Michael Fitzsimmons CPA San Diego California

Don’t Claim Depreciation?? Part V: Depreciation Recapture

2010-03-20T13:22:00.000-07:00

This final installment in the series on whether to claim depreciation on a rental property or home office clarifies the term depreciation recapture. Since depreciation is an ordinary expense, without depreciation recapture a taxpayer could get an ordinary tax deduction in one year and then sell the asset in a later year and pay capital gains tax on the income that results from the basis reduction from depreciation. In addition to shifting income to a later year, this converts ordinary income into capital gain. This a great deal for the taxpayer. To prevent this, the depreciation recapture rules say that the portion of the gain that results from depreciation is taxed as ordinary income instead of capital gain. However, this is yet another area of the tax law where real estate investments really shine. Unlike other business assets, only the real property gain attributable to depreciation in excess of straight line depreciation is recaptured. Since real estate put into service after 1986 generally must be depreciated using the straight line method, there is typically no depreciation recapture on real property. However, there is unrecaptured Section 1250 gain, which is similar to depreciation recapture but uses a special “capital gains” tax rate not to exceed 25%. Since this is a capital gains rate, it is not technically depreciation recapture. While 25% is not as good as the capital gains rates for most assets, it sure beats paying tax at an ordinary rate of up to 35%.

© Michael Fitzsimmons, CPA, San Diego, CA http://fitz-cpa.com/

Don’t Claim Depreciation?? Part IV: Passive Activity Rules

2010-02-12T06:17:00.000-08:00

Continuing the discussion of whether to claim depreciation on a rental property or home office… The passive activity rules can suspend the deduction for depreciation so that it is not immediately available to offset ordinary income from such items as salary, interest, non-qualified dividends, self-employment earnings, and retirement/pension. Since rental losses are passive, it will still offset other passive income, either from the same property, other properties, or a flow-through entity such as a partnership, limited liability company (LLC), S-corporation, estate, or trust. But any suspended deduction is carried forward until adjusted gross income drops below $150,000, or positive passive income is realized, or the property is sold. So even if the depreciation deduction is suspended under the passive activity rules, you are almost always no worse off than if you did not claim the depreciation, and will usually be much better off.

Automobile Mileage Tax Deduction – Mileage Logs

2010-02-05T09:05:00.000-08:00

A recent court case illustrates the importance of automobile mileage logs. A self-employed salesperson did not keep a mileage log and instead tried to prove his business use of automobile by such means as a random sampling of invoices and odometer readings at beginning and end of year. This evidence fell far short of the strict record-keeping requirements for business use of automobile tax deductions, which require the date, location, business purpose, and number of miles for each trip. Douglas A. Royster v. Commissioner, (2010) TC Memo 2010-16. IRS standard mileage rates provide deductions for business use of an automobile of $0.55 per mile for 2009 and $0.50 for 2010.

Don’t Claim Depreciation?? Part III: Time Value of Money

2010-02-04T06:01:00.000-08:00

Previous installments of this series discussed depreciation concepts for rental real estate property owners and taxpayers claiming the home office deduction, including “allowed or allowable” and capital gain vs. ordinary tax rates. Another reason to claim the depreciation when allowed is the time value of money. If you claim a depreciation deduction now and offset your salary or other ordinary income, but you don’t pay tax on the related capital gain until you sell the property, maybe 10 years or more in the future, you effectively earn interest or an investment return on the amount of deferred tax during the interim. This is a basic wealth-building concept that should be employed whenever possible. To take it one step further, you may use a Section 1031 exchange to defer the capital gain indefinitely or use the ultimate tax strategy: die while still owning the property and get a step-up in basis for your heirs so that the tax gain just disappears.

How is a the Income of a Decedent’s Estate Taxed?

2010-02-03T06:14:00.000-08:00

Many people know that the estate tax applies only to estates of several million dollars, but that doesn’t mean that an estate has no tax obligations. An estate must file an income tax return and, depending on the timing of distributions, pay income tax. Typical items of taxable income include interest, dividends, and capital gains. An estate reports income and deductions similarly to a complex trust on IRS Form 1041. However, there are some important differences, such as choice of fiscal year, quarterly estimated tax payments, and rental real estate losses. Often a person dies with assets held in a revocable trust and some or all of the trust becomes irrevocable upon death. Typically this results in the creation at death of two taxable entities, the decedent’s estate and the irrevocable trust. If proper procedures are followed, income tax law allows these two entities to be combined for income tax return purposes. This usually results in more favorable tax rules, and, since only one income tax return is required per year, saves on professional tax preparation fees.

Business Use of Cell Phone Record-Keeping Required

2010-02-02T06:38:00.000-08:00

Cell phones are used all the time in business. What many people don’t know is that tax deductions for business use of cellular phones are not guaranteed. Since cellular telephones are "Listed Property" under Internal Revenue Code Sections 274 and 280F, the IRS can require taxpayers to produce detailed records to justify the business tax deductions. Tax regulations require evidence of the amount, date/time, and the business purpose of each business use of a cellular phone. Most expenses other than the purchase of the phone will be listed on your cellular phone bills, which will provide the dollar amounts and dates/times of usage. However, the law technically requires taxpayers to prove the business purpose of each call. Although this is an unreasonably burdensome record-keeping requirement, it is the letter of the law. Luckily, this may change this year. Commissioner of the IRS Douglas Shulman recently stated that he is optimistic that Congress will pass a law this year so that personal use of employer-provided cell phones is not taxable.

When is a Trust Income Tax Return, Form 1041, Required?

2010-01-29T06:57:00.000-08:00

For income tax purposes, the IRS does not recognize that a trust exists when it is revocable. Accordingly, all of a revocable trust’s income and tax deductions are reported on the grantor’s personal income tax return. No trust income tax return, IRS Form 1041, needs to be filed unless the trustee is someone other than the grantor. Because of this, a revocable trust typically does not need to obtain a tax identification number, or FEIN (Federal Employer Identification Number). When a revocable trust turns into an irrevocable trust, which typically occurs when the grantor dies, a trust income tax return, IRS Form 1041, usually must be filed each year. However, no trust income tax return is required if all of these conditions are met: there is no taxable income, gross income is less than $600, and there is no nonresident alien beneficiary. When a trust tax returns is filed and there is a distribution or deemed distribution to a beneficiary, the beneficiary receives a Schedule K-1 showing the share of income and tax deductions. http://fitz-cpa.com/trust_estate.aspx

Don’t Claim Depreciation?? Part II: Tax Rates

2010-01-28T04:37:00.000-08:00

My previous entry in this series explained that rental real estate property owners and taxpayers claiming the home office deduction have to pay tax on the depreciation that they could have deducted even if they didn’t claim it on their tax returns over the years. Ouch! Luckily, there is a provision in the tax law that allows you to catch up your depreciation deductions in the year you sell the property. What does it matter if you get a deduction in the year of sale for the same dollar amount as the extra gain it relates to? It can be of huge importance because the depreciation deduction first offsets your ordinary income, such as rental income, salary, interest, non-qualified dividends, self-employment earnings, and retirement/pension income that is taxed at your highest marginal ordinary tax rate, whereas the gain attributable to the depreciation is taxed at a maximum capital gains tax rate of 25%. That’s a great deal: the deduction offsets other ordinary income and the corresponding income is a capital gain. This is the core of the foolishness of not claiming depreciation to which you are entitled. A future installment in this series will discuss how the passive activity rules can delay the ordinary tax deduction. http://fitz-cpa.com/real_estate.aspx

2009 Tax Deduction for Haiti Earthquake Donation

2010-01-27T07:14:00.001-08:00

Haiti earthquake relief donations can be deducted on either the 2009 or 2010 income tax return. As with other charitable contributions, the taxpayer must itemize deductions on Schedule A. The contribution must be fully earmarked for the relief of victims in areas affected by the Jan. 12 earthquake in Haiti. Generally, only contributions to U.S. charities are tax-deductible. Most such organizations are listed in an IRS searchable, online database available under “Search for Charities” (http://www.irs.gov/charities/article/0,,id=96136,00.html ). But some organizations, such as churches or government agencies, may be qualified even though they're not listed on IRS's website. Contributions to foreign organizations generally aren't deductible.

GAO S Corporation Report

2010-01-25T05:46:00.000-08:00

The U.S. Government Accountability Office (GAO) recently released the report “Actions Need to Address Noncompliance with S Corporation Tax Rules.” The report included compilation of statistics on S corporation income tax returns, return preparation errors, and ideas on squeezing more payroll or self-employment taxes from S corporation shareholder-employees.

From tax year 2000 to 2006, the total number of S corporations increased 35% to almost 4 million. S corporations grew from 11.4% of all entities in tax year 2000 to 12.6% in tax year 2006. The S corporation is the most popular business entity. Although an S corporation can have up to 100 shareholders, in tax year 2006, 60% had just a single shareholder, 89% had two or fewer shareholders, and 94% had three or fewer shareholders.

Regarding the accuracy of S corporation tax return reporting, 68% of returns filed for tax years 2003 and 2004 (the years data were available) misreported at least one item. About 80% of the time the misreporting provided a tax advantage to the corporation and/or shareholder. Common reporting errors included shareholder distributions, personal expenses, and unsubstantiated deductions. The GAO estimated that 71% of S corporations that used a paid preparer for their returns were noncompliant.

The GAO estimated that 13% of S corporations paid shareholder wage / salary compensation that was not reasonable (too low), resulting in just over $23.6 billion in net underpaid wage compensation to shareholders. The median misreporting adjustment for underpaid shareholder compensation was $20,000. The GAO also found that the fewer the number of shareholders, the more likely an S corporation was to pay an unreasonable salary to a shareholder-employee.

The report recommended a number of tax law changes to mitigate the S corporation tax return errors, including subjecting to self-employment tax the entire net income of the S corporation, or of service sector S corporations, or income attributable to majority shareholders. Other alternatives include subjecting to payroll taxes not just shareholder wages but also distributions, or all payments up to a certain dollar amount.

These ideas have been kicked around for years, and although there is a threat that taxes may increase, there is no specific tax law change on the horizon that would hamper the huge self-employment / payroll tax savings that can be achieved through an S corporation.

Trust Modification – Court-Approved

2010-01-21T07:42:00.000-08:00

In a recent private letter ruling, the IRS determined that a court-approved modification of a revocable trust created by a decedent and spouse doesn’t provide the surviving spouse with a “general power of appointment”. Therefore, the value of assets in by-pass trust won't be included in surviving spouse's gross estate. Trust assets were to be divided upon death of first spouse among by-pass trust, marital trust, and survivor's trust. (PLR 201002013)

LLC Member’s Income Subject to Self-Employment Tax

2010-01-20T09:44:00.000-08:00

Tax law had been unclear for years to what extent self-employment tax must apply to income earned by a Limited Liability Company member. Taxpayers and the IRS over the years have taken positions that LLC units are the same as limited partnership interests, general partner interests, or sometimes one and sometimes the other. Congress has not passed any law to clarify the issue. Recently, however, an important Tax Court case, Garnett (132 T.C. No. 19), provided some clarification. Although the case was about the application of the passive activity rules to LLC income, the court’s conclusion on the nature of LLC units impacts self-employment tax. The tax court found that LLC units are not the same as limited partnership interests under federal tax law. In the past some had argued that LLC income is not subject to self-employment tax because LLC interests are the same as limited partnership interests, which are by definition not subject to self-employment tax. In light of this new court case, that argument is no longer valid.

2009 Tax Deduction for Haiti Earthquake Donation

2010-01-19T06:40:00.000-08:00

A charity contribution tax deduction may be possible on 2009 tax returns for donations to 501(c)(3) nonprofit organizations providing relief to the Haiti earthquake victims, even though the donations are made in 2010. Leaders in congress have made it known that they intend to introduce legislation to make this tax law change. Similar tax rules were made for January of 2005 donations to charity organizations helping victims of the Dec. 26, 2004, Indian Ocean tsunami.

Don’t Claim Depreciation?? Part I: Allowed or Allowable

2010-01-18T17:10:00.000-08:00

“Don’t take depreciation because you will have to have pay tax on it when you sell the property.” I have heard this from many real estate rental property owners and taxpayers claiming the home office deduction. What they don’t realize is that you have to pay tax on the depreciation you could have claimed even if you didn’t claim it. What? Yes! The tax law on this has been around for many years and is very well established. If you doubt it, just look at Line 22 of IRS Form 4797, “Sales of Business Property” (home office and rental real estate are Internal Revenue Code Section 1250 business property for this purpose). The cost basis of the property sold must be decreased (and therefore the gain increased) by the amount of depreciation allowed or allowable, whichever is higher. “Allowed” means what you claimed on your tax returns over the years. “Allowable” means what you could have claimed. Future discussion of this topic expands on this issue, discussing catching up missed depreciation, capital gains and ordinary tax rates, and the time value of money.

Trust Income Tax Return Distributions – 65-Day Rule

2010-01-16T11:31:00.000-08:00

Since trust income tax rates are generally higher than the beneficiaries’ income tax rates, it is often beneficial to have the income taxed to the beneficiaries rather than the trust. Unique to trust income tax returns (IRS Form 1041), the concepts of fiduciary accounting income distributable net income affect who is liable for the tax. Typically, a trust must distribute income to beneficiaries in order for it to be taxed at their (usually lower) rates. However, a special provision in the trust income tax law allows the fiduciary to elect to treat some or all of the distributions made in the first 65 days of the following tax year as if they were made in the preceding tax year. So if there were not enough distributions in 2009 to cause all of the estate or trust income to be taxed to the beneficiaries, fiduciaries should consider making this tax election. These are the trust income tax rules applicable to trusts taxed as “complex trusts” and also generally apply to a decedent’s estate income tax return, which is made on the same IRS Form 1041, but do not apply to what is considered a “simple trust” under tax law.

As in much of the tax law, there is some gray area that allows for planning / wiggle room. The pertinent trust income tax return law uses the term “properly paid or credited”. The trust income tax return regulations are unclear as to what “properly credited” means and the Tax Court has allowed distributions that were made after the 65-day period where they were shown to be “credited”. Nonetheless, the prudent action is actually pay the distributions within the first 65 days of the estate or trust’s tax year.

Although the foregoing applies equally to California trust income tax returns, the structure of the tax rates applicable to California trust income tax returns differs such that the issue is usually mute.

2010 Business Income Tax Depreciation / Research Credit

2010-01-14T17:27:00.000-08:00

As of today, the following business tax breaks expired at the end of 2009 and are no longer available in 2010: 50% bonus depreciation on new business equipment / fixed assets, including the extra $8,000 automobile first-year depreciation deduction; research credit. Also, IRC Section 179 “depreciation” / “expense election” of $250,000 drops to $134,000 (California tax amount is still $25,000) and the phase-out starts at $540,000 rather than $800,000 (California tax amount remains at $200,000).

Flip Real Estate Ineligible for Section 1031 Exchange

2009-12-18T09:12:00.000-08:00

Working with a new real estate investor client yesterday and heard again what I have heard so many times: the real estate agent handling his flip offered him the choice of doing a Section 1031 exchange when selling the property. This is not possible. In a flip the buyer’s intention is clearly to hold the property short term and resell it, usually after making substantial improvements. The intent is not to hold for long-term appreciation. Therefore, the property is dealer property, not investment property, and ineligible for Section 1031 deferral of the tax gain. As dealer property, the gain is ordinary income, not capital gain, self-employment tax is usually owed.

Military Spouses Residency Relief Act

2009-12-16T07:06:00.000-08:00

Under the new Military Spouses Residency Relief Act, signed into law on November 11, 2009, spouses of military service members who relocate from one state to another on military orders do not become residents of the new state for income tax purposes. This means that the military spouse’s wage/salary and self-employment income is not taxable by the new state. This new law will result in big California tax savings for some military families. This makes the income tax treatment of the military spouse similar to that of the service member, who does not acquire residency in the new state because of the Servicemembers Civil Relief Act. This new law is effective January 1, 2009.

Previously, a military spouse would acquire California tax residency when moving to California under the service member’s Permanent Change of Station (PCS) orders. The military service member would not, so the spouses had different state tax residency and the spouse’s wage/salary and self-employment income was taxed by California.

S-Corporation Officer Reasonable Salary

2009-12-14T09:20:00.000-08:00

IRS launches in February 2010 random employment tax audits. The goal of this Employment Tax National Research Project, the first in 25 years, is to figure out where the IRS can get the most money through audits. One key issue is S-Corporation owner / officer / shareholder reasonable compensation / salary / wages. The IRS loses huge amounts of money when S-Corporation owners take unreasonably low salaries, mainly due to loss of the 6.2% Social Security portion of the FICA tax. Social Security tax applies to the first $106,800 of salary but does not apply to S-corporation distributions / dividends.

S-Corporation Tax Court Case on Basis and Losses

2009-10-22T06:51:00.000-07:00

In the tax court case Rodney Jordan v. Commissioner, shareholder loans were bona fide, as reported on the S-corporation tax return, but some repayments were taxable income because S-corporation tax losses had reduced the shareholder’s cost basis in the debt. It was also determined that the debt was open-account debt and that some S-corporation tax losses were disallowed for lack of basis.

LLC Member Not Limited Partner – Deductions Allowed

2009-10-21T07:29:00.000-07:00

The Tax Court again rejected IRS's position that an LLC member must be treated as a “limited partner” under passive activity loss rules. In the Hegarty case, taxpayers were allowed to deduct losses from their limited liability company tax return under a rule generally not applicable to limited partners. This follows similar decisions against the IRS on this issue by both the full tax court, in Garnett (2009), and the Court of Federal Claims, in Thompson (7/20/2009).

Home Energy Credits

2009-08-10T06:18:00.000-07:00

Current tax law provides two credits for energy-efficient improvements to a taxpayer’s residence: the Nonbusiness Energy Property Credit and the Residential Energy Efficient Property Credit. These tax credits reduce a taxpayer’s tax bill dollar-for-dollar for 30% of the cost of qualifying energy-efficient home improvements. The credits apply for years 2009-2010 and 2008-2017, respectively. Qualifying property includes common improvements such as windows, doors, and roofs, furnaces & water heaters. Also available for the credit are solar electric and water heating, fuel cell, small wind energy, and geothermal heat pump property.

LLC to S-Corporation Conversion Clarified

2009-05-14T11:39:00.000-07:00

The IRS has issued a new ruling that applies to a Limited Liability Company (LLC) electing to be taxed as an S-corporation. The ruling clarifies that there does not need to be a short tax year as a C-corporation in the middle of the process of converting from a “partnership” (the default tax status of an LLC) to an S-corporation. Avoidance of the accounting and tax burdens of an intervening C-corporation tax year is welcome to all involved.

Foreign Financial Account Reporting (FBAR – TD F 90-22.1)

2009-05-13T08:28:00.000-07:00

“United States persons”, and foreign persons that were located in and doing business in the United States during the calendar year, must report to the United States Treasury their foreign financial accounts if the total value of all such accounts on any day of the year exceeded $10,000. The report, Form TD F 90-22.1, also known as FBAR, must be mailed before July 1 of the following year and no extension of this deadline is possible. “United States persons” are U.S. citizens and residents, including partnerships, LLC’s, corporations, estates, and trusts. Even individuals who are not U.S. residents under immigration law may be considered residents because of the number of days they spent in the U.S. in the last 3 years. An account is foreign based on the geographical location of the account, not the nationality of the financial institution; exceptions exist for US military banking facilities. The penalty for failure to file the report on time is $10,000. FBAR isn't an income tax return, and it shouldn't be mailed with any income tax return.

Beginning of Estate for Tax Purposes

2009-05-12T11:29:00.000-07:00

Although a decedent’s estate is created at the moment of death, its income tax year begins the next day. The timing of appointment of personal representative or administrator or executor has no effect on the beginning of the estate tax year. The date of death, therefore, is the last day of the decedent’s personal income tax year. Income received after the date of death is generally reportable on the estate income tax return using the estate’s tax ID#, not the decedent’s personal income tax return and Social Security number. This is true even though many payers issue tax forms, such as 1099’s and W-2’s, in the name and tax ID# of the decedent.

Real Estate Tax Assessment Appeals in San Diego, California

2009-05-11T11:23:00.000-07:00

The California State Board of Equalization Letter to Assessors 2009/021, 04/29/2009, confirmed that San Diego County has certified the last day of the real estate tax assessment filing period. The regular appeals filing period for San Diego real estate tax assessments will begin on July 2, 2009 and will end on November 30, 2009.

Small Business Tax Net Operating Loss Election Clarified

2009-05-08T16:30:00.000-07:00

The IRS has issued clarification on the election to carry back a small business tax net operating (NOL) loss 3, 4, or 5 years. In this case the IRS has taken the pro-taxpayer interpretation regarding which years’ revenues are used to determine whether the loss is a qualifying small business tax NOL. The election may be made by filing the applicable refund claim forms, by attaching a statement to the tax return for the year in which the small business tax NOL arose.

Updated Life Expectancy for Gift Tax / Estate Tax Valuations

2009-05-05T06:13:00.000-07:00

IRS has issued new tables for valuing life estates, term interests, remainders and reversions for estate, gift and income tax purposes. The new tables reflect today’s longer life expectancies. For gifts made in May or June 2009, or deaths occurring then, the gift donor or estate executor may choose to use either the old or new tables.

Unmarried Co-Owners of Residence with > $1 Million Mortgage

2009-03-20T06:10:00.000-07:00

Home mortgage interest is only deductible on up to $1 million of debt used to buy or improve a taxpayer’s primary residence. If two unmarried persons are co-owners of a home they both use as their primary residence, the question arises as to whether each owner has a separate $1 million limit. The IRS recently took the position (no surprise) that the $1 million limit applies per property, not per taxpayer. Therefore, the $1 million has to be split among the owners based on their percentages of ownership. IRS office of Chief Counsel Internal Legal Memorandum 200911007.

S-Corporation Built-In Gains Period Now 7 Years

2009-03-13T20:20:00.000-07:00

The new stimulus law, the American Recovery and Reinvestment Act of 2009, signed into law by President Obama on Feb. 17, temporarily reduced the S-Corporation built-in gains period from 10 to 7 years. For tax years 2009 and 2010, S-corporations can avoid C-corporation maximum-rate income tax on built-in gains. Built-in gains are generally gains that were unrealized at time of conversion from C-corporation to S-corporation. Generally these gains are subject to the maximum C-corporation tax rate if realized (the property is sold) by the S-corporation within 10 years of S-election.

Employee-Shareholder Reasonable Compensation

2009-03-12T11:42:00.000-07:00

In addressing the issue of employee-shareholder reasonable compensation in the Menard Inc. tax court case, the Court of Appeals for the Seventh Circuit rejected the Tax Court's multi-factor approach in favor a single “independent investor” test. Under the independent investor test, if a hypothetical independent investor would consider the rate of return on his investment to be far higher than he had any reason to expect, the compensation paid is presumptively reasonable [regarding whether the compensation is unreasonably high, in the case of a C-corporation]. However, the presumption may be rebutted by evidence that the company's success was the result of extraneous factors, such as an unexpected discovery of oil under the company's land, or that the company intended to pay the owner/employee a disguised dividend rather than salary. Menard Inc. v Commissioner (CA 7 3/10/2009).

California Releases Tax Refunds

2009-03-11T10:34:00.000-07:00

California State Controller announced he has begun releasing more than $2.8 billion in payments that he was forced to delay in February, due to the state's cash shortage. Both personal and corporate tax refunds have now resumed.

Who Really Pays Income Tax

2009-03-06T09:04:00.000-08:00

According to the IRS Winter 2009 Statistics of Income Bulletin, taxpayers in the top 1% of Adjusted Gross Income (AGI) reported AGI of at least $388,806. This group accounted for 40% of the total income tax reported, compared to 39% in 2005. Taxpayers in the top 5% of AGI reported AGI of at least $153,542 and this group accounted for 60% of total income tax.

California Real Estate Agent is a Qualifying Real Estate Professional

2009-03-05T10:14:00.000-08:00

The IRS argued that a rental property owner who held a California real estate agent’s license, but not a California real estate broker’s license, was not engaged in the real estate brokerage trade or business. The IRS said that the agent was not a qualifying real estate professional entitled to the exception from the passive activity loss rules that generally apply to rental real estate losses, and disallowed the loss deductions on the agent’s tax returns. This is completely contrary to the way that this issue has been handled for many years by taxpayer, CPA’s, and the IRS. In the Tax Court case Agarwal, TC Summary Opinion 2009-29, the Tax Court summarily slapped down the IRS for this nonsense and determined that the taxpayer didn't even have to be licensed as a real estate agent, let alone a broker, to be treated as engaged in the real estate brokerage trade or business and eligible for the qualifying real estate professional exception to the passive activity loss rules on rental real estate.

Energy Efficient Home Improvements Tax Credit

2009-03-04T16:13:00.000-08:00

The new stimulus law, the American Recovery and Reinvestment Act of 2009, signed into law by President Obama on Feb. 17, provides homeowners more tax credits for energy efficient home improvements. Previously, the credit was 10% with a lifetime maximum of $500 and ended after 2009. Now a credit can be claimed on 2009 and 2010 purchases and the maximum is $1,500 for 2009 and 2010 combined.

California Homebuyer’s Credit

2009-03-03T11:10:00.000-08:00

California taxpayers who purchase a new home (new construction) March 1, 2009 through February 28, 2010 and use it as their primary residence for the following two years can get a tax credit of 5% of the purchase price (maximum $10,000). 1/3 of the credit is claimed in the year of purchase and each of the two succeeding years. To apply for the credit, the escrow person, on behalf of the seller and buyer, must fax the completed Form 3528-A, Application for New Home Credit, to the FTB , within seven calendar days after the close of escrow. Only the first $100 million of valid credit applications will be approved. (FTB—Tax Credit for New Home Purchase, 02/27/200).

Real Estate Section 1031 Exchange QI Conversion

2009-02-28T11:19:00.000-08:00

Conversion of Qualified Subchapter S-corporation Subsidiaries (QSSS or QSub) serving as real estate tax-deferred Section 1031 exchange Qualified Intermediary (QI) to C-corporations will not cause the corporations to be treated as new or different Section 1031 QI’s. Therefore, S-Corporation subsidiary conversion to C-Corporation will not cause pending real estate tax Section 1031 exchanges to fail. (PLR 200908005).

Qualified Small Business Stock Gain Exclusion 75%

2009-02-26T12:23:00.000-08:00

Under the American Recovery and Reinvestment Act of 2009, signed by President Obama on 2/17/2009, noncorporate taxpayers can exclude 75% (rather than 50% or 60%) of gain on the sale or exchange of Qualified Small Business Stock (QSBS) held for more than 5 years if acquired after Feb. 17, 2009 and before Jan. 1, 2011. Beware that Alternative minimum Tax (AMT) may eliminate some of the benefit. Does not apply to S-Corporation stock, only to regular C-Corporation stock.

California Budget Tax Changes

2009-02-25T10:49:00.000-08:00

HIGHER PERSONAL INCOME TAX RATES: personal income tax rates increased by 0.125% to 0.25% for tax years 2009 through 2012. HIGHER SALES TAX RATES: sales tax rates go up by 1%. San Diego’s 7.75% rate becomes 8.75%. AUTOMOBILE REGISTRATION / VEHICLE LICENSE FEE INCREASE: the vehicle license fee portion of automobile registration, which is a “property tax” on the value of the vehicle, increased from 0.65% to 1.15% for registrations beginning May 19, 2009. NEW HOME BUYER TAX CREDIT: purchase of a new home (new construction) March 1, 2009 through February 28, 2010 used as personal residence for two years results in a tax credit of 5% of the purchase price (maximum $10,000); once $100 million of credits have been claimed, no more credits will be issued.

New Motor Vehicle Tax Deduction

2009-02-24T14:08:00.000-08:00

The stimulus act signed into law by President Obama, on Feb. 17, called the American Recovery and Reinvestment Act of 2009, allows an itemized deduction for state or local sales or excise taxes on the purchase of a new motor vehicle between 2/17/2009 and 12/31/2009. The deduction is the amount of taxes on up to $49,500 of the purchase price of a passenger automobile, light truck or motorcycle (gross vehicle rating not more than 8,500 pounds), or a motor home. Even taxpayers who claim the standard deduction can use this deduction in addition to the standard deduction. Taxpayers with Modified Adjusted Gross Income (MAGI) over $125,000 ($250,000 married filing jointly) get reduced or no benefit. Unlike other state/local tax deductions, this one is allowed for AMT. However, the deduction is not available to a taxpayer who elects to deduct state and local sales and use taxes in lieu of income taxes as an itemized deduction.

First-Time Homebuyer Tax Credit

2009-02-23T10:48:00.000-08:00

The new stimulus law, the American Recovery and Reinvestment Act of 2009, changed the first-time homebuyer tax credit. Gone is the 15-year recapture, which rendered the old credit somewhat useless. Now there is no recapture unless the home ceases to be the taxpayer’s or spouse’s principal residence within 3 years. The credit of 10% of the purchase price (maximum of $8,000) is a dollar-for dollar reduction in federal income taxes. If the credit is larger than the tax liability, the rest simply paid to the first-time homebuyer as a “tax refund”. Either way, the government is essentially giving the first-time homebuyer cash of 10% of the purchase price of the new home. This is a huge benefit, and I highly recommend claiming the credit. The home purchase must close before December 1, 2009. Even better, if you buy the home in 2009, you can claim the tax credit on your 2008 tax return. This way you get the money much sooner

Longer Net Operating Loss Carry-Backs for Business Tax

2009-02-20T09:41:00.000-08:00

The new tax law, the American Recovery and Reinvestment Act of 2009, allows small businesses that incur Net Operating Losses (NOL’s) in 2008 and later years to carry the loss back 2, 3, 4, or 5 years. Previously only a 2-year carry-back was allowed. For businesses that paid taxes in any of these years but incurred a loss in 2008, this carry-back can result in an immediate tax refund. The new rules apply to all small business tax returns, including S-Corporation tax returns, C-Corporation tax returns, Limited Liability Company (LLC) tax returns, partnership tax returns, and sole proprietorship / Schedule C tax returns. The rules also apply to losses from rental real estate.

Section 179 Business Equipment Deduction Increased

2009-02-19T18:28:00.000-08:00

The new tax act increased 2009 Section 179 limits to $250,000 deduction for businesses buying less than $800,000 of equipment. Section 179 allows a taxpayer, other than an estate, trust, and certain noncorporate lessors, to deduct the cost of equipment as an expense instead of claiming depreciation over a number of years.

Bonus Depreciation on Automobiles

2009-02-18T09:18:00.000-08:00

Under the new stimulus law, the American Recovery and Reinvestment Act of 2009, a business can increase the first-year depreciation deduction by $8,000 of bonus depreciation for new passenger automobiles, light trucks, and vans placed in service in 2009 is. Since depreciation of passenger automobiles is severely limited by the tax law, this is a good opportunity to accelerate deductions. Applies to all business tax returns: corporate tax returns, S-corporation tax returns, partnership & Limited Liability Company / LLC tax returns, and sole proprietor tax returns.

Bonus Depreciation Under the New Tax Act

2009-02-17T09:22:00.000-08:00

Businesses can deduct 50% of the cost of most types of new property other than buildings. Used property does not qualify. Ordinary depreciation is deducted on the remainder of the cost basis, so total first year depreciation deduction is more than 50%. Alternatively, the Section 179 expense election can be used to deduct the entire cost of the property in the first year, if the taxpayer qualifies.

American Recovery and Reinvestment Act of 2009

2009-02-16T12:44:00.000-08:00

The new stimulus law extended to 2009 the 50% bonus depreciation and the Section 179 deduction limit of $250,000 -- big tax savings for business. Tax breaks for individuals include a refundable “making work pay” stimulus credit, enhanced child tax credit and earned income tax credit, an improved homebuyer credit, a new deduction for state sales and excise taxes paid on new vehicles, and a sweetened higher education credit. There's also a one-year AMT patch.

Employee or Independent Contractor?

2009-02-12T17:13:00.000-08:00

Treasury Inspector General for Tax Administration (TIGTA) stated in a new audit that “misclassification of employees as independent contractors is a nationwide issue affecting millions of workers that continues to grow and contribute to the tax gap.” Treating a worker as an independent contractor typically saves money for both the employer and the worker. The employer avoids payroll taxes, including FICA taxes of up to 15%, and the worker is able to claim more tax deductions as an independent contractor than an employee.

Donating Money to a Charity or Non-Profit Organization

2009-02-10T13:40:00.000-08:00

Charitable contributions of money (cash, check, or credit/debit card) are deductible on your income tax return if the right records are kept. Record-keeping rules changed over the past several years for these tax deductions. For contributions of less than $250 each, the taxpayer must keep either a bank record (i.e., cancelled check or credit card receipt) or a written communication from the charity showing the name of the organization, date of contribution, and dollar amount. Contributions of $250 or more require a written acknowledgement from the organization received by the taxpayer before the tax return is filed showing:

Dollar amount of money contributed.
Whether or not the organization provided any goods or services in exchange for all or a part of the donation.
Description and estimation of value of any goods or services that the organization provided.
Statement that the organization provides intangible religious benefits, if applicable.

Trust Distributions Deduction Late Election

2009-02-09T13:38:00.000-08:00

The IRS issued a Private Letter Ruling allowing a trust to make a late election to deduct a charitable contribution in one year on the tax return for the prior year. PLR 200905027.

Estate Tax Discount for S-Corporation Built-In Gains

2009-02-06T12:25:00.000-08:00

Estate tax valuation discounts continue to be an effective tool to dramatically lower estate taxes. Recently the tax court ruled in the case of Estate of Marjorie Degreeff Litchfield that estate could claim significant discounts for S-Corporation built-in gains taxes and accepted the amounts calculated by the taxpayer’s expert witness.

Executive Deferred Compensation Donated to Charity is Deductible by Employer

2009-02-04T12:30:00.000-08:00

The IRS has privately ruled that a company can claim a tax deduction when an executive donates his deferred compensation to a charity. PLR 200905016.

Computer Programmer was Independent Contractor

2009-02-03T12:02:00.000-08:00

Court of appeals determined that a computer programmer was an independent contractor and not an employee. Decision based upon control over the details of work, duration of projects only six to twelve months each, accounting and tax reporting by both parties (1099-MISC form and Form 1040 Schedule C / Sole Proprietorship), beliefs of the parties regarding the relationship, “distinct occupation or business” factor, the “kind of occupation” factor, and the “skill required” factor. Suskovich v. Anthem Health Plans of Virginia, Inc., (CA 7 1/22/2009).

Trust as IRA Beneficiary

2009-01-30T14:50:00.000-08:00

Heirs lost the ability to benefit from many years of tax free buildup of IRA value because the beneficiary designation was too vague. The IRA owner wrote “as stated in will” for his IRA beneficiary, intending the money to go into a trust. Specifically identifying the trust would have achieved the desired result.

Taxpayer Can Claim Home Tax Deductions Even if Not on Title or Loan

2009-01-29T11:34:00.000-08:00

The tax court in the Njenge case recently validated something I’ve been telling clients for years: a taxpayer can deduct personal residence mortgage interest and property taxes even though loan and/or title to the home are in someone else’s name, under the right circumstances. The person who lived in the home, made the payments, and bore all benefits and burdens of ownership is treated as the “equitable owner” and can deduct the property tax and interest payments.

IRA Rollover 60-Day Period Waivers

2009-01-28T17:04:00.000-08:00

IRS has issued Private Letter Rulings to allows IRA rollovers even though the 60-day period expired. The rulings covered cases of mistakes by financial institutions and financial advisors, and mental condition of taxpayer. PLR 200904030, PLR 200904027, PLR 200904028, PLR 200904032, PLR 200904034.

Late S-Corporation Election Allowed

2009-01-27T16:19:00.000-08:00

IRS has again issued a Private Letter Ruling allowing a retroactive late S-corporation election when a corporation and its shareholders have reported income as if an S-Corporation election has been timely made, where reasonable cause was shown for failure to timely make the election. PLR 200904018.

Splitting Trust into 4 Separate Trusts Ruled Non-Taxable

2009-01-26T12:06:00.000-08:00

In 3 Private Letter Rulings the IRS has recently ruled that splitting a trust into 4 separate trusts won't cause taxable gain or loss to any beneficiary, trust, or severed trust. The rulings addressed testamentary trusts and an irrevocable inter vivos trust. PLR 200904014, PLR 200904015, PLR 200904016.

S-Corporation Election Not Terminated by Convertible Debt

2009-01-23T10:21:00.000-08:00

IRS privately ruled that an S-corporation that inadvertently created a second class of stock by issuing notes convertible into stock was allowed to continue as S-corporation as long as corrective adjustment were made.

Estate Credited for Additional Charity Deduction

2009-01-22T12:51:00.000-08:00

Estate was given credit for additional charitable contributions for portion of settlement payments that were made to charitable beneficiaries and involved stock willed to non-charitable beneficiaries, who were alleged to have manipulated stock/stock's disposition so as to keep decedent from selling it and to preserve it for their benefit. (Estate Of Eugenia F. Williams, et al. v. Commissioner, (2009) TC Memo 2009-5)

"Luxury" Auto Tax Values 2009

2009-01-21T14:20:00.000-08:00

IRS has released the 2009 maximum fair market values (FMVs) for employer-provided autos ($15,000), trucks and vans ($15,200) the personal use of which can be valued for fringe benefit purposes at the mileage allowance rate (55¢ per mile for 2009).

Employee vs. Independent Contractor: 1099-MISC or W-2?

2009-01-19T08:43:00.000-08:00

Court case Peno Trucking: Appeals Court found that contracts that say workers aren’t employees can be disregarded in determining whether they are independent contractors. Instead, it is the degree of control that a company exerts over workers that determines whether they are employees or independent contractors. However, some exceptions may allow a company to still treat workers as independent contractors and avoid IRS penalties and back taxes.

S-Corporation Shareholder-Guaranteed Debt = No Basis to Deduct Losses

2009-01-16T10:40:00.000-08:00

Tax court case Russell, TC Memo. 2008-246, reaffirms AGAIN that shareholder cannot deduct losses financed with debt in the name of the corporation. The S-corporation borrowed money from a bank and the shareholder guaranteed the debt. When the S-corporation incurred losses, the shareholder was not allowed to use the debt guarantee as basis to deduct the losses, which were suspended.

Non-Resident Partners or Shareholders?

2009-01-15T12:55:00.000-08:00

S-Corporations, partnerships, and LLC’s: March 16, 2009 is the Franchise Tax Board deadline for first-time filers and remitters of nonwage withholding for nonresidents to apply under the FTB's 2008 Nonresident Withholding Incentive Program and avoid penalties. Can send in past-due 2008 withholding as additional compensation on behalf of the nonresident payee and pay interest by March 16, 2009 and the FTB will waive some failure-to-file penalties and will not audit withholding for tax year 2007 and earlier.

E-File Season Opens Tomorrow

2009-01-15T12:45:00.000-08:00

IRS announced that 2009 e-filing season will open on 1/16.

Rental Owners Under-Reporting Income

2009-01-14T10:56:00.000-08:00

Government Accountability Office estimates that 50% of rental property owners either underreported revenues or overstated expenses, costing the government $13 billion in lost tax collections in 2001. Look for reminder letters from the IRS on this issue – their weak attempt to increase collections.

S-Corporation Continues Despite Trustee’s Mistake

2009-01-12T15:11:00.000-08:00

IRS privately ruled that an S-corporation election was not terminated in spite of trustee’s inadvertent failure to make ESBT (Electing Small Business Trust) election.

S-Corporation Continues Despite Beneficiary’s Failure

2009-01-08T08:26:00.000-08:00

IRS ruled privately that an S-corporation could continue even though a trust beneficiary did not make the QSST (Qualified Subchapter S Trust) on time. When the case is effectively presented by a CPA, the IRS continues to allow S-corporations to continue despite technicalities that should cause termination of the S-elections.

California Limits NOL’s and Business Credits

2009-01-08T08:12:00.000-08:00

For 2008 & 2009, California taxpayers with net business incomes of $500,000 or more cannot take a net operating loss (NOL) deduction and their use of business credits is limited to 50% of their tax liability. Common credits involved include the Research and Development Credit, Low Income Housing Credit, and Enterprise Zone Credit, and credits not allowed are carried over to future years.

IRS Tax Per Diem Meals & Travel Deductions

2009-01-07T06:06:00.000-08:00

Effective Oct. 1, 2008. Reimbursements of an employee's business travel costs (lodging, meal and incidental expenses (M&IE)) at a per diem rate are payroll-and income-tax free if simplified substantiation is provided and the daily rate doesn't exceed the federal per diem rate (the maximum amount that the federal government reimburses its employees) for the locality of travel for that day. While the per diem rates vary by travel destination, employers can make reimbursements at the simplified “high-low” per diem rates, which assign one per diem rate to high-cost areas within the continental U.S., and another to non-high-cost areas. The IRS has issued the “high-low” simplified per diem rates for post-Sept. 30, 2008, travel. An employer may reimburse up to $256 for high-cost localities ($198 for lodging and $58 for M&IE) and $158 for other localities ($113 for lodging and $45 for M&IE). The list of high-cost areas is also updated.

Standard mileage rates down for 2009

2009-01-07T06:05:00.000-08:00

The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is 55¢ per mile for business travel after 2008. That's 3.5¢ less than the 58.5¢ allowance for business mileage that applied in the last six months of 2008. Further, the rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction is 24¢ per mile, down 3¢ from the 27¢ per mile allowance for the last half of 2008.

Late Election to Treat All Rental Properties as Single Activity for Material Participation / Loss Deductions

2009-01-05T13:48:00.000-08:00

Married taxpayers who acted reasonably in good faith allowed by IRS in Private Letter Ruling to make a late election to treat all their interests in rental real estate as single rental real estate activity, allowing them to meet active participation requirement to deduct losses. – San Diego CPA Michael Fitzsimmons

60-Day IRA Rollover Extended

2009-01-05T13:46:00.000-08:00

IRS waived 60-day rollover requirement for failure to roll over funds within 60 days because medical condition impacted taxpayer’s ability to manage his financial affairs. – San Diego CPA Michael Fitzsimmons

Alzheimer’s Patient Guardianship Deductible

2009-01-02T09:26:00.001-08:00

IRS has ruled that the costs of establishing a guardianship for an Alzheimer’s patient are deductible medical expenses. [2008-0033]

Energy Efficient Home Improvements Tax Credit

2009-01-02T09:19:00.000-08:00

Effective for 2009 (but NOT 2008) Congress reinstated a tax credit for energy efficient home improvements and expanded the credit to cover biomass fuel stoves (whatever those are!). – San Diego CPA Michael Fitzsimmons

Real Estate Section 1031 Exchange Escrow Earnings

2008-12-31T17:13:00.000-08:00

IRS has ruled that earnings on section 1031 exchange escrow funds are not taxable if used for exchange fees on small exchanges (exchange proceeds are $2 million or less).

S-Corporation Shareholder Reasonable Salary

2008-12-31T17:12:00.000-08:00

Tax court case Beckley: S-corporation must properly document shareholder loans to avoid IRS challenge re: constructive dividends. This C-corp case can be applied to s-corporations with regard to salary instead of constructive dividends.

Year-End W-2 Reminders

2008-12-22T12:37:00.000-08:00

Business Tax: Personal use of company-owned car should be added to each employee’s Form W-2, Wage & Tax Statement. Standard mileage rate not available for cars costing more than ~$15,000.

S-corporation: Shareholder’s health insurance premiums should be added to the shareholder’s Form W-2, Wage & Tax Statement. This income is not subject to FICA, and is then allowed as a deduction on the shareholder's income tax return (yes, it seems silly: the rules require you to add it to income and then turn around and deduct it).

Tax News Roundup 22 Dec 2008

2008-12-22T11:24:00.000-08:00

Rental real estate: Where taxpayers showed good faith, IRS granted extension to treat all their interests in rental real estate as single rental real estate activity (PLR 200851001). This is good news for taxpayers, but an expensive and risky way to go about it. Better to just make the election on the tax return.

S-Corporation: IRS allowed continued treatment as an S-corporation even though stock was issued to stock to LLC/ineligible shareholder, ruling that the action was inadvertent (PLR 200851008).

S-Corporation: IRS did not allow a corporation to re-elect S-corporation status before the 5-year post-termination period was up (PLR 200851003).

S-Corporation: IRS continuing to allow late S-corporation elections where reasonable cause can be shown (PLR 200851015; PLR 200851022).

Trust: Trust disregarded and self-employment tax imposed on distributions where trusts lacked economic substance (Alfred J. Olsen, et ux. v. Commissioner, TC Memo 2008-275).

Estate: Estate allowed to deduct attorney's fees for estate administration, although attorney's papers were sloppy and record was otherwise “thin” (Estate of Thelma G. Hurford v. Commissioner, TC Memo 2008-278.