Bftu 03 all clw 112703


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Bftu 03 all clw 112703

  1. 1. Surgent Associates Best Federal Tax Update 2003 Presented to NYSSCPA Cecil Woodard, MBA, CPA, CIA. CISA, CFE
  2. 2. Jobs and Growth Tax Relief Reconciliation Act of 2003-Agenda <ul><li>Objective – Update practitioners on 2003 tax law changes & related tax cases </li></ul><ul><li>Schedule </li></ul><ul><ul><li>09:00-09:15 Introductions </li></ul></ul><ul><ul><li>09:15-10:15 JGTRRA </li></ul></ul><ul><ul><li>10:15-10:30 Break </li></ul></ul><ul><ul><li>10:30-12:00 JGTRRA </li></ul></ul><ul><ul><li>12:00-01:00 Lunch </li></ul></ul><ul><ul><li>01:00-02:30 Cases & Rulings - Individuals </li></ul></ul><ul><ul><li>02:30-02:45 Break </li></ul></ul><ul><ul><li>02:45-05:00 Cases & Rulings - Business </li></ul></ul><ul><li>Ask Questions. </li></ul><ul><li>Have fun! </li></ul>
  3. 3. Introductions <ul><li>Name </li></ul><ul><li>Previous Surgent Seminar attendee? </li></ul><ul><li>Type of work you do </li></ul><ul><li>Tax experience </li></ul><ul><li>Seminar expectations </li></ul>
  4. 4. Provisions Affecting Individuals <ul><li>Tax Cuts Without Revenue Offsets (Tax Increases) </li></ul><ul><li>Accelerates provisions of 2001 Act </li></ul><ul><li>Capital Gain and Dividend Tax Relief </li></ul><ul><li>Small Business provisions </li></ul><ul><li>Limited time periods (again) </li></ul><ul><li>Many provisions only for 2003/2004 </li></ul><ul><li>Others through 2005 or 2008 </li></ul><ul><li>Retroactive to 2001 Act – sunsets after 2010 </li></ul><ul><li>Expiring provisions list provided for 2002-2010 </li></ul>
  5. 5. Marginal Tax Rate Reductions (Back to the Future) <ul><li>10% rate bracket accelerated to 2008 levels for 2003/2004 </li></ul><ul><li>Single = was $6,000/now $7,000 </li></ul><ul><li>Married Joint = $12,000/now $14,000 </li></ul><ul><li>Head of Household = $10,000 </li></ul><ul><li>All adjusted for inflation in 2004 </li></ul><ul><li>2005 – back to original levels (maybe?) </li></ul>
  6. 6. Tax Savings for 10% Rate <ul><li>Single = $50 </li></ul><ul><ul><li>5% X ($7,000-$6,000) </li></ul></ul><ul><li>Married Joint = $100 </li></ul><ul><ul><li>5% X ($14,000 - $12,000) </li></ul></ul><ul><li>Shift of income from 35% to 10% brackets = $250 savings </li></ul><ul><ul><li>(35%-10%) X $1,000 </li></ul></ul><ul><li>New withholding tables </li></ul>
  7. 7. Individual Tax Brackets – Pre-Act v. Act 35% 33% 28% 25% Pre-Act 35% 33% 28% 25% Act 2006-2010 37.6% 34% 29% 26% Pre-Act 35% 33% 28% 25% Act 2004-2005 38.6% 35% 30% 27% Pre-Act 35% 33% 28% 25% Act 2003
  8. 8. Example 1 (p. 1-6) <ul><li>Single taxpayer with taxable income of $100,000 </li></ul><ul><li>Save $50 for 10% bracket change </li></ul><ul><li>Save $1,432 for rate reductions </li></ul><ul><li>Total savings = $1,482 </li></ul>
  9. 9. Example 2 (p. 1-6) <ul><li>Married filing jointly with taxable income of $200,000 </li></ul><ul><li>Save $100 for 10% bracket change </li></ul><ul><li>Save $1,122 on 15% bracket changes </li></ul><ul><li>Save $2,864 from rate reductions </li></ul><ul><li>Total savings = $4,086 </li></ul>
  10. 10. Example 3 (p. 1-6) <ul><li>Head of household with taxable income of $50,000 </li></ul><ul><li>Save $239 from rate reductions </li></ul>
  11. 11. 15% Maximum Tax On: <ul><li>Dividends through 2008 </li></ul><ul><li>Personal Holding Company Income and Accumulated Earnings Tax </li></ul>
  12. 12. Marriage Penalty Relief <ul><li>Accelerates 15% tax bracket expansion for 2003 and 2004 to scheduled 2008 levels instead of phasing them in over four years beginning in 2005 </li></ul><ul><li>15% bracket for married joint return to twice the single level </li></ul>
  13. 13. Example Marriage Penalty Relief (p. 1-8) <ul><li>Married couple each with taxable income of $28,400 or $56,800 together </li></ul><ul><li>Prior to Act the marriage penalty = $1,122 (includes rate reduction of 2%) </li></ul><ul><li>After Act the marriage penalty = $0 </li></ul><ul><li>Maximum taxed at 15% under old law$47,450; now $56,800 </li></ul><ul><li>Taxpayers with taxable income greater than $47,450 will benefit </li></ul><ul><li>Also benefits married taxpayers filing separately </li></ul>
  14. 14. Acceleration of Increase in Standard Deduction <ul><li>Accelerates standard deduction increase for 2003 and 2004 to scheduled 2009 levels instead of phasing them in over five years beginning in 2005 </li></ul><ul><li>Married filing separately is one-half the joint return amount – NOT the inflation adjusted amount from prior law </li></ul><ul><li>2003/2004 Standard deduction = $9,500 ($4,750 X 2) </li></ul><ul><li>Reduce/eliminate mortgage interest deduction for many taxpayers </li></ul><ul><li>Reduce benefit of capital losses against ordinary income </li></ul>
  15. 15. Accelerated Increase in Child (<17) Tax Credit <ul><li>From $600 to $1,000 for 2003/2004 </li></ul><ul><li>Refundable to extent of 10% of the taxpayers earned income in excess of $10,500 </li></ul><ul><li>Increases to 15% in 2005 </li></ul><ul><li>For families with three or more children, it is refundable to extent social security taxes exceed the earned income credit, if greater than 10% earned income > $10,500. </li></ul>
  16. 16. Example Child Credit (p. 1-12) <ul><li>Still phased out above $75,000 single and $110,000 joint returns at $50 for each $1,000 above limits </li></ul><ul><li>Example </li></ul><ul><ul><li>Married filing jointly two children Modified AGI of $135,000 </li></ul></ul><ul><ul><li>Old rules no child credit (25 x $50 = $1,250 reduction) </li></ul></ul><ul><ul><li>New rules = credit of $750 </li></ul></ul>
  17. 17. Advance Payments <ul><li>Increased child tax credit amount paid in advance – based on 2002 tax return and expected 2003 eligibility. </li></ul><ul><li>Example 1 </li></ul><ul><ul><li>Joint return-one child still eligible $400 </li></ul></ul><ul><li>Example 2 </li></ul><ul><ul><li>Joint return-two children in 2002, only one eligible in 2003 $400 </li></ul></ul>
  18. 18. Tax Credits Allowed in 2003 Reduced by Advance Payments <ul><li>Example 3 </li></ul><ul><ul><li>Example 1 received $400 and will have a $600 ($1,000 - $400) credit if still qualified. </li></ul></ul><ul><li>Example 4 </li></ul><ul><ul><li>Example 2 received $400 and will also have a $600 credit if still qualified. </li></ul></ul><ul><li>Given past history-the advance payment will NOT have to be repaid if they are not eligible for the child tax credit. </li></ul>
  19. 19. IRS Procedures for Advance Payments <ul><li>Notices sent to taxpayers on amount of advance payment, number of children used to determine, whether limited due to phase-out or tax liability or earned income limits. </li></ul><ul><li>New worksheet in 1040 package to determine credit (One of the top 10 errors on 2001 returns!) </li></ul>
  20. 20. NOL Extension <ul><li>5-year carryback extended through 2005 </li></ul><ul><li>May offset 100% of AMTI through 2005 </li></ul>
  21. 21. Planning Tips <ul><li>Increased emphasis on CG since the 5% drop in CG is greater than the 3.6%/2% change in regular tax rates </li></ul><ul><li>Spread between top individual rates and CG rate increased. </li></ul><ul><li>Reduced taxes on sale of luxury homes with gain in excess of the exclusion limits </li></ul><ul><li>Older clients should evaluate whether to sell appreciated assets and invest proceeds in dividend paying stock. </li></ul><ul><li>Consider gifting assets to children over age 13 to get lower rate – 5% now and 0% in 2008. </li></ul>
  22. 22. Repeal of Five-Year Gain Property <ul><li>18%/8% rates for >5 year property repealed </li></ul><ul><li>§1202 also requires a five-year holding period to exclude gain </li></ul>
  23. 23. Capital Gains Rates 8% 8% 18% LT gain >60 months in 2009 10% 15% 20% Lt gain >12 months in 2009 0% 0% 15% LT gain in 2008 5% 5% 15% LT gain prior to 2008 10% 15% 28% Collectible/§1202 gain 10% 15% >15% Type Gain - Taxpayer Bracket
  24. 24. Pass-Through Entities and CG <ul><li>Recognition date determined at the entity level </li></ul><ul><li>What about when an owner sells his interest prior to an actual capital gain by the entity if the per share per day rule is used and the books are not closed? </li></ul><ul><li>Example 8 (p. 1-20) – S Corporation </li></ul><ul><ul><li>$100,000 CG July ($200,000 x 50%) </li></ul></ul><ul><ul><li>50% shareholder sold entire interest March 31 st </li></ul></ul><ul><ul><li>$25,000 post May 5 th gain allocated to him and he gets a lower CG tax rate </li></ul></ul>
  25. 25. Capital Gains Complexity <ul><li>8 new lines added to Schedule D, Schedule D Tax Worksheet, Form 6251 – AMT, and Form 8801 – AMT credit </li></ul><ul><li>Column (g) of Schedule D revised for amounts after May 5 and worksheet for 28% gains that was in column (g) </li></ul><ul><li>Luckily, 1040 software will reduce the computational complexity for preparers. </li></ul><ul><li>Form 1099-DIV will have to be revised for dividends after May 5 also. </li></ul><ul><li>Taxpayers with only CG distributions will need to file Form 1040 and Schedule D – NOT use the 1040 worksheet and Form 1040A to get lower rates. </li></ul>
  26. 26. Installment Sales <ul><li>Payments received after May 5, 2003 and before 2009 eligible for new rates. </li></ul><ul><li>If part of the gain is 25% gain – it is taxed first. </li></ul><ul><li>15% rate may not apply immediately. </li></ul><ul><li>Installment sales should be structured to maximize the use of the new rates. </li></ul><ul><li>Plan for sunset or extension </li></ul><ul><ul><li>Can sell or modify terms to recognize gain </li></ul></ul><ul><ul><li>Can transfer to taxpayer in lower brackets and get 0% in 2008, if gift prior to 2008 </li></ul></ul>
  27. 27. Dividend Tax Relief For Individuals <ul><li>2003-2008 Dividends taxed at same rates as capital gains, but effective for entire year. </li></ul><ul><li>Applies to both common and preferred dividends </li></ul><ul><li>Does NOT apply to 401(k) plans and IRA’s </li></ul><ul><li>Gives new emphasis to taxable investments vs. tax exempt investments </li></ul><ul><li>Planning Tip - Investors with both taxable and tax-deferred accounts may want to reallocate investments to put interest earning ones into tax-deferred and ones that earn dividends into taxable accounts. </li></ul>
  28. 28. Qualified Dividend Income <ul><li>Domestic and qualified foreign corporation </li></ul><ul><ul><li>Does not include foreign personal holding companies, foreign </li></ul></ul><ul><ul><li>investment companies, and passive foreign investment companies </li></ul></ul><ul><li>Exclusions </li></ul><ul><ul><li>Holding period – less than 60 days during 120 days prior to ex-dividend date (PF stock is 90 of 180 days) </li></ul></ul><ul><ul><li>Extraordinary dividend is qualifying, but if stock sold at loss, the loss is treated a long-term capital loss to extent of dividend. </li></ul></ul><ul><ul><li>Dividends if taxpayer is obligated to make related payments on similar or related property (i.e., short sale) </li></ul></ul><ul><ul><li>Any amount taken into investment income to support an investment interest deduction </li></ul></ul><ul><ul><li>Dividends from tax exempt corporation </li></ul></ul><ul><ul><li>Deducted under §591 by Mutual Savings Banks </li></ul></ul><ul><ul><li>Paid on ESOP’s </li></ul></ul>
  29. 29. Example of Impact of New Rules <ul><li>Unmarried taxpayer salary = $80,000 </li></ul><ul><li>Interest $4,000 </li></ul><ul><li>CG - $12,000 </li></ul><ul><li>Dividends = $8,000 </li></ul><ul><li>Old law tax = $21,888 </li></ul><ul><li>New law tax = $19,082 </li></ul><ul><li>Tax savings = $2,806 </li></ul>
  30. 30. Investments <ul><li>Change in rates will put more emphasis on dividends and not as much emphasis on stock buy-backs. </li></ul><ul><li>Stock buy-backs still will produce less income since basis will reduce the gain (p. 1-32). </li></ul>
  31. 31. Corporate Distributions <ul><li>Dividends – Distributions of property from Earnings & Profits </li></ul><ul><li>Current E&P first, then Accumulated E&P </li></ul><ul><li>Example 1 (p. 1-41) </li></ul><ul><ul><li>E&P $10,000 </li></ul></ul><ul><ul><li>Distributes $16,000 </li></ul></ul><ul><ul><li>Dividends = $10,000 </li></ul></ul><ul><ul><li>Return of capital then capital gain for remainder of distribution </li></ul></ul><ul><li>Example 2 (p. 1-42) </li></ul><ul><ul><li>Accumulated E&P ($200,000) </li></ul></ul><ul><ul><li>Current E&P $100,000 </li></ul></ul><ul><ul><li>$100,000 distributed in quarterly payments – all dividends </li></ul></ul><ul><ul><li>If distribution was following year, then $0 dividend if no current E&P in 2004. </li></ul></ul>
  32. 32. Taxation of Corporate Distribution to Shareholder <ul><li>Amount received plus fair market value of property less any liability assumed. Fair market value cannot be less than liability assumed. </li></ul><ul><li>Three Tier Taxing System </li></ul><ul><ul><li>Dividends to extent of E&P </li></ul></ul><ul><ul><li>Reduction of basis </li></ul></ul><ul><ul><li>Gain from sale of property </li></ul></ul><ul><li>Basis of property is fair market value </li></ul><ul><li>Corporation must recognize gain on appreciated property distributed. </li></ul>
  33. 33. Allocation of E&P To Distributions <ul><li>Current E&P first – Both current gains and losses must be prorated if distributions in excess of current E&P. </li></ul><ul><li>Accumulated E&P in chronological order if distributions exceed current E&P. </li></ul>
  34. 34. Penalty Taxes #1 Accumulated Earnings tax <ul><li>Assumes tax avoidance </li></ul><ul><li>15% tax rate now (38.6% under old law) on: </li></ul><ul><li>Greater of: </li></ul><ul><ul><li>$250,000 ($150,000 for personal service companies) OR </li></ul></ul><ul><ul><li>Reasonable business needs </li></ul></ul><ul><li>Holding and investing company limited to $250,000 </li></ul><ul><li>Based on economic concept of income (similar to E&P) </li></ul>
  35. 35. Penalty Taxes #2 Personal-Holding Company Tax <ul><li>Personal Holding Company </li></ul><ul><ul><li>At least 60% AGI from dividends, interest, royalties, annuities, rents, oil & gas, etc. </li></ul></ul><ul><ul><li>>50% of stock owned by 5 or fewer </li></ul></ul><ul><li>Assumes tax avoidance </li></ul><ul><li>15% tax rate now (38.6% under old law) </li></ul>
  36. 36. Distributions for S Corporation with Accumulated E&P (p. 1-51) <ul><li>Nontaxable return of capital to extent of Accumulated Adjustments Account (AAA) (Tax-free to extent of S/H’s basis in S Corp. Stock) </li></ul><ul><li>Dividend from E&P </li></ul><ul><li>Return of capital </li></ul><ul><li>Gain on sale or exchange </li></ul><ul><li>May make election to bypass AAA and go directly to E&P </li></ul>
  37. 37. §179 Expensing Election <ul><li>Tax years beginning after 2002 and before 2006 </li></ul><ul><li>$100,000 – up from $25,000 </li></ul><ul><li>Dollar Limitation - $400,000 (phased out as before for excess) </li></ul><ul><li>After 2003, the limits will be indexed for inflation. </li></ul><ul><li>Taxable income limit still applies. </li></ul><ul><li>Added off-the-shelf software to §179 property </li></ul><ul><li>May revoke §179 election without IRS consent, but decision is irrevocable after made </li></ul><ul><li>§179 reduces E&P ratably over 5 years </li></ul>
  38. 38. Special Depreciation For Certain Property <ul><li>2002 Act allows additional 30% depreciation for property purchased after 9-10-2001 and before 9-11-2004 </li></ul><ul><li>Must meet four requirements </li></ul><ul><ul><li>Classes of property </li></ul></ul><ul><ul><li>Original use property </li></ul></ul><ul><ul><li>Acquired during the allowed period </li></ul></ul><ul><ul><li>Placed-in-service date (one year extension for 10-year or longer property and certain transportation property) </li></ul></ul><ul><li>Additional $4,600 for first year of “luxury” automobiles – Total first year $7,660 </li></ul><ul><li>Could elect out of additional depreciation </li></ul>
  39. 39. New Bonus Depreciation <ul><li>50% for property placed in service after May 5, 2003 and before January 1, 2005 (2006 for certain property as before) </li></ul><ul><li>Applies to tax years ending after May 5, 2003 </li></ul><ul><li>Additional $7,650 for first year of “luxury” automobiles – Total first year $10,710 </li></ul><ul><li>May elect 30%, 50%, or none </li></ul><ul><li>Fiscal-year pass-through entity will recognize bonus depreciation at end of fiscal year – may not show up until 2004 </li></ul><ul><li>Basis is adjusted to reflect additional depreciation & §179 </li></ul><ul><li>Applies for both regular tax and AMT </li></ul>
  40. 40. Property Acquired in 2003 <ul><li>May be eligible for: </li></ul><ul><ul><li>30%, 50%, §179 at $100,000, or §179 at $24,000 (or some combination of these) </li></ul></ul><ul><li>Examples </li></ul><ul><ul><li>$200,000 purchase on July 1 – entitled to both 50% and §179 at $100,000 </li></ul></ul><ul><ul><li>$200,000 May 1 – §179, but only 30%, not 50% </li></ul></ul><ul><ul><li>$200,000 on July 1 for 9-30 year-end taxpayer – 50%, but §179 at only $24,000 </li></ul></ul><ul><li>Mid-quarter convention applies, but §179 amounts reduce the amount placed in service for this calculation. </li></ul>
  41. 41. Increased First-Year Depreciation for Luxury Automobiles <ul><li>Additional $7,650 – Maximum $10,710 </li></ul><ul><li>>6,000 lb. GVW exempt (includes trucks, vans, SUVs, & minivans) </li></ul><ul><li>Hummer vs. Mercedes </li></ul><ul><li><50% business use recaptures depreciation and §179 </li></ul>
  42. 42. Like-Kind Exchanges (example-p. 1-68) <ul><li>Adjusted basis is eligible for bonus depreciation, not just the “boot” </li></ul><ul><ul><li>Purchase in 2002 and take 30% </li></ul></ul><ul><ul><li>Like-kind trade in 2003 and take 50% of adjusted basis </li></ul></ul>
  43. 43. AMT Exemption Increased for 2003 and 2004 <ul><li>Joint - $58,000 was $49,000 </li></ul><ul><li>Single - $40,250 was $35,750 </li></ul><ul><li>Married separately - $29,000 was $24,750 </li></ul><ul><li>Phase-out levels NOT changed </li></ul><ul><li>After 2004 levels revert back to prior levels of $45,000, $33,750, and $22,500 respectively </li></ul><ul><li>No change is exemption for estates and trusts - $22,500 </li></ul><ul><li>Rapidly increasing number of AMT returns </li></ul><ul><ul><li>1998 – .4 million </li></ul></ul><ul><ul><li>2003 – 2.4 million </li></ul></ul><ul><ul><li>2005 – 11.3 million </li></ul></ul><ul><ul><li>2010 – 35.5 million </li></ul></ul>
  44. 44. Alternative Minimum Tax <ul><li>Taxable income </li></ul><ul><li>+/  Certain adjustments to taxable income </li></ul><ul><li>+ Tax preference items </li></ul><ul><li>= Alternative minimum taxable income (AMTI) </li></ul><ul><li> Exemption (reduced for higher income levels) </li></ul><ul><li>= Alternative minimum tax base </li></ul><ul><li>x 26% of first $175,000 plus 28% of amount > $175,000 </li></ul><ul><li>= Tentative minimum tax before the foreign tax credit </li></ul><ul><li> Credit for foreign taxes </li></ul><ul><li>= Tentative alternative minimum tax </li></ul><ul><li> Regular tax (reduced by foreign tax credit only) </li></ul><ul><li>= Alternative minimum tax liability </li></ul>
  45. 45. AMT Adjustments <ul><li>Itemized deductions/standard deduction </li></ul><ul><li>Exemptions </li></ul><ul><li>Tax credits not allowed for AMT after 2003 </li></ul><ul><li>NOL’s from tax preference items </li></ul><ul><li>Depreciation for post-1986 property </li></ul><ul><ul><li>Repealed for property placed in service after December 31, 1998, if taxpayer elects same recovery period and depreciation method </li></ul></ul><ul><li>Research expenses over 10 years-not expensed </li></ul><ul><li>% completion for LT contracts </li></ul><ul><li>Passive activity losses </li></ul><ul><li>Installment sales </li></ul><ul><li>Incentive stock options </li></ul><ul><li>Adjusted gain or loss </li></ul>
  46. 46. AMT Itemized Deductions <ul><li>Casualty losses </li></ul><ul><li>Gambling losses </li></ul><ul><li>Charitable contributions </li></ul><ul><li>Medical expenses in excess of 10% of AGI </li></ul><ul><li>Estate tax on IRD </li></ul><ul><li>Qualified interest (qualified housing & investment interest) </li></ul><ul><li>3% floor for high AGI taxpayers does not apply </li></ul>
  47. 47. Cases and Rulings - Individuals Chapter Two
  48. 48. Individual Taxation - 1 <ul><li>2002 Std. Deduction </li></ul><ul><ul><li>Joint $7,850 </li></ul></ul><ul><ul><li>HH $6,900 </li></ul></ul><ul><ul><li>Single $4,700 </li></ul></ul><ul><ul><li>Kiddie $ 750 </li></ul></ul><ul><ul><li>OR Kiddie EI + $250 </li></ul></ul><ul><li>Age/Blindness $900 & $1,150 </li></ul><ul><li>Exemption $3,000 </li></ul><ul><li>2003 Std. Deduction </li></ul><ul><ul><li>Joint $9,500 </li></ul></ul><ul><ul><li>Surviving Sp. $9,500 </li></ul></ul><ul><ul><li>HH $7,000 </li></ul></ul><ul><ul><li>Single $4,750 </li></ul></ul><ul><ul><li>Kiddie $ 750 </li></ul></ul><ul><ul><li>OR Kiddie EI + $250 </li></ul></ul><ul><li>Age/Blindness $950 & $1,150 </li></ul><ul><li>Exemption $3,050 </li></ul>
  49. 49. Individual Taxation – 2 <ul><li>Phase-out of personal exemptions </li></ul><ul><li>Reduction of itemized deductions </li></ul><ul><li>“ Qualified transportation fringe benefits” </li></ul><ul><ul><li>$100 month transportation/transit passes </li></ul></ul><ul><ul><li>$190 month qualified parking </li></ul></ul><ul><li>Excise tax on luxury cars repealed </li></ul><ul><li>Standard mileage rate/mile – </li></ul><ul><ul><li>$.36 (down from $.365) </li></ul></ul><ul><ul><li>$.14 – charitable </li></ul></ul><ul><ul><li>$.12 medical/moving </li></ul></ul>
  50. 50. Individual Taxation – 3 <ul><li>§179 - $100,000 </li></ul><ul><li>First year depreciation on luxury auto </li></ul><ul><ul><li>$7,660 prior to May 6 </li></ul></ul><ul><ul><li>$10,710 after May 5 </li></ul></ul><ul><li>Leased auto inclusion amount </li></ul><ul><li>Annual lease value for employee use </li></ul><ul><li>Federal per-diem rates </li></ul><ul><ul><li>$125 - $90 lodging & $35 meals </li></ul></ul><ul><ul><li>$204 – High cost areas ($159 & $45) </li></ul></ul><ul><ul><li>Incidental does NOT include laundry, cleaning, telephone, lodging taxes, etc. </li></ul></ul>
  51. 51. Individual Taxation – 4 <ul><li>Net unearned income of a child </li></ul><ul><li>Earned income credit </li></ul><ul><ul><li>Earned income by the credit amount </li></ul></ul><ul><ul><li>Phase-out based on AGI </li></ul></ul><ul><ul><ul><li>AGI disregards net capital losses, net losses from trusts and estates, net losses from nonbusiness rents and royalties, and 50% of net losses from businesses. </li></ul></ul></ul><ul><ul><li>Exclusion of income for redemption of U.S. savings bonds, but phased-out over a $30,000 range. </li></ul></ul>
  52. 52. Individual Taxation – 5 <ul><li>Social security adjustments </li></ul><ul><ul><li>Wages base is $87,000 for OASDI. </li></ul></ul><ul><ul><li>$11,520 earnings level for ages 62 to 65 for cutback of social security benefits. No cutback age 65 or older. </li></ul></ul><ul><li>Education benefits </li></ul><ul><ul><li>Hope credit – maximum is $1,500 (100% of first $1,000 and 50% of next $1,000) and phased-out between $83,000-$103,000 joint and $41,000-$51,000 single </li></ul></ul><ul><ul><li>Lifetime learning credit – Maximum is $2,000 (20% of up to $10,000) </li></ul></ul>
  53. 53. Individual Taxation – 6 <ul><li>Student loan interest </li></ul><ul><ul><li>$2,500 maximum </li></ul></ul><ul><ul><li>Above-the-line deduction </li></ul></ul><ul><ul><li>Phased-out based on MAGI </li></ul></ul><ul><ul><ul><li>Joint $100,000-$130,000 </li></ul></ul></ul><ul><ul><ul><li>Single $50,000-$65,000 </li></ul></ul></ul>
  54. 54. Coverdell Education Savings – 1 <ul><li>$2,000 contribution; not a deduction </li></ul><ul><li>Grows tax free until distributed </li></ul><ul><li>Child under age 18 </li></ul><ul><li>Phased-out based on MAGI </li></ul><ul><ul><li>Joint $190,000-$220,000 </li></ul></ul><ul><ul><li>Single $95,000-$110,000 </li></ul></ul><ul><li>Funds can be used to pay K-12 costs </li></ul>
  55. 55. Coverdell Education Savings – 2 <ul><li>Anyone may make contributions </li></ul><ul><li>Entity contributions permitted </li></ul><ul><li>Deadline April 15 </li></ul><ul><li>Reverse excess funding by June 1 </li></ul><ul><li>CES withdrawal and Hope/LLC in same year allowed </li></ul><ul><li>May contribute to both CES and §529 plans </li></ul>
  56. 56. §529 Plans - 1 <ul><li>Two types of plans </li></ul><ul><ul><li>Prepaid tuition </li></ul></ul><ul><ul><li>Savings plan </li></ul></ul><ul><li>In 2003 </li></ul><ul><ul><li>Tax-free if spent on higher education </li></ul></ul><ul><ul><ul><li>2004 for private institutions/no 10% penalty until then </li></ul></ul></ul><ul><ul><li>Sponsorship by educational institutions </li></ul></ul><ul><ul><li>Excess distribution §72 applies – Proportionate income </li></ul></ul><ul><ul><li>Hope or L.L. credits OK in year of §529 plan withdrawal </li></ul></ul><ul><ul><li>Rollover to other plans tax-free </li></ul></ul>
  57. 57. <ul><li>OK to fund CES in same year </li></ul><ul><li>First cousins now included as family </li></ul><ul><li>10% penalty on income portion of excess withdrawal, except for: </li></ul><ul><ul><li>Death and disability </li></ul></ul><ul><ul><li>Nontaxable scholarship </li></ul></ul><ul><li>Special needs beneficiary expenses </li></ul><ul><li>Completed gift in year of contribution </li></ul><ul><li>Room and board now “reasonable expenses” instead of dollar limit </li></ul><ul><li>5 years of annual gift exclusions may be used by special election </li></ul>§529 Plans - 2
  58. 58. Questions About §529 Plans? <ul><li>2001ARD 247-3 Congressional Research Service Report – 12/17/01 </li></ul><ul><li>Basics outlined </li></ul><ul><li>May move between plans once per year </li></ul><ul><li>Relationship between §529 plans and student financial aid </li></ul>
  59. 59. Pension Limits - 2003 <ul><li>Defined-benefit plan limit - $160,000 </li></ul><ul><li>Defined-contribution plans </li></ul><ul><ul><li>Annual addition limit - $40,000 </li></ul></ul><ul><ul><li>Elective deferral limit - $12,000 </li></ul></ul><ul><ul><li>Maximum catch-up - $2,000 ($1,000 for SIMPLE §401(k)) </li></ul></ul><ul><li>SEP compensation cap - $200,000 </li></ul><ul><li>Highly compensated employees - $90,000 </li></ul><ul><li>SIMPLE maximum deferral - $8,000 ($1,000 maximum catch-up) </li></ul><ul><li>SEP minimum compensation level - $450 </li></ul><ul><li>IRA - $3,000 (catch-up $500) </li></ul>
  60. 60. Dependent Care Credit & Exclusion <ul><li>Maximum expense allowed </li></ul><ul><ul><li>$3,000 for one child </li></ul></ul><ul><ul><li>$6,000 for two or more </li></ul></ul><ul><li>35% maximum credit </li></ul><ul><li>20% minimum credit </li></ul><ul><li>Phase-down between $15,000 and $43,001 of AGI at a rate of 1% for each $2,000 </li></ul><ul><li>Dependent care exclusion limited to $5,000 </li></ul>
  61. 61. Miscellaneous Individual Provisions <ul><li>Medical insurance deduction for self-employed taxpayers at 100%. </li></ul><ul><li>Qualified long-term care deduction increased (depends on age). </li></ul><ul><li>Medical savings accounts have been extended (again) and with higher deductibles. </li></ul><ul><li>Foreign earned income exclusion - $80,000 </li></ul><ul><li>110% safe harbor for estimated taxes for high income taxpayers (>$150,000) </li></ul><ul><li>Deduction for education expenses - $3,000 ($4,000 in 2004) </li></ul>
  62. 62. Family Cases – 1 (p. 2-23) <ul><li>Bonus payments not deductible as alimony </li></ul><ul><ul><li>Ninth Circuit – individual’s obligation to make bonus payments under divorce decree not subject to termination on death was NOT alimony (Fithian v. United States). </li></ul></ul><ul><li>Innocent-spouse relief for nonrequesting spouse </li></ul><ul><ul><li>Rev. Proc. 2003-19 effective after April 1, 2003 and prior to this if no preliminary determination was issued – a nonrequesting spouse may now file a written protest and receive an appeals conference on decision to grant any relief to requesting spouse. </li></ul></ul>
  63. 63. Family Cases – 2 (p. 2-24/25) <ul><li>No innocent-spouse relief </li></ul><ul><ul><li>Spouse knew of some, but not all of unreported income (Dalton v. Commissioner, T.C. Memo 2002-268). </li></ul></ul><ul><ul><li>Equitable relief granted by Tax Court when denied by the Service (Washington v. Commissioner, 120 T.C. No. 9, 2003). </li></ul></ul>
  64. 64. Income Cases - 1 <ul><li>Compensation or Gift? </li></ul><ul><ul><li>Taxpayer received Form W-2 with base salary, but did not include bonus. </li></ul></ul><ul><ul><li>Corporation did not withhold income or employment taxes from bonus, but deducted it as salary expense. </li></ul></ul><ul><ul><li>Taxpayer argued that they were gifts from the corporation due to her being friends with the President. </li></ul></ul><ul><ul><li>Decision - They were compensation and was subject to accuracy-related penalty. (Williams v. Commissioner, T.C. Memo. 2003-97) </li></ul></ul>
  65. 65. Income Cases – 2 <ul><li>Discharge-of-Indebtedness income </li></ul><ul><ul><li>Disability insurance policy to cover loans </li></ul></ul><ul><ul><li>Received some payments under this policy </li></ul></ul><ul><ul><li>Insurance company decided that he was not entitled to payments made, but that repayment would not be possible and sent a 1099 MISC. </li></ul></ul><ul><ul><li>Taxpayer did not include discharge in income. </li></ul></ul><ul><ul><li>He argued that it was not income since he did not receive the 1099-MISC. </li></ul></ul><ul><ul><li>Decision - Discharge of debt was income. (Violette v. Commissioner, T.C. Summary Opinion 2002-149) </li></ul></ul>
  66. 66. Income Cases – 3 <ul><li>Interest income </li></ul><ul><ul><li>Taxpayer received annual payment plus interest on divorce settlement, but did not report the interest. </li></ul></ul><ul><ul><li>Settlement called for payments plus interest at 5.5%. </li></ul></ul><ul><ul><li>Taxpayer argued that the interest was post-divorce appreciation of her former spouse’s law practice and was not taxable. </li></ul></ul><ul><ul><li>Decision - Court held that it was interest & that attorney fees were not deductible. Cipriano v. Commissioner, No. 02-1055 (3 rd Cir. 2003), aff’g T.C. Memo 2001-157) </li></ul></ul>
  67. 67. Income Cases – 4 <ul><li>Return preparer (Stupidity or Greed?) (Group discussion pp. 2-30/31) </li></ul><ul><ul><li>Preparer did not report income from his return-preparation activity and his taxable social security payments. </li></ul></ul><ul><ul><li>IRS asked for records of bank accounts and he did not provide them. </li></ul></ul><ul><ul><li>IRS sent questionnaires to clients about fees and estimated his income. </li></ul></ul><ul><ul><li>Decision - ? (Joseph v Commissioner, T.C. Memo 2003-19) </li></ul></ul>
  68. 68. Income Cases – 5 <ul><li>Cancellation payments </li></ul><ul><ul><li>District manager of insurance company received commission on sales in the district. </li></ul></ul><ul><ul><li>Insurance company terminated agreement and gave him a termination settlement based on length of service and last six months earnings. </li></ul></ul><ul><ul><li>Taxpayer treated payments as gain from sale of insurance agency (franchise). </li></ul></ul><ul><ul><li>Decision - Tax Court held that payments were ordinary income and subject to self-employment tax. (Parker v Commissioner, T.C. Memo. 2002-305) </li></ul></ul>
  69. 69. Income Cases – 6 <ul><li>Gross income </li></ul><ul><ul><li>Taxpayers received income from fishing activity without any withholding by boat owners. </li></ul></ul><ul><ul><li>They argued that income was not taxable since the boat owners should have withheld the taxes. </li></ul></ul><ul><ul><li>Decision - Tax Court held that gross receipts were taxable regardless of whether the boat owner had properly withheld taxes. (Goins v. Commissioner, T.C. Memo. 1997-521, aff’d, 4 th Cir. 1998) </li></ul></ul>
  70. 70. Income Cases – 7 <ul><li>Assignment of Income I </li></ul><ul><ul><li>In 2001 Service allowed leave-based donation program without applying assignment-of-income doctrine. In 2003, they will apply it. (Notice 2003-1) </li></ul></ul><ul><li>Assignment of Income II </li></ul><ul><ul><li>Donating appreciated stock can provide double benefit: </li></ul></ul><ul><ul><ul><li>Deduction at fair market value </li></ul></ul></ul><ul><ul><ul><li>Exclusion of gain </li></ul></ul></ul><ul><ul><li>Service may apply assignment-of-income doctrine if sale is complete PRIOR to the donation. </li></ul></ul><ul><ul><li>They tried to apply it to a case where the taxpayer knew the sale was imminent, but not complete. </li></ul></ul><ul><ul><li>Decision - Tax Court held for the taxpayer. (Rauenhorst v. Commissioner, 119 T.C. No. 9 (2002) </li></ul></ul>
  71. 71. Income Cases – 8 <ul><li>Lottery Winners </li></ul><ul><ul><li>Taxpayer argued that the lottery winnings was a property interest and produced a capital gain when sold. </li></ul></ul><ul><ul><li>Decision - Tax Court held it was ordinary income. (Boehme v. Commissioner, T.C. Memo. 2003-81) </li></ul></ul><ul><li>Savings-bond interest </li></ul><ul><ul><li>Exclusion for redemption of U.S. Savings bonds used to pay higher education expenses. </li></ul></ul><ul><ul><li>Taxpayer failed to show that expenses were paid in the year that bonds were redeemed. </li></ul></ul><ul><ul><li>Decision - Exclusion denied by Tax Court. (Medina v. Commissioner, T.C. Summary Opinion 2003-115) </li></ul></ul>
  72. 72. Deductions Cases – 1 <ul><li>Charitable deductions to ministry disallowed </li></ul><ul><ul><li>Taxpayers were “ministers” of Alpha Ministries and claimed charitable deductions for amounts used to pay personal expenses. </li></ul></ul><ul><ul><li>Decision - Court disallowed deductions and impose20% accuracy-related penalty for negligence. (Smith v. Commissioner, T.C. Summary Opinion 2003-16) </li></ul></ul><ul><li>Who is minister of the gospel? </li></ul><ul><ul><li>Teachers and administrative staff of a school that is an affiliate of a church are not “ministers of the gospel” and not entitled to exclusion of housing allowance. </li></ul></ul><ul><ul><li>Their duties did not include duties performed by Christian ministers (Lord’s supper, baptism, marriage, moderating of church sessions, conducting worship services, performing funeral services, ministering to sick and needy). (TAM 200318002 ) </li></ul></ul>
  73. 73. Deductions Cases – 2 <ul><li>Substantiation </li></ul><ul><ul><li>Taxpayer must maintain adequate records. </li></ul></ul><ul><ul><li>Taxpayer did not have records. </li></ul></ul><ul><ul><li>Court followed Cohan rule to establish a small deduction for clothing donations, but disallowed a claimed cash deduction and one for a paving stripping machine, they claimed was given to the Church to complete a parking lot repavement project, due to lack of documentation. (Cameron v. Commissioner, T.C. Summary Opinion 2002-4) </li></ul></ul>
  74. 74. Deductions Cases – 3 <ul><li>Home interest disallowed since taxpayer failed to secure the loan with his personal residence. (Boehme v. Commissioner, T.C. Memo. 2003-810 </li></ul><ul><li>Margin interest – Tax court held that taxpayer may deduct margin interest paid on brokerage account trades as investment interest. (Miner v. Commissioner, T.C. Memo. 2003-39) </li></ul><ul><li>Roof repair </li></ul><ul><ul><li>Taxpayer replaced roof on rental house due to leaks and expensed it. </li></ul></ul><ul><ul><li>IRS claimed it should be a capital expenditure. </li></ul></ul><ul><ul><li>Decision - Tax Court allowed the deduction since it merely restored the rental to a previous condition (leak free roof). (Campbell v. Commissioner, T.C. Summary Opinion 2002-117) </li></ul></ul>
  75. 75. Deductions Cases – 4 <ul><li>Improvement costs </li></ul><ul><ul><li>Taxpayer made improvements on lease – some in lieu of rent. </li></ul></ul><ul><ul><li>Taxpayer deducted all improvements. </li></ul></ul><ul><ul><li>Service ruled that they must capitalize improvements. </li></ul></ul><ul><ul><li>Decision - Court held that payments in lieu of rent could be deducted and others must be capitalized. (McGrath v. Commissioner, T.C. Memo. 2002-231) </li></ul></ul>
  76. 76. Deductions Cases – 5 <ul><li>Home Office I </li></ul><ul><ul><li>Taxpayer was full-time freelance writer and received payment when work completed and some royalty and residual income, but he was considered an employee in the industry. </li></ul></ul><ul><ul><li>Home office met exclusive use test, regularly used, was the principal place of business, and was for the convenience of the employer. </li></ul></ul><ul><ul><li>He had an office in his home and two rental apartments in which he worked and was entitled to limited deductions for home office and business expenses. </li></ul></ul><ul><ul><li>Decision </li></ul></ul><ul><ul><ul><li>Deductible expenses could not exceed gross income from writing. </li></ul></ul></ul><ul><ul><ul><li>Income from writing did not include residuals. (Radnitz v. Commissioner, T.C. Summary Opinion 2003-29) </li></ul></ul></ul>
  77. 77. Deductions Cases – 6 <ul><li>Home Office II </li></ul><ul><ul><li>Self-employed interior decorator rented an apartment and used part for an office. </li></ul></ul><ul><ul><li>He purchased computer equipment and software and included their cost in cost of goods sold on his Schedule C. </li></ul></ul><ul><ul><li>Taxpayers did not attach Form 4562 and made no indication they were claiming a §179 expense. </li></ul></ul><ul><ul><li>Service disallowed some home office deductions based on the income limitations and disallowed the deduction for the computer equipment and software in total, but did allow depreciation. </li></ul></ul><ul><ul><li>Decision - §179 is not allowed retroactively. (Visin v. Commissioner, T.C. Memo. 2003-246) </li></ul></ul>
  78. 78. Deductions Cases – 7 <ul><li>Dance expenses </li></ul><ul><ul><li>Taxpayer claimed dance expenses of 14 year old daughter were in connection to profit as a manager of entertainment and sports clients. </li></ul></ul><ul><ul><li>He had had not been paid by anyone he represented and did not have an agreement for future earnings. </li></ul></ul><ul><ul><li>Daughter had many years training and won many contests. </li></ul></ul><ul><ul><li>He and his daughter had a management contract. </li></ul></ul><ul><ul><li>Decision - Court held all were personal expenses since he seemed to be in parental activity versus an activity for profit. (Carino v. Commissioner, T.C. Summary Opinion 2002-140) </li></ul></ul>
  79. 79. Deductions Cases – 8 <ul><li>Medical deductions </li></ul><ul><ul><li>Deducted payments to wife by insurance company to pay for care – NOT allowed since not paid by him and if they had been it was long-term care, not medical. </li></ul></ul><ul><ul><li>Van expense in excess of car expense to haul scooter – NOT allowed since not essential to medical care. </li></ul></ul><ul><ul><li>Dependent care expenses for disabled son while traveling – NOT allowed due to personal nature and lack of substantiation. </li></ul></ul><ul><ul><li>Electrical generator to backup electricity since son very distressed when radio, television, air conditioning not operating – NOT deductible as medical expense. </li></ul></ul><ul><ul><li>Maintenance of swimming pool used for rehab – Allowed even without actual receipts. </li></ul></ul><ul><ul><li>Expenses of sending son to special camp – Allowed. (Emanual v. Commissioner, T.C. Summary Opinion 2002-127) </li></ul></ul>
  80. 80. Deductions Cases – 9 <ul><li>§1244 Loss on small-business stock </li></ul><ul><ul><li>Not allowed since it was ruled as not being an operating company. (Crigler v. Commissioner, T.C. Memo. 2003-93) </li></ul></ul><ul><li>Rental activity subject to passive-loss limitations (Group Discussion – pp. 2-48/51) </li></ul><ul><ul><li>Taxpayers had five apartments & three single family condominiums they rented. </li></ul></ul><ul><ul><li>Taxpayer was Engineer & wife an Accountant who worked 1,800 hours. She also actively managed rentals. Later she quit work to manage rentals full-time. </li></ul></ul><ul><ul><li>They did not elect to treat all rentals as one activity. She made general notes on her calendar on rental activities. </li></ul></ul><ul><ul><li>Deducted losses on Schedule E based on her assertion that she was a Real Estate Professional. </li></ul></ul><ul><ul><li>Decision - ? </li></ul></ul><ul><ul><li>(Jahina v. Commissioner, T.C. Summary Opinion 2002-150) </li></ul></ul>
  81. 81. Capital Transactions – 1 <ul><li>Like-kind property </li></ul><ul><ul><li>Taxpayer traded water rights for fee simple interest in land and treated it as a like-kind exchange. </li></ul></ul><ul><ul><li>Decision - Court held that is was not a like-kind exchange. (Wiechens v. United States; No. CIV 00-1858-PHX-SMM (D. Ariz. 2002) </li></ul></ul><ul><li>Loss on sale of former home (Group Discussion-pp. 2-52/53) </li></ul><ul><ul><li>Taxpayer owned home and couldn’t make payments so he leased it for a short period and then sold it the next year. </li></ul></ul><ul><ul><li>He deducted the loss as a capital loss. </li></ul></ul><ul><ul><li>Service disallowed since he did not provide proof of cost in excess of selling price and, alternately, that the transaction was not entered into for profit. </li></ul></ul><ul><ul><li>Decision - ? (Abrams v. Commissioner, T.C. Summary Opinion 2002-155) </li></ul></ul>
  82. 82. Capital Transactions – 2 <ul><li>Revocation of an election out of installment reporting </li></ul><ul><ul><li>Election must be made by due date – any revocation is retroactive. </li></ul></ul><ul><ul><li>Taxpayer inadvertently revoked installment method when his accountant overlooked it and included all the gain on sale and he signed the return. </li></ul></ul><ul><ul><li>Service allowed revocation of election (PLR 200305014). </li></ul></ul><ul><ul><li>Taxpayer had to file amended return. </li></ul></ul><ul><ul><li>Similar ruling in PLR 200308042. </li></ul></ul><ul><li>Foreclosure proceeds used to pay real estate taxes includable in capital gain calculation even though proceeds went directly to county treasurer for taxes. (Jokinen v. Commissioner, [not for publication] (11 th Cir. 2002) </li></ul>
  83. 83. Transfer Tax Cases – 1 <ul><li>2003 transfer tax limitations </li></ul><ul><ul><li>$11,000 annual gift exclusion </li></ul></ul><ul><ul><li>$345,800 applicable credit ($1,000,000 estate) </li></ul></ul><ul><ul><li>2004 the gift tax stays the same </li></ul></ul><ul><ul><li>2004 – Estate tax credit is $555,800 ($1,500,000 estate) </li></ul></ul><ul><ul><li>$112,000 gift tax exclusion for non-U.S. citizen </li></ul></ul><ul><ul><li>$840,000 – Maximum reduction for special use value </li></ul></ul><ul><ul><li>$1,120,000 – Maximum value for deferral of estate tax payment for closely held business </li></ul></ul><ul><ul><li>$1,120,000 – Exemption for generation skipping tax </li></ul></ul><ul><ul><li>$7,700 – qualified funeral trust </li></ul></ul><ul><ul><li>25% of State death tax credit that was allowed pre-2001 </li></ul></ul>
  84. 84. Transfer Tax Cases – 2 <ul><li>Estate tax rates </li></ul><ul><li>Present interest in gifts of entity interests </li></ul><ul><ul><li>Must be present interest. </li></ul></ul><ul><ul><li>Taxpayers formed LLC to manage tree farm for long-term income. </li></ul></ul><ul><ul><li>Court ruled no present interest and therefore no gift eligible for annual exclusion. (Hacki v. Commissioner, 7 th Cir. 2003, aff’g 118 T.C. 279 (2002) </li></ul></ul>
  85. 85. Transfer Tax Cases – 3 <ul><li>Estate tax valuation of family limited partnership interests – Underlying assets may be measure of value. </li></ul><ul><ul><li>They were successful where partnership had marketable stock and securities. </li></ul></ul><ul><ul><ul><li>Commingling of funds </li></ul></ul></ul><ul><ul><ul><li>Disproportionate distribution </li></ul></ul></ul><ul><ul><ul><li>Unilateral nature of formation without adequate consideration (Estate of Harper v. Commissioner, T.C. Memo 2002-121) </li></ul></ul></ul><ul><ul><li>Another Tax Court case required inclusion of family limited partnership interests in gross estate valued at underlying assets transferred. </li></ul></ul><ul><ul><ul><li>Decedent held enjoyment of assets. </li></ul></ul></ul><ul><ul><ul><li>Principal economic beneficiary </li></ul></ul></ul><ul><ul><ul><li>None of the beneficiaries participated in business. (Estate of Thompson v. Commissioner, T.C. Memo 2002-246) </li></ul></ul></ul><ul><ul><ul><li>Strangi v. Commissioner (T.C. Memo 2003-145) had same results. Biggest difference was that decedent had ability to transfer assets, actual economic benefit NOT required. </li></ul></ul></ul>
  86. 86. Substantially Equal Periodic Payments – 1 <ul><li>10% penalty for early withdrawal of the taxable amount unless an exception, one of which is substantially equal periodic payments. If the owner changes the method before age 59 ½ the penalty is retroactive to all payments. </li></ul><ul><ul><li>Example 1 – TP payments begin at age 53. Age 57 withdrew balance of account. She is liable for 10% penalty on all payments. </li></ul></ul><ul><li>Substantially equal payments prior to age 59 ½ must generally continue for at least 5 years or they are subject to 10% penalty. </li></ul><ul><ul><li>Example 2 – TP started withdrawals at age 57. Four years later she withdrew the balance. Liable for 10% penalty on the payments received PRIOR to age 59 ½. </li></ul></ul>
  87. 87. Substantially Equal Periodic Payments – 2 <ul><li>Prohibition on change within five years is not applicable if due to death or disability. </li></ul><ul><ul><li>Example 3 – TP needs to withdraw balance four years later since she is disabled. No 10% penalty is due for any amounts received. </li></ul></ul><ul><li>Substantially equal payments – 3 approaches recognized by IRS: </li></ul><ul><ul><li>Life Expectancy method – Required minimum distribution based on IRA owner or joint life expectancy of IRA owner and designated beneficiary. </li></ul></ul><ul><ul><li>Amortization method – Balance evenly over life expectancy as above. </li></ul></ul><ul><ul><li>Annuity method – Balance by an annuity factor using reasonable mortality table and reasonable interest rate. </li></ul></ul>
  88. 88. Substantially Equal Periodic Payments – 3 <ul><li>Example – TP is 50 year old woman with no designated beneficiary. </li></ul><ul><ul><li>Life expectancy method – Using formula with a deemed life expectancy of 43.5 years and a $105,000 balance = $2,370.20 distribution (recalculated each year). </li></ul></ul><ul><ul><li>Amortization - $100,000 balance with 8% amortization over life of 33.1 years = $8,679 distribution each year. </li></ul></ul><ul><ul><li>Annuity - $100,000 with interest at 8% the mortality table gives a factor of 11.109 = $9,002 distribution each year. </li></ul></ul><ul><li>The owner must receive the EXACT amount. </li></ul><ul><li>Exceptions apply to EACH IRA, not the aggregate. </li></ul><ul><li>If taxpayer chooses the amortization or annuity method, they may change to the required minimum distribution method at any time. </li></ul><ul><li>The new method is required in all subsequent periods and is not considered a change in method. </li></ul>
  89. 89. Substantially Equal Periodic Payments – 4 <ul><li>Divorcing taxpayer – Payment changes made subject to a QDRO in a divorce is not considered a change. </li></ul><ul><li>Distributions from qualified plan subject to additional tax </li></ul><ul><ul><li>Taxpayer retired at age 52 and rolled pension plan into IRA. </li></ul></ul><ul><ul><li>Calculated minimum distributions based on a 29 percent growth rate and used the amortization method. </li></ul></ul><ul><ul><li>Court held it was not a reasonable growth rate and distributions were subject to 10% penalty. (Farley v. Commissioner, T.C. Summary Opinion 2003-43) </li></ul></ul>
  90. 90. Substantially Equal Periodic Payments – 5 <ul><li>Withdrawal from qualified retirement plan subject to additional tax – Taxpayer withdrew money to pay for higher education expenses and asked IRS help line if she had to pay the tax. They told her that she was not subject to penalty tax. </li></ul><ul><li>Taxpayer could not substantiate that she was eligible for inclusion of room and board (1/2 time student). She continued full-time employment as a nurse. </li></ul><ul><li>She withdrew money one year and spent it over two years (less than distribution). </li></ul><ul><li>Decision - Only amounts spent for education in year of withdrawal was exempt from the tax. (Dunn v. Commissioner, T.C. Summary Opinion 2002-108) </li></ul>
  91. 91. Substantially Equal Periodic Payments – 6 <ul><li>Early IRA distribution beyond $10,000 for first house was subject to 10% penalty. (Tussey v. Commissioner, T.C. Summary Opinion 2003-47) </li></ul><ul><li>Rollover of plan proceeds into rental property (held NOT to be a retirement plan) subject to tax on early distribution. (Beneventi v. Commissioner, T.C. Summary Opinion 2003-13) </li></ul><ul><li>Taxation of beneficiary of a qualified employee benefit plan – Lump-sum distribution of employer stock into another qualified plan does not bar an employee from excluding net unrealized appreciation on stock distribution in kind. (PLR 200243052) </li></ul>
  92. 92. Substantially Equal Periodic Payments – 7 <ul><li>IRA distribution includable in gross income. (Group Discussion – pp. 2-75/76) </li></ul><ul><ul><li>Taxpayer withdrew IRA and put in nonqualified annuity and did not include amount in gross income. </li></ul></ul><ul><ul><li>IRS contacted and taxpayer had bank try to correct by making it a qualified annuity and labeled it a bank error and they back dated the document. </li></ul></ul><ul><ul><li>A year later the actual funds were still in same nonqualified account. </li></ul></ul><ul><ul><li>Decision - ? (Crow v. Commissioner, T.C. Memo. 2002-178) </li></ul></ul>
  93. 93. Retirement Plans - 1 <ul><li>§401(k) contribution limits </li></ul><ul><ul><li>$12,000 – 2003 and increasing $1,000 a year until it reaches $15,000 in 2006 and then adjusted for inflation. </li></ul></ul><ul><ul><li>Catch-up elective deferrals are $2,000 in 2003 and increasing $1,000 a year until they reach $5,000 in 2006. </li></ul></ul><ul><ul><li>These limits are applied to the individual. </li></ul></ul>
  94. 94. Retirement Plans – 2 <ul><li>SEP </li></ul><ul><ul><li>Maximum contribution is $40,000 or 25% of employee’s compensation. </li></ul></ul><ul><ul><li>6% excise tax on excess contributions </li></ul></ul><ul><li>SIMPLE plan contributions </li></ul><ul><ul><li>Salary reduction contribution and </li></ul></ul><ul><ul><ul><li>Employer matching contributions (up to 3%) OR </li></ul></ul></ul><ul><ul><ul><li>Employer nonelective contribution (2% if employee earns at least $5,000 with a maximum of $4,000 contribution) </li></ul></ul></ul><ul><ul><li>$8,000 maximum and increasing $1,000 year until it reaches $10,000 </li></ul></ul><ul><ul><li>Catch-up is $1,000 and increasing $500 a year until $2,500 in 2006 </li></ul></ul><ul><li>New IRAs – Deemed IRA & new $3,000 limit </li></ul>
  95. 95. Principal Residence Regulations - 1 <ul><li>What is a residence? </li></ul><ul><li>If more than one, which one is the principal residence? </li></ul><ul><ul><li>Generally, the one used the majority of the time. </li></ul></ul><ul><li>Can vacant land be a principal residence? Probably, if adjacent and used as part of residence. </li></ul><ul><li>Ownership and use – two years of last five. Do not have to be the same two years nor does it have to be concurrent years. </li></ul><ul><li>Short temporary absences OK. </li></ul><ul><li>Only one year use required if physically or mentally incapable if self-care. </li></ul>
  96. 96. Principal Residence Regulations - 2 <ul><li>Depreciation – Exclusion does not include gain on sale that is attributable to depreciation after May 6, 1997. Any gain is §1250 unrecaptured gain at 25% tax rate. </li></ul><ul><li>Property used in part as a principal residence and part for other purposes – No allocation is required if residential and nonresidential portions are within the same dwelling unit. The exclusion would apply to the entire sale except any possible §1250 unrecaptured gain for depreciation taken. </li></ul><ul><li>If the nonresidential portion is not in the same dwelling unit, a prorata allocation of the sale and basis must be made to determine the gain. The exclusion is only for the residential portion. </li></ul>
  97. 97. Principal Residence Regulations - 3 <ul><li>Maximum exclusion - $250,000 single & $500,000 joint </li></ul><ul><ul><li>Either spouse can meet ownership requirements. </li></ul></ul><ul><ul><li>Both spouses must meet use test. </li></ul></ul><ul><ul><li>Neither spouse excluded gain in last two years. (Sale or exchange prior to May 7, 1997, is disregarded.) </li></ul></ul><ul><ul><li>Reduced maximum exclusion – Prorata amount of maximum exclusion if less than 2 years due to: </li></ul></ul><ul><ul><ul><li>Health </li></ul></ul></ul><ul><ul><ul><li>Changes of employment </li></ul></ul></ul><ul><ul><ul><li>Unforeseen circumstances </li></ul></ul></ul><ul><ul><ul><li>Involuntary conversion </li></ul></ul></ul><ul><ul><ul><li>Natural disasters, death, etc. </li></ul></ul></ul>
  98. 98. Principal Residence Regulations - 4 <ul><li>Planning Opportunities: </li></ul><ul><ul><li>Multiple rentals </li></ul></ul><ul><ul><li>Multiple Residences, e.g., “Snow Birds” </li></ul></ul>
  99. 99. Cases and Rulings - Business Chapter 3
  100. 100. S Corporations - 1 <ul><li>Couple not entitled to deduct losses from S Corporation </li></ul><ul><ul><li>Taxpayers formed corporation, but did not file Forms SS-4 or 2553 for S Corporation status. </li></ul></ul><ul><ul><li>Filed tax return on Schedule E and Service advised them to file Form 1120. </li></ul></ul><ul><ul><li>After deficiency notice, accountant had them file an amended return and move the business to Schedule C. </li></ul></ul><ul><ul><li>Decision - Court disallowed all losses due to lack of substantiation and ruled they were C Corporation since they did not file as required. (Highbee v. Commissioner, T.C. Summary Opinion 2002-128) </li></ul></ul>
  101. 101. S Corporations – 2 <ul><li>Passive-loss limitations </li></ul><ul><ul><li>(Group discussion-p. 3-2/3) </li></ul></ul><ul><ul><li>Taxpayer owned part of S Corporation that operated bowling alleys. </li></ul></ul><ul><ul><li>Taxpayer purchased equipment individually and leased to S Corporation since they couldn’t get financing. </li></ul></ul><ul><ul><li>Deducted losses from lease on Schedule E and argued that lease was not a rental since it was provided to his business. </li></ul></ul><ul><ul><li>Service ruled that it was a rental and subject to passive loss rules. (“Duck” theory) </li></ul></ul><ul><ul><li>Decision - ? </li></ul></ul><ul><ul><li>Would could the TP done differently so the loss would be allowed? (Sciabica v. Commissioner, T.C. Summary Opinion 2002-146) </li></ul></ul>
  102. 102. S Corporations – 3 <ul><li>Passive-investment income in general </li></ul><ul><ul><li>S Corporation had E&P and invested in 3 publicly traded partnerships that met the requirements to be partnerships for tax purposes. </li></ul></ul><ul><ul><li>Was the nature of the income from these partnerships passive or not? </li></ul></ul><ul><ul><li>Decision - Gross receipts were not converted to passive income upon allocation to S Corporation. The character of the receipts for Taxpayer is the same as the character of the receipts to the partnership. (PLR 200309021) </li></ul></ul>
  103. 103. S Corporations – 4 <ul><li>S Corporation rental income not passive – two separate rulings </li></ul><ul><ul><li>S Corporation provided significant services and incurred substantial costs in connection with commercial property leases. </li></ul></ul><ul><ul><li>Decision - They were a trade or business. (PLRs 200252036 & 200252037) </li></ul></ul><ul><li>Self-Employment income </li></ul><ul><ul><li>S Corporation pass-through items are not self-employment income and losses cannot offset other self-employment income. ( Ding v. Commissioner, 9 th Cir. 1999, aff’g 1997-435 T.C. Memo) </li></ul></ul>
  104. 104. S Corporations – 5 <ul><li>Form of doing business </li></ul><ul><ul><li>Facts: </li></ul></ul><ul><ul><ul><li>Shareholders paid back taxes for partnerships that were 60% owned by S Corporation. </li></ul></ul></ul><ul><ul><ul><li>They deducted 100% of payments. </li></ul></ul></ul><ul><ul><li>Decision: </li></ul></ul><ul><ul><ul><li>Payments were treated as capital contributions to S Corporation and then by S Corporation to partnerships. </li></ul></ul></ul><ul><ul><ul><li>60% of expenses by partnerships were then pass-through to S Corporation. (Griffin v. Commissioner, T.C. Memo. 2002-6) </li></ul></ul></ul>
  105. 105. S Corporations – 6 <ul><li>LIFO recapture </li></ul><ul><ul><li>C Corporation was a member of partnerships that used LIFO. </li></ul></ul><ul><ul><li>C Corporations restructured and elected S Corporation status. </li></ul></ul><ul><ul><li>Decision - Required to include prorata share of partnership inventories in gross income as its ratable share of LIFO recapture amount. (Coggin Automotive Group v. Commissioner, 115 T.C. 349 (2000) </li></ul></ul>
  106. 106. S Corporations – 7 <ul><li>Recent IRS statistics prove S Corporation are the most popular choice of entity (1999). </li></ul><ul><ul><li>2,700,000 – S Corporations </li></ul></ul><ul><ul><li>889,000 – Partnerships </li></ul></ul><ul><ul><li>589,000 – LLCs </li></ul></ul><ul><ul><li>354,000 – Limited partnerships </li></ul></ul><ul><ul><li>42,000 – LLPs </li></ul></ul><ul><ul><li>1,071 - REITs </li></ul></ul><ul><li>Discharge of Indebtedness </li></ul><ul><ul><li>Discharge of indebtedness income does not flow through to the shareholders to allow losses after October 11, 2001 </li></ul></ul><ul><ul><li>Law change to overrule the Supreme Court in the Gitlitz case. </li></ul></ul>
  107. 107. S Corporations – 8 <ul><li>ESOP distribution does not jeopardize S corporation status. </li></ul><ul><ul><li>S Corporation stock may be held by ESOP, but not by IRA. </li></ul></ul><ul><ul><li>Taxpayer may want to rollover account into IRA. </li></ul></ul><ul><ul><li>Service issued Rev. Proc. 2003-23 that sets forth requirements to allow this. </li></ul></ul><ul><ul><ul><li>S Corporation must immediately repurchase stock from IRA simultaneously with the direct rollover distribution and no distributions of any kind are attributed to the IRA. </li></ul></ul></ul>
  108. 108. S-Corporation Planning Tip <ul><li>Corporate tax rates not reduced </li></ul><ul><li>Small business owners should still tale advantage of S-Corporation election. </li></ul>
  109. 109. Partnerships – 1 <ul><li>Option to acquire partnership interest coupled with distribution was a disguised sale. </li></ul><ul><ul><li>Taxpayer formed partnership with two affiliates that granted an option to acquire an interest from an unrelated party. </li></ul></ul><ul><ul><li>Unrelated party contributed exercise price equal to taxpayer’s prior contributions less distributions to taxpayer. </li></ul></ul><ul><ul><li>Decision - Service ruled a disguised sale. (TAM 20030104) </li></ul></ul><ul><li>Group restructuring into pass-through entities </li></ul><ul><ul><li>Service revised earlier ruling that now makes this partially taxable as a liquidation and partially tax-free. (PLR 200310026 revising PLR 200252014) </li></ul></ul>
  110. 110. Partnerships – 2 <ul><li>Final regulations on partnership basis adjustments under §705: </li></ul><ul><ul><li>Issued to prevent inappropriate increases or decreases in the adjusted basis of a corporate partner’s interest resulting from the partnership’s disposition of the corporate partner’s stock. </li></ul></ul><ul><ul><li>The increase or decrease in the corporation’s adjusted basis is the amount of gain/loss that they would have recognized (without application of §1032) if a §754 election had been in effect. </li></ul></ul><ul><li>Service efforts to match Schedule K-1 forms to tax returns (renewed K-1 matching program) </li></ul>
  111. 111. C Corporations – 1 <ul><li>Unamortized covenants-not-to-compete: </li></ul><ul><ul><li>Taxpayer operated commercial logging business. </li></ul></ul><ul><ul><li>Endangered Species (Mexican Spotted Owl) discovered and logging halted. </li></ul></ul><ul><ul><li>Taxpayer deducted value of covenants-not-to-compete. </li></ul></ul><ul><ul><li>Service disallowed </li></ul></ul><ul><ul><li>Decision - Court allowed deduction (Covenant was worthless). (Precision Pine & Timber, Inc. v. Commissioner, T.C. Summary Opinion 2003-19) </li></ul></ul><ul><li>Payment of shareholder personal expenses is nondeductible by corporation. (Pigs get fat; hogs get slaughtered.) (Group discussion-p. 3-17) </li></ul><ul><ul><li>Decision-? (Dobbe v. Commissioner, (9 th Cir. 2003) [not for publication], aff’g T.C. Memo 2000-330) </li></ul></ul>
  112. 112. C Corporations – 2 <ul><li>Loan to gas station corporation </li></ul><ul><ul><li>Corporation ran station/convenience stores. </li></ul></ul><ul><ul><li>Made deal with AMOCO for products. </li></ul></ul><ul><ul><li>AMOCO agreed to provide equipment and services and payments would be deemed paid if dealer supply agreement still in effect. </li></ul></ul><ul><ul><li>Note called for payments and interest. </li></ul></ul><ul><ul><li>Taxpayer guaranteed indebtedness to AMOCO. </li></ul></ul><ul><ul><li>Corporation recorded note as deferred income on books and Form 1120. </li></ul></ul><ul><ul><li>Service ruled that full amount was income when received. </li></ul></ul><ul><ul><li>Decision - Court held it was a loan. (Erickson Post Acquisitions, Inc. v. Commissioner, T.C. Memo 2003-218) </li></ul></ul>
  113. 113. Methods of Accounting – 1 <ul><li>Deferral of advance payments </li></ul><ul><ul><li>To reduce litigation over whether payments are for services, nonservices, or a combination, the Service issued a proposed procedure that expands the scope of the deferral rules to include advance payments for some nonservices and mixed service/nonservices. Allows deferral to next year if same deferral for financial reporting purposes. (Rev. Proc. 2002-79) </li></ul></ul>
  114. 114. Methods of Accounting – 2 <ul><li>Service’s position on changes in accounting method: </li></ul><ul><ul><li>Change in method usually over four years unless <$25,000. </li></ul></ul><ul><ul><li>Now positive adjustments over four years and negative adjustments in year of change. </li></ul></ul><ul><ul><li>Change in method allowed prospectively, but without audit protection, if the method is an issue pending for a tax year under examination or an issue under consideration by an appeals office or a federal court. (Rev. Procs. 2002-9, 2002-19, 2002-54) </li></ul></ul>
  115. 115. Methods of Accounting – Cases & Rulings – 1 <ul><li>Advance payments </li></ul><ul><ul><li>Taxpayer manufactured and sold items and systems directly to customer. </li></ul></ul><ul><ul><li>Contract to design, build, and deliver </li></ul></ul><ul><ul><li>Advance payment received with balance due when delivery took place. </li></ul></ul><ul><ul><li>Taxpayer considered income when it delivered for both tax and financial purposes. </li></ul></ul><ul><ul><li>Decision: Service allowed (FSA 200246016) </li></ul></ul>
  116. 116. Methods of Accounting – Cases & Rulings – 2 <ul><li>Goods mistakenly shipped and billed </li></ul><ul><ul><li>Accrual basis taxpayer must recognize income when shipped. Any correction is generally made in the year in which it is determined. </li></ul></ul><ul><ul><li>If taxpayer has used this method for two or more years and wishes to now take corrections back to the year of the sale, they must file for a change in accounting method. </li></ul></ul><ul><ul><li>Accrual taxpayer would not include in income if amount is disputed by the customer. (Rev. Rul. 2003-10) </li></ul></ul>
  117. 117. Methods of Accounting – Cases & Rulings – 3 <ul><li>Rotable spare parts may be treated as depreciable assets rather than as inventory held for sale. (Rev. Rul. 2003-37) </li></ul><ul><li>Completed contract method </li></ul><ul><ul><li>Taxpayer transferred partially completed contracts to 4 C Corporations. </li></ul></ul><ul><ul><li>Subsequently incurred expenses related to these contracts and deducted them </li></ul></ul><ul><ul><li>Service disallowed the deductions as benefiting the C Corporation and was not a business expense of the S Corporation. </li></ul></ul><ul><ul><li>Decision - Tax Court agreed and was affirmed by the Circuit Court. (Bone v. Commissioner, (11 th Cir. 2003), aff’g T.C. Memo 2001-43) </li></ul></ul>
  118. 118. Other Useful Information <ul><li>Practice Pointers </li></ul><ul><li>Average Fees </li></ul><ul><li>Software </li></ul><ul><li>IRS Restructuring </li></ul><ul><li>News You Can Use </li></ul><ul><li>New Filing Address </li></ul>
  119. 119. Practice Pointers <ul><li>Engagement Letters </li></ul><ul><li>Tax Organizers </li></ul><ul><li>Pre-Scheduled Appointments </li></ul><ul><li>Year-End Tax Planning Letter </li></ul><ul><li>Fee Schedules v. Hourly Rates </li></ul>
  120. 120. Average Fees <ul><li>1040 </li></ul><ul><li>1065 </li></ul><ul><li>C Corporation </li></ul><ul><li>S Corporation </li></ul>
  121. 121. Software <ul><li>Tax </li></ul><ul><li>Accounting </li></ul><ul><li>Payroll </li></ul>
  122. 122. IRS Restructuring <ul><li>Industry/Functional v. Geographic Re-Alignment </li></ul><ul><li>Industry Audit Guides & Specialists </li></ul><ul><li>Offers in Compromise </li></ul><ul><li>System Modernization </li></ul><ul><li>Put the “Service” back in IRS </li></ul><ul><li>New IRS Circular 230 </li></ul><ul><ul><li>Code of Conduct </li></ul></ul><ul><ul><li>Doubling number of agents assigned to enforcement as of 3/9/03. </li></ul></ul>
  123. 123. News You Can Use #1 <ul><li>Senate Probe Targets KPMG Shelters </li></ul><ul><li>IRS Issues New Guidelines for Charitable Organizations (Publications 4220 & 4221) </li></ul><ul><li>IRS May Share Data with INS </li></ul><ul><li>GAO Reports </li></ul><ul><ul><li>IRS Fines Taxpreparers $2.4M, But Doesn’t Collect (only 12% collected) </li></ul></ul><ul><ul><li>IRS Has ‘Material Weaknesses’ in Security Controls </li></ul></ul>
  124. 124. News You Can Use #2 <ul><li>Federal Court Blocks Tax Avoidance Scheme – Colorado couple charged $1,595 fee to provide forms to remove TP form tax roles </li></ul><ul><li>IRS Expands Locations for Convention Expense Deductions </li></ul><ul><li>IRS Launches Online Tools to Help Access Client Information </li></ul><ul><li>2004 Standard Mileage Deduction $.375/mile in 2004 </li></ul><ul><li>Many OK with cheating on taxes, survey says </li></ul>
  125. 125. New Filing Address for 1040 <ul><li>New York clients balance due returns: </li></ul><ul><ul><li>Internal Revenue Service </li></ul></ul><ul><ul><li>P.O. Box 37002 </li></ul></ul><ul><ul><li>Hartford, CT 06716-0002 </li></ul></ul>
  126. 126. That’s All Folks!