax preparation franchise that they did not qualify for dependent care expenses because neither had employment income. Of course I got pissed off because I’m just so sick and tired of tax practitioner ineptitude and deceit that I felt compelled to throw down this post at the end of a long day which is basically a brief overview of IRS Publication 503, Child and Dependent Care Expenses reported on IRS Form 2441.
This can be a hard topic to understand. Here’s the basic deal on dependent care – expenses paid while either working, seeking employment or attending school are qualified dependent care expenses under IRC [§21(e)(7); Reg. §1.21-1(a)(3)]. As long as the husband/wife file a joint return, the expenses paid while the wife attends school full-time for at least five months of the year and the expenses paid while the husband actively seeks employment are qualifying dependent care expenses.
A taxpayer who is a student is deemed to have earned $250 per month thus meeting the earned income requirement of §21. This is what tripped up the neophyte tax practitioner.
Regarding the Child and Dependent Care Tax Credit, according to IRS Tax Topic 602 this tax credit is “generally a percentage of the amount of work-related child and dependent care expenses you paid to a care provider. The percentage depends on your adjusted gross income. Work-related child and dependent care expenses qualifying for the credit are those paid for the care of a qualifying individual to enable you to work or actively look for work for any period when you had one or more qualifying individuals. Expenses are paid for the care of a qualifying individual if the primary function is to assure the individual’s well being and protection.”
Three points that tend to trip taxpayers up are:
1. In general. amounts paid for services outside your household qualify for the credit if the care was provided for a qualifying individual who (i) was your qualifying child under age 13 or (ii) regularly spent at least 8 hours each day in your household.
2. The expenses qualifying for the credit must be reduced by the amount of any dependent care benefits provided by your employer that you excluded from gross income.
3. The total expenses qualifying for the credit are capped at $3,000 (if you had one qualifying individual) or at $6,000 (if you had two or more qualifying individuals), and may not exceed the lesser of your and your spouses earned incomes.
A qualifying individual is:
1. Your dependent who was under age 13 when the care was provided and was your qualifying child
2. Your dependent who was physically or mentally incapable of self-care and who had the same principal place of abode as you for more than half of the year, or
3. An individual who was physically or mentally incapable of self-care, had the same principal place of abode as you for more than half of the year, and was your dependent. For this purpose, whether the individual was your dependent is determined without regard to the individual’s gross income, whether the individual filed a joint return with the individual’s spouse, or whether you or your spouse could be claimed as a dependent on someone else’s return.
I’ve been engaged in a running dialog with extraordinary nuances as to whether a loosely organized group of people are or are not fully recognizing taxable revenue from engagement in barter transactions with each other. The nuances inside this topic ranged from record keeping (as in if neither party kept written record did a taxable transaction occur) to gift giving (as in is a fully depreciated tractor given to a relative for example a taxable event) to conspiracy to defraud (as in if we all agree that we are giving each other gifts inside the annual gift tax exclusion are there really any tax laws being violated).
The follow revenue sources are not considered taxable income:
Adoption expense reimbursements for qualifying expenses
Child support payments
Gifts, bequests and inheritances
Some, but not all, workers’ compensation benefits
Reimbursement for meals and lodging for the convenience of your employer
Compensatory damages awarded for physical injury or physical sickness
Cash rebates from a dealer or manufacturer
Examples of items that may or may not be included in your taxable income are:
Life insurance If you surrender a life insurance policy for cash, include in income all proceeds that are more than the cost of the life insurance policy. Life insurance proceeds, which were paid to you because of the insured person’s death, are generally not taxable unless the policy was turned over to you for a price.
Scholarship or fellowship grant If you are a candidate for a degree, you can exclude from income amounts you receive as a qualified scholarship or fellowship. Amounts used for room and board do not qualify for the exclusion.
Non-cash income Taxable income may be in a form other than cash referred to as bartering, which is an exchange of property or services. The fair market value of goods and services exchanged is fully taxable and must be included as income on Form 1040 of both parties.
All other items—including income such as wages, salaries, tips and unemployment compensation AS WELL AS REVENUE FROM BARTERING — are fully taxable and must be included in your income unless it is specifically excluded by law.
According to IRS administrative guidelines to its examiners concerning Rev. Rul. 2012-18, published in the 2012-26 Internal Revenue Bulletin, when performing a tip examination (aka audit), IRS examiners must ensure that service fees or charges are properly characterized as wages and not tips. If the payment is not a tip then it is a service charge and reported as wages.
Whether payments should be reported as tips or service charges basically distills down to whether the following factors were present:
(1) The payment was made free from compulsion;
(2) The customer had the unrestricted right to determine amount;
(3) The payment was not be the subject of negotiation or dictated by employer policy; and
(4) The customer determined who receives the payment.
Automatic gratuities (for parties of a certain size for example) should according to this directive to examiners be reported as service charges and not tips in my humble opinion. Comments on the interim guidance may be submitted either electronically at TIP.Program@irs.gov or in writing to:
Internal Revenue Service
National Tip Reporting Compliance
3251 North Evergreen Dr. NE
Grand Rapids, MI 49525
Also I learned that the IRS intends to solicit public comments on proposed changes to it’s existing voluntary tip compliance agreements. Specifically, the Tip Reporting Alternative Commitment (TRAC) program and other variations of TRAC agreements.
The principal author of this revenue ruling is Linda L. Conway-Hataloski of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt & Government Entities). For further information regarding this revenue ruling, contact Linda L. Conway-Hataloski at 202-622-0047.
Taxpayers who inherit IRAs also inherit the decedent’s basis or amount invested in those IRAs, regardless of the relationship between the beneficiary and the decedent. Ideally, the decedent will have filed IRS Form 8606 (Nondeductible IRAs), showing the amount of basis in the IRA. Any remaining basis in the IRA shown on Form 8606 then becomes the beneficiary’s basis. However, if the decedent did not file Form 8606, the taxpayer has the same challenges as any IRA owner in demonstrating that he or she has basis in the IRA.
If the decedent had no basis in the IRA at the date of death, the beneficiary is taxed fully on distributions from the inherited IRA which must equal or exceed the Required Minimum Distribution (RMD). If the decedent did have basis in the IRA, the beneficiary must file Form 8606. The 1099-R issued by the payer should identify whether there is basis in the IRA.
Generally, there are several options for how to handle the inherited IRA, and the RMD rules differ for each option. Check out these three:
1. Treat the account as her own IRA by designating yourself as the account owner. If you treat the IRA as your own, you will have to take RMDs if over 70 1/2. However, you may use your own life expectancy for the RMD calculation, so theoretically less will be withdrawn from the account with each distribution.
2. Roll the IRA into your own existing IRA or qualified plan subjecting yourself again to the RMD
3. Treat yourself as the beneficiary of the IRA instead of the owner and begin taking distributions over her life expectancy.
The basis and Fair Market Value (FMV) of an inherited IRA are kept separate from your basis and FMV in your own IRA. If you elect to treat the inherited IRA as your own, the inherited IRA could be aggregated with his other IRAs on Form 8606.
Beneficiaries must begin to take required distributions from the account by December 31 following the year of death. If the beneficiaries are nonresident aliens for U.S. tax purposes, the IRA trustee may need to withhold U.S. tax on the distributions.
If the owner of an IRA dies before reaching the required beginning date for RMDs, each beneficiary can take required minimum distributions based on her own life expectancy, or take a distribution of the entire account balance by December 31 of the calendar year that includes the fifth anniversary of the decedent’s death.
Unfortunately, according to IRC 4974 if an RMD is not taken, a hefty fifty-percent excise tax may be assessed. Penalties are reported on IRS Form 5329. The IRS however may waive the fifty-percent penalty if there was a reasonable cause for failing to take the distribution such as erroneous advice given, and steps to correct the error have been taken.
If there was a reasonable cause for failure to take the RMD, the taxpayers need not pay the fifty-percent excise tax when they file their tax returns. Form 5329 instructions direct the taxpayer to complete lines 50 and 51 and enter “RC” and the amount of waiver requested on the dotted line next to line 52. This amount should be subtracted from the total, with the tax paid on the remaining amount (line 53).
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:
• 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.
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.