This presentation explains 10 concerns in the preparation of Form 1040 as the tax law existed at December 7, 2012.

1. Top 10 Concerns in
Preparation of Form 1040
Tax & Financial Planning Conference
Fort Lauderdale, Florida
December 7, 2012
1

2. by
Alan D. Campbell, Ph.D., CPA, CMA, CFP®
Associate Professor of Accounting
Troy University
Montgomery, Alabama
and
Author of the forthcoming book
Tax Savings Prescriptions: How to Keep More
Money to Achieve Your Family’s Goals, New
York: Morgan James Publishing, 2013
2

3. Learning Objectives
1. Explain how to report
sales of business
properties on
Form 4797
2. Explain how to report
like-kind exchanges on
Form 8824
3. Explain how to report
installment sales on
Form 6252
3

4. Learning Objectives
4. Explain how to report
discharge of
indebtedness income
and exclusions from
discharge of
indebtedness income,
and reduction of tax
attributes
5. Explain how to report
contributions to IRAs
and other retirement
plans
4

5. Learning Objectives
6. Explain how to report
distributions from IRAs and
other retirement plans
7. Explain where to deduct tax
preparation fees to realize
the greatest tax benefit
8. Explain how to calculate the
penalty for underpayment of
estimated tax
9. Explain how to report the
additional child tax credit
10. Explain how to avoid the
penalty for understating the
client’s tax liability under
Sec. 6694
5

6. Learning Objective 1
Explain how to report
sales of business
properties on Form 4797
6

7. What to Determine on a Sale of
an Asset Used in a Trade or Business
• Amount realized
• Gain or loss realized
• Gain or loss recognized
• Character of gain or loss
recognized
7

8. Amount Realized (Sec. 1001(b))
• Cash received
• FMV of property received
• Notes received
• Debt relief
(Reg. 1.1001-2)
• Real estate taxes imposed
on the seller and paid by
the buyer
• Less: Selling expenses
• Equals: Amount realized
8

9. Gain or Loss
Realized (Sec. 1001(a))
• Amount realized
• Less: Adjusted basis
(generally cost plus
capital improvements
minus accumulated
depreciation)
• Equals: Gain or loss
realized
9

10. Gain or Loss
Recognized (Sec. 1001(c))
• Unless the law provides
otherwise, all realized
gains and losses are
recognized
• Common exceptions
– Transfer to a controlled
corporation in exchange
for its stock (Sec. 351)
– Like-kind exchange
(Sec. 1031)
– Involuntary conversion
(Sec. 1033)
10

11. Character of
Gain or Loss Recognized
• Ordinary gain (Sec. 64) or
loss (Sec. 65)
• Ordinary income from
discharge of indebtedness
(Sec. 61(a) and Reg.
1.1001-2(c) Example 8)
• Sec. 1231 gain or loss
• Short-term capital gain or
loss (Sec. 1223)
• Long-term capital gain or
loss (Sec. 1223)
11

12. Is Operating Rental
Property a Trade or Business?
• The courts have generally
said yes based on the facts
and circumstances
– Higgins v. Commissioner, 312
US 212, 41 USTC ¶9233
(USSC, 1941)
– Curphey v. Commissioner, 73
TC 766 (1980)
12

13. Sale of Rental Property
• Many people believe that a sale of
rental property results in a capital
gain or loss
• But the law generally treats it as an
asset used in a business and not a
pure capital asset under Sec. 1221
• Thus, gain or loss is usually a
Sec. 1231 gain or loss
• If held for less than one year, gain
is ordinary gain and loss is ordinary
loss
13

14. Treatment of
Net Sec. 1231 Losses
• Sec. 1231 gains and Sec.
1231 losses are
combined (Sec. 1231(a))
• A net Sec. 1231 loss is
an ordinary loss that is
fully deductible
(Secs. 165 and
1231(a)(2))
14

15. Treatment of
Net Sec. 1231 Gains
• A net Sec. 1231 gain is
ordinary to the extent of
net Sec. 1231 losses
recognized in the previous
five years that have not
previously caused a net Sec.
1231 gain to be treated as
an ordinary gain
(Sec. 1231(c))
• Any remaining net Sec.
1231 gain is treated as if it
were a long-term capital
gain (Sec. 1231(a)(1))
15

16. Depreciation Recapture
• Any remaining net Sec. 1231 gain
on the sale of depreciable real
estate is treated as if it were a
long-term capital gain
• It is subject to depreciation
recapture at a maximum tax rate
of 25 percent
(Sec. 1(h)(1)(D))
• Any remaining net capital gain
(excess of net long-term capital
gain over any net short-term
capital loss) is subject to a
maximum tax rate of 15 percent
through 2012 and 20 percent for
2013 and later unless Congress
changes the law
(Sec. 1(h)(1)(C))
16

17. Real Estate Held for
Resale by a Real Estate Dealer
• Real estate can never be
inventory because a taxpayer
may not account for it using
the lower of cost or market
method (Rev. Rul. 69-536,
1969-2 CB 109)
• It can be asset held primarily
for sale to customers in the
ordinary course of business,
which is not a capital asset
(Sec. 1221(a)(1))
• Gain or loss on its sale is
ordinary gain or ordinary loss
and subject to self-
employment tax
17

18. Factors Used to Determine
Whether the Taxpayer is a Dealer
• Frequency and regularity
of sales
• Substantiality of sales
• How long the taxpayer
held the property
• Nature and extent of the
taxpayer’s business
• Purpose for acquiring the
property
• Time and effort devoted to
sales
18

19. Sales and Exchanges
of Business Properties
• Use Form 4797 to report
sales or exchanges of
business property other
than
– Inventory or
– Property held primarily for
sale to customers in the
ordinary course of business
19

20. Part I
• From a brief look at Part
I, one would think that
is where one would
report all sales of
business properties
held for more than one
year
• But that is NOT true
20

21. What to Report in Part I
• Report sales of land,
depreciable personal
property, and
depreciable real estate
if the taxpayer
– Held them for more than
one year and
– Sold them at a loss
21

22. What to Report in Part II
• Depreciable personal
property and
depreciable residential
real estate the taxpayer
– Held for one year or less
and
– Sold at a gain or loss
22

23. What to Report in Part III
• Depreciable personal
property that the taxpayer
– Held for more than one year
and
– Sold at a gain
• In general, the ordinary
income under Sec. 1245 is
the lesser of the
– Total gain realized or
– The accumulated
depreciation, including the
Sec. 179 deduction and bonus
depreciation
• Any remaining gain is a
Sec. 1231 gain
23

24. Learning Objective 2
Explain how to report
like-kind exchanges on
Form 8824
24

25. Like-Kind Exchanges
• The like-kind exchange rules of
Sec. 1031 are exceptions to
the general rule of
Sec. 1001(c) that all gains and
losses realized during the year
are recognized
• Applies to real estate
exchanged often through
qualified intermediaries
• Also applies to exchanges of
personal property including a
trade-in of a business vehicle
for another business vehicle
and other similar trades
25

26. Multiple Like-Kind Exchanges
• If the taxpayer engaged in
more than one like-kind
exchange, file only one Form
8824 and use it as a summary
• Write “Summary” on Line 1
• Write the total recognized
gains on Line 23
• Write the total basis of like-
kind property received on
Line 25
• Attach complete information
required on Form 8824 for
each exchange
26

27. Basic Information
• Part I of Form 8824
requires you to report basic
information about the like-
kind exchange to be sure
that it qualifies as a like-
kind exchange under
Sec. 1031
• Describe the like-kind
property given up on Line 1
• Describe the like-kind
property received on Line 2
27

28. Trade or Business Use Required
• Both the property received in the
exchange and the property given
in the exchange must be used in a
trade or business or held for
investment (Sec. 1031(a)(1))
• Personal use assets, such as a
taxpayer’s principal residence,
are not eligible for a like-kind
exchange
• The taxpayer does not care what
the other party to the exchange
did with the other party’s old
property or the property received
in the exchange (but see special
rule for related parties regarding
dispositions)
28

29. Tax Court Allows Home Converted
to Principal Residence to Qualify
• In Reesink v. Commissioner, TC
Memo 2012-118 (April
23, 2012), the United States
Tax Court allowed a couple
that obtained a house in a like-
kind exchange to treat it as
investment property even
though the taxpayers moved
into the house and used it as a
personal residence
• Intent is a question of fact for
which the taxpayers bear the
burden of proof
• Business or investment intent
must be the primary intent
29

30. Taxpayers Had Investment Intent
• Taxpayers had advertised the
property for rental and had
showed it to potential renters,
but were not successful in
renting it
• Taxpayers waited about eight
months before moving into
the property
• The Tax Court ruled that based
on the facts and circumstances
that the taxpayers had the
intent to hold the property for
investment at the time of the
exchange
30

31. Federal Law Defines Like-Kind Property
• In Chief Counsel Advice (CCA)
201238027 (September 21,
2012), the Office of Chief
Counsel concluded that federal
law, rather than state law,
determines whether properties
are of like-kind for purposes of
Sec. 1031
• The Office of Chief Counsel ruled
that state law was relevant to
determine if property is real
property or personal property,
but that federal law controls
• The determination must be based
on all the facts and circumstances
31

32. What Is Like Kind
Property for Real Estate?
• For real estate, any real
estate in the United
States qualifies whether
improved (has buildings
on it) or unimproved (raw
land)
(Reg. § 1.1031(a)-1(b))
• Real estate located in the
United States is not like
kind property to real
estate located in a
different country
(Sec. 1031(h)(1))
32

33. What Is Like-Kind Personal Property?
• To be like-kind
property, personal
property must be of like
class
(Reg. § 1.1031(a)-2(a))
• See Rev. Proc. 87-
56, 1987-2 CB 674 and
Reg. § 1.1031(a)-2(b)(2)
for general asset classes
• Properties may differ as
to grade and quality
33

34. Not Like-Kind Property
• Livestock of different
sexes is not like-kind
property (Sec. 1031(e))
• Personal property used
predominantly in the
United States and
personal property used
predominantly outside
the United States are
not like-kind properties
(Sec. 1031(h)(2))
34

35. Ineligible Assets
• Inventory
• Property held for sale to
customers in the ordinary
course of business
• Stocks, bonds and notes
• Other securities or
evidence of indebtedness
• Partnership interests
• Certificates of trust or
beneficial interest
• Choses in action
(Sec. 1031(a)(2))
35

36. Lines 3 and 4
• Lines 3 and 4 require
you to report
– The date the taxpayer
originally acquired the
property given up in the
exchange and
– The date the taxpayer
transferred the like-kind
property to the other
party
36

37. Lines 5 and 6
• On Line 5 you report
– The date the like-kind
property received by the
taxpayer was identified
to the other party
• On Line 6 you report
– The date the taxpayer
received the like-kind
property from the other
party
37

38. Mandatory Nonrecognition
• If the exchange meets the
requirements of a like-
kind exchange,
– Nonrecognition of loss is
mandatory even if boot is
received or paid
(Secs. 1031(a)(1) and
1031(c))
– Nonrecognition of gain is
mandatory except that
gain is recognized to the
extent of boot received
(Secs. 1031(a)(1) and
1031(b))
38

39. Boot
• Cash
• Fair market value of unlike
kind property
• Notes receivable
• Net debt relief
• Debts incurred can offset boot
from debt relief, but debts
incurred may NOT offset other
forms of boot
(Reg. § 1.1031(b)-1(c))
• See Reg. § 1.1031(d)-2 for
detailed examples of the
effects of debts incurred and
debt relief
39

40. Time Limits
• The taxpayer must identify the
property to be received within
45 days of the date the
taxpayer gave up the property
in the exchange
(Sec. 1031(a)(3)(A))
• The taxpayer must
complete the exchange
within the earlier of
– 180 days of the first
transfer or
– The due date of the tax
return, including
extensions
(Sec. 1031(a)(3))
40

41. Related Party Information
• Line 7 requires you to
indicate whether the
taxpayer made the
exchange directly or
indirectly with a related
party
• If yes, complete Part II
• If no, skip Part II and go
to Part III
41

42. Related Parties
• For purposes of Sec.
1031, a related party is a
party listed in Sec. 267(b)
or Sec. 707(b)(1)
• If the exchange was with
a related party, the usual
rules of Sec. 1031 apply at
the time of the exchange
• File Form 8824 for the
year of the exchange and
for each of the next two
years (Instructions for
Form 8824)
42

43. Disposition by Related Party
• If the like-kind exchange
was with a related party
and within two years of the
last transfer of the like-kind
exchange
– The related party disposes of
the property received or
– The taxpayer disposes of the
property received from the
related party, then
– The nonrecognition of gain or
loss under Sec. 1031 no
longer applies and the
taxpayer should file an
amended return
(Sec. 1031(f)(1))
43

44. Exceptions to Two-Year Rule
• The disposition occurs because of
the death of the related party or
the death of the taxpayer, or
• The disposition was a compulsory
or involuntary conversion as
defined in Sec. 1033 and the
exchange occurred before the
threat or imminence of the
conversion, or
• The taxpayer proves to the IRS
that neither the exchange nor the
subsequent disposition within the
two-year period had as one of its
principal purposes the avoidance
of Federal income tax
(See Line 11 of Form 8824)
(Sec. 1031(f)(2))
44

45. Relinquishment of
Unlike-Kind Property
• The taxpayer must recognize
the gain or loss realized on the
transfer of unlike-kind
property (boot property) as
part of the exchange unless
another provision applies that
allows nonrecognition
(Sec. 1001(c))
• Report the FMV of the boot
property, its adjusted
basis, and the gain or loss
recognized on it on Lines
12, 13, and 14, respectively
• Also, report the gain or loss
recognized on the appropriate
tax form, such as Form 4797
45

46. Amount Realized
• On Line 15, report the amount
realized from boot—
everything the taxpayer
received in the exchange
except for the FMV of the like-
kind property
• On Like 16, report the FMV of
the like-kind property received
• Add Lines 15 and 16 and
report the result on Line 17,
which is the total amount
realized on the exchange
(Sec. 1001(b) and
Reg. § 1.1001-2(a))
46

47. Gain or Loss Recognized
• Gain recognized (Line 23) is lesser
of
– Gain realized (Line 19)
– Boot received (Line 15)
(Sec. 1031(b))
• The taxpayer must recognize
ordinary income due to
depreciation recapture before
recognizing any Sec. 1231 gain
(See Line 21)
• Sec. 1231 gain or capital gain
goes on Line 22
• Losses are never recognized on a
like-kind exchange (except on
boot property)
(Secs. 1031(a)(1) and 1031(c))
47

48. Gain or Loss Deferred
• Gain realized (Line 19)
• Minus: gain recognized
due to boot received
(Line 23)
• Equals: gain deferred
(Line 24)
• If the taxpayer realized a
loss on the exchange, the
loss realized (Line 19)
equals the loss deferred
because losses are never
recognized on a like-kind
exchange (Line 24)
48

49. Basis of Like Kind Property Received
• Fair market value of
new like-kind property
received
• Less: gain deferred or
plus loss deferred
• Equals: basis of new
like-kind property
received (Sec. 1031(d))
49

50. How Basis Is Calculated on Form 8824
• Add adjusted basis of
like-kind property given
up and any amount paid
to the other party,
including net debts
incurred
• Add recognized gain
• Subtract boot received
• Equals basis of new like-
kind property (Line 25)
50

51. Holding Period
• If all gain that was realized
is recognized because of the
boot received, then the
holding period for the new
property begins on the date
of the exchange
• If some or all of the gain
was deferred or a loss was
realized on the exchange,
then the holding period of
the new property includes
the holding period of the
old property (Sec. 1223(1))
51

52. Basis of Boot Property Received
• The basis of any property
that is not of like kind (boot
property) is a cost basis
equal to its FMV on the date
of the exchange (Sec. 1012)
• Do NOT reduce the basis for
any debts the taxpayer
assumed on the property or
to which the property is
subject
• The holding period for any
boot property received
begins on the date of the
exchange
52

53. Learning Objective 3
Explain how to report
installment sales on
Form 6252
53

54. Installment Sale
• A sale in which at least
one payment occurs in
the year after the sale
and the taxpayer realized
a gain (Sec. 453(b)(1))
• Installment method is
mandatory for an
installment sale of eligible
property
(Sec. 453(a))
• Taxpayer may elect out of
the installment method
(Sec. 453(d)(1))
54

55. Loss on Installment Sale
• A taxpayer recognizes any
loss realized on an
installment sale of
business or investment
property in the year of
the sale or exchange
(except for a like-kind
exchange) (Sec. 1001(c))
• Do NOT file Form 6252 if
the taxpayer realized a
loss on an installment
sale
55

56. Properties Not Eligible
• Inventory
(Sec. 453(b)(2)(B))
• Real property held for sale
to customers in the ordinary
course of business
(Sec. 453(l)(1)(B))
• Securities traded on an
established exchange such
as the NYSE or NASDAQ
(Sec. 453(k))
• Depreciable personal
property where all of the
gain is due to depreciation
recapture (Sec. 453(i))
56

57. Depreciation Recapture
• The part of the gain that is
ordinary income due to
depreciation recapture is
recognized in the year of sale
(Sec. 453(i))
• Report ordinary income from
depreciation recapture on
Form 4797, Part III
• Add to adjusted basis for
purposes of calculating the
Sec. 1231 gain on Form 6252,
Line 12 from Form 4797, Part
III (Reg. § 15a.453-1(b)(2)(v))
57

58. Amount Realized
and Total Contract Price
• Sales price reported on
Form 6252, Line 5
• Subtract debt relief on Form
6252, Line 6
• The total contract price is
generally equal to the sales
price minus the debt relief
and is reported on Form
6252, Line 7
(Reg. § 15a.453-1(b)(2)(iii))
• Debt relief includes debts
assumed by the buyer or to
which the property is
subject
58

59. Debt Relief > Adjusted Basis
• If total debt relief exceeds the
adjusted basis of the property
as increased by any ordinary
income recognized due to
depreciation recapture, then
• Excess of total debt relief over
adjusted basis adds to the
total contract price
• Excess debt relief is also
treated as though it were a
cash payment in the year of
sale
• In such cases, the gross profit
percentage will always be 100
percent
59

60. Demand Notes
• Demand notes received
are not eligible for gain
deferral
• Treat them the same as
cash received under the
constructive receipt
doctrine
• Include as a cash
payment in the year of
sale (Sec. 453(f)(4))
60

61. Sec. 1231 Gain or
Capital Gain Recognized
• Sum of cash payments
received on
principal, demand
notes, and debt relief in
excess of adjusted basis
• Multiplied by
• Gross profit percentage
(gross profit / total
contract price)
• Equals Sec. 1231 gain or
capital gain recognized
(Sec. 453(c))
61

62. Interest
• Interest is recognized
separately as ordinary
income
• If rate of interest is not
adequate, interest is
imputed
62

63. Learning Objective 4
Explain how to report
discharge of indebtedness
income and exclusions
from discharge of
indebtedness income, and
reduction of tax attributes
63

64. Recourse Debt Discharged
on Property Sold or Exchanged
• If a recourse debt
discharged in a transfer of
property, include debt
relief in amount realized
on sale of property up to
the FMV of the property
(Reg. 1.1001-2(c)
Example 8)
• Debt relief in excess of
FMV of property is gross
income from discharge of
indebtedness under
Sec. 61(a)(12)
64

65. Nonrecourse Debt Discharged
on Property Sold or Exchanged
• If a nonrecourse debt
discharged in a transfer of
property, include all debt
relief in amount realized
on sale of property (Reg.
1.1001-2(c) Example 7)
• In such a case, there is no
gross income from
discharge of indebtedness
under Sec. 61(a)(12)
65

66. Exclusions Under Sec. 108
• Income from discharge
of indebtedness under
Sec. 61(a)(12) may be
eligible for exclusion
under Sec. 108
• Debt relief included in
the amount realized on
the sale of property is
NOT eligible for
exclusion under
Sec. 108
66

67. Available Exclusions
• Debt discharged in
bankruptcy
(Sec. 108(a)(1)(A))
• Debt discharged while
insolvent (to the extent
of the insolvency)
(Sec. 108(a)(1)(B))
• Debt discharged is
qualified farm
indebtedness
(Sec. 108(a)(1)(C))
67

68. More Exclusions
• Debt discharged is
qualified real property
business indebtedness for
taxpayers except C
corporations
(Sec. 108(a)(1)(D))
• For debt discharged
through 2012, the debt
discharged is qualified
principal residence
indebtedness
(Sec. 108(a)(1)(E))
68

69. Where to Report
• Report gain or loss on sale of
capital assets on Schedule D
• De not report losses on
personal use assets such as a
principal residence
(Sec. 165(c))
• Report gain or loss on sale of
assets used in a trade or
business on Form 4797
• Report income from discharge
of indebtedness that is not
excluded under Sec. 108 as
other income on Page 1 of
Form 1040
69

70. Exclusions Under
Sec. 108 Are Really Deferrals
• Taxpayer must reduce tax
attributes for income
excluded from gross
income under Sec. 108
• Report on Form 982,
“Reduction of Tax
Attributes Due to
Discharge of
Indebtedness (and
Section 1082 Basis
Adjustment)”
70

71. Order of Reduction of Tax Attributes
• Net operating loss for the
year and any NOL carryover
to the year
• General business credit
• Minimum tax credit
• Capital loss carryover for
the year and any capital loss
carryover to the year
• Basis of property
• Any passive activity loss or
credit carryover from the
year of the discharge
• Foreign tax credit carryover
71

72. Amount of Reduction
• Reduce credits by one-
third of each dollar of
the exclusion
(Sec. 108(b)(3)(B))
• Reduce other tax
attributes dollar for
dollar
(Sec. 108(b)(3)(A))
72

73. Election to Reduce Basis Only
A taxpayer may elect to
reduce the basis of
property the taxpayer
owns as of the beginning
of the next tax year after
the year of the discharge
only rather than reducing
other tax attributes
(Sec. 108(b)(5))
73

74. Basis Reduction in Home
Taxpayer must reduce the
basis in the principal
residence (but not below
zero) for any debt
discharge excluded from
gross income as qualified
principal residence
indebtedness
(Sec. 108(h)(1))
74

75. Learning Objective 5
Explain how to report
contributions to IRAs and
other retirement plans
75

76. Contributions to IRAs
• If taxpayer and spouse were not
covered by a qualified pension plan,
they may make deductible IRA
contributions up to the annual limit
regardless of income (Sec. 219(a))
• If taxpayer and/or spouse is covered
by a qualified pension plan, the IRA
contribution may be limited
(Sec. 219(g))
• The deduction may not exceed
earned income included in gross
income (Sec. 219(b)(1)(B))
• Taxpayers may make an IRA
contribution up to the unextended
due date of the tax return and treat it
as having been made in the previous
tax year
76

77. IRA Contribution Limits for 2012
• $5,000
• $6,000 if the taxpayer is
age 50 or older before
the end of the tax year
($5,000 + $1,000 catch-
up contribution)
77

78. Phaseout for Single Taxpayers
• For 2012, if single or head
of household and covered
by a qualified pension plan
and
– Modified AGI is $58,000 or
less, there is no reduction in
the deduction
– Modified AGI is $68,000 or
more, no deduction is
allowed
– Modified AGI is between
$58,000 and $68,000, a
partial deduction is allowed
(Sec. 219(g))
78

79. Phaseout for Married Taxpayers Filing
a Joint Return or Surviving Spouse
• For 2012, if married filing a
joint return or a surviving
spouse (widow(er) with
dependent child) and the
taxpayer is covered by a
qualified pension plan and
– Modified AGI is $92,000 or less,
there is no reduction in the
deduction
– Modified AGI is $112,000 or
more, no deduction is allowed
– Modified AGI is between
$92,000 and $112,000, a partial
deduction is allowed
(Sec. 219(g))
79

80. Phaseout for Married
Taxpayers Filing a Separate Return
• For 2012, if married filing
a separate return and the
taxpayer is covered by a
qualified pension plan
and
– Modified AGI is less than
$10,000 a partial
deduction is allowed
– Modified AGI is $10,000 or
more, no deduction is
allowed
(Sec. 219(g))
80

81. Contributions to
Other Retirement Plans
• For 2012, the maximum
contribution to
401k, 403(b), and 457
plans is $17,000
• If age 50 or older before
the end of the tax
year, the maximum
total contribution to
such plans is $22,500
($17,000 + $5,500
catch-up contribution)
81

82. AGI Limits for 2012 for
Contributions to Roth IRAs
• Single or head of
household: $110,000 to
$125,000
• Married filing jointly:
$173,000 to $183,000
82

83. Learning Objective 6
Explain how to report
distributions from IRAs
and other retirement
plans
83

84. Distributions from IRAs
• Distributions before age
59 ½ result in the 10-percent
additional tax unless an
exception applies
• The 10-percent additional tax
is often called a penalty, but it
is not a penalty (Sec. 72(t))
• A taxpayer can have penalties
abated for reasonable cause
• To avoid the 10-percent
additional tax, the taxpayer
must qualify for a specific
statutory exception
84

85. Exceptions to 10-Percent
Additional Tax for Distributions from IRAs
• Made to designated
beneficiary after the
employee’s death
• Because employee is
disabled
• Payments based on life
expectancy that continue
for at least 5 years or until
the employee is 59 ½,
whichever is later
• Distributions made on
behalf of taxpayer to the
IRS because of a levy
85

86. More Exceptions to 10-Percent
Additional Tax for Distributions from IRAs
• Used for qualified
higher education
expenses
• Used for medical
expenses in excess of
the 7 ½ percent AGI
floor
• Used for first time
homebuyer purchase
86

87. Exceptions That Do NOT
Apply to IRA Distributions
• The age 55 and separation
from service exception does
NOT apply to distributions
from IRAs (Secs.
72(t)(2)(A)(v) and
72(t)(3)(A))
• The exception for alternate
payees under a qualified
domestic relations order
(QDRO) does NOT apply to
distributions from
IRAs(Secs. 72(t)(2)(C) and
72(t)(3)(A))
87

88. When Required
Minimum Distributions Must Begin
• Required minimum
distributions must begin
by April 1 following the
later of
– The end of the tax year in
which the taxpayer attains
age 70 ½ or
– The end of the year in
which the employee retires
unless the taxpayer is an
employee who is a five
percent owner as defined
in Sec. 416
(Sec. 401(a)(9)(C))
88

89. Distributions to Beneficiaries
• Distributions to
beneficiaries from tax-
deferred traditional
IRAs and qualified
pension plans after the
account holder’s death
result in income in
respect of a decedent
(IRD) under Sec. 691(a)
89

90. Distributions from Roth IRAs
• Tax free if the Roth IRA
account has been
deemed to have been
established for at least
five years and
• The taxpayer is at least
age 59 ½
90

91. Distributions from
Roth IRAs to Beneficiaries
• Distribution is generally
tax free
• If the Roth IRA is not
deemed to have been
established for five
years, then the
beneficiary can have
gross income as income
in respect of a decedent
(Sec. 691(a))
91

92. Distributions from
Other Retirement Plans
• Taxable as ordinary
income
• Additional 10-percent
tax unless an exception
applies
• Exceptions to 10-
percent additional tax
for
– Age 55 and separation
from service applies
– Other exceptions apply
92

93. Age 55 and Separation Exception
• The taxpayer must have
separated from service
after the taxpayer
attained age 55
• Separating from service
before age 55 and
receiving a distribution
after age 55 does NOT
qualify for the exception
(Notice 87-13, 1987-1 CB
432, Q&A 20)
93

94. Learning Objective 7
Explain where to deduct
tax preparation fees to
realize the greatest tax
benefit
94

95. Deducting Tax Preparation Fees
• Schedule A provides a line to
deduct tax preparation fees as a
miscellaneous itemized deduction
(Secs. 212, 62(a), and 67)
• The taxpayer must reduce total
miscellaneous itemized
deductions by 2 percent of AGI
(Sec. 67(a))
• Miscellaneous itemized
deductions provide no tax benefit
unless
– Total miscellaneous itemized
deductions exceed 2 percent of
AGI and
– Total itemized deductions exceed
the standard deduction
95

96. Deducting Tax Preparation Fees
• Miscellaneous itemized
deductions are not
allowed at all for AMT
purposes
(Sec. 56(b)(1)(A)(i))
• Miscellaneous itemized
deductions are not
allowed in calculating
self-employment income
and therefore do not
reduce the self-
employment tax
(Sec. 1402(a))
96

97. Tax Preparation Fees
for Business and Farm Income
• Deduct tax preparation fees
related to a self-employed
individual’s business income and
deductions reported on Schedule
C and related schedules, including
Form 4562, Schedule SE, and
depreciation schedule on
Schedule C
(Sec. 162(a) and 62(a)(1))
• Deduct tax preparation fees
related to the income and
expenses of a self-employed
farmer on Schedule F and related
schedules on
Schedule F
(Sec. 162(a) and 62(a)(1))
97

98. Tax Preparation Fees
for Rent and Royalty Income
• Deduct tax preparation fees
related to rent and royalty
income and deductions
reported on Schedule E and
related forms and schedules,
such as Form 4562 and
depreciation schedules on
Schedule E (Secs. 162(a) or
212, and 62(a)(4))
• Deduct remaining tax
preparation fees on Schedule
A as a miscellaneous itemized
deduction
(Rev. Rul. 92-29, 1992-1 CB 20)
98

99. Collateral Effects of Deducting
Tax Preparation Fees Properly
• Tax preparation fees deducted
on Schedules C, E, or F, reduce
AGI
• A reduction in AGI can
– Reduce the taxable amount of
Social Security benefits
(Sec. 86)
– Increase the net itemized
deductions subject to an AGI
floor such as medical expenses
(Sec. 213), casualty and theft
losses (Sec. 165), and
miscellaneous itemized
deductions (Sec. 67)
– Affect the deductible IRA
contribution and
– Can affect some tax credits
99

100. Self-Employment Tax
• Tax preparation fees
deducted on Schedule C
for a self-employed
individual or Schedule F
for a farmer save
– Income tax and
– Self-employment tax
(Sec. 1402(a))
100

101. Invoice for Tax Preparation Fees
• The invoice for tax preparation
fees should state how much of
the fee is deductible on
Schedules A, C, E, and F
• Provide to clients for use in
preparing next year’s return or
in case client uses different tax
preparer next year
• If client does not have an
invoice for tax preparation
fees for the previous year that
shows the amount deductible
on each schedule, then use a
reasonable estimate
101

102. Learning Objective 8
Explain how to calculate
the penalty for
underpayment of
estimated tax
102

103. Exceptions to Penalty for
Underpayment of Estimated Tax
• Amount due is less than
$1,000 (Sec. 6654(e)(1)) and
amount paid in consists of
withholding and/or timely
estimated payments
• Prior year’s tax exception
(Sec. 6654(d)(1)(C))
• When prior year has no tax
liability
(Sec. 6654(e)(2))
• Annualized method
• Special rules for farmers
and fishermen
103

104. Learning Objective 9
Explain how to report the
additional child tax credit
104

105. Additional Child Tax Credit
• The child tax credit is a
nonrefundable tax
credit (Sec. 24(b)(3))
• But the additional child
tax credit is a
refundable tax credit
(Sec. 24(d))
• Report the additional
child tax credit on
Form 8812
105

106. Who Qualifies?
• The additional child tax
credit is for people who got
less than the maximum
regular child tax credit of
$1,000 per qualifying child
for 2012 (drops to $500 per
eligible child in 2013 unless
Congress changes the law)
• A qualifying child must be
UNDER age 17 at the end of
the tax year and meet other
requirements
106

107. Opportunity for Fraud
• The additional child tax credit is
not a loophole in the tax law as
alleged in a video called “Tax
loophole costs billions” posted
online by WHTR, Channel 13 in
Indianapolis
http://www.wthr.com/story/1779
8210/tax-loophole-costs-billions
• It is a refundable tax credit
passed by Congress and
contained in Section 24 of the
Internal Revenue Code to help
low income families with children
• Because it is a refundable tax
credit, fraud on the part of some
taxpayers has become a serious
problem
107

108. Learning Objective 10
Explain how to avoid the
penalty for understating
the client’s tax liability
under Sec. 6694
108

109. Penalty for Unreasonable Position
• Sec. 6694(a) provides
for a preparer penalty
of the greater of
– $1,000 or
– 50 percent of the
income received or to be
received for preparing
the return
109

110. Penalty for Unreasonable Position
• For an understatement
of the client’s tax
liability due to an
unreasonable position
taken on the tax return
unless
– There is substantial
authority for the
position or
– The tax preparer
properly disclosed the
position on the return
110

111. What Is an Understatement?
• The understatement of
the tax liability does
NOT have to be
significant
• An understatement is
ANY understatement of
the net tax payable
(Sec. 6694(e))
111

112. What Is Substantial Authority?
• Internal Revenue Code
• Proposed, temporary, or final
Treasury Regulations
• Revenue Rulings
• Revenue Procedures
• Tax treaties
• Court cases
• Committee reports
• The Blue Book
• Private letter rulings
• Technical advice memoranda
(Reg. § 1.6662-4(d)(3)(iii))
112

113. Not Substantial Authority
• Tax treatises
• Articles in tax journals
• Opinions by tax
professionals
• Editorial materials in tax
services such as CCH and
RIA
• But these secondary
sources are useful in
finding substantial
authority
113

114. Proper Disclosure
• Proper disclosure is
defined in Sec.
6662(d)(2)(B)(iii)(I)
• Must disclose relevant
facts in the tax return or
in a statement attached
to the tax return
• Use Form 8275 or Form
8275-R if the position is
contrary to a regulation
114

115. Form 8275
• Provides protection for tax
preparer and client
• Be more concerned about
avoiding possible penalties
than any possible increase
in the chance for an audit
• Be sure to discuss Form
8275 with the client
• If client will not allow
Form 8275 to be attached,
considering withdrawing
from the engagement
115

116. Form 8275-R
• Use to report positions
taken on the tax return
contrary to the Treasury
Regulations
• Temporary and Final
Regulations generally have
the force of law unless they
are
• Not within the meaning of
the related Code section
• Have been overturned by a
court of competent
jurisdictio
116

117. Tax Shelters
and Reportable Transactions
• Even if disclosed, a position with
respect to a tax shelter as defined
in Sec. 6662(d)(2)(C)(ii) or
reportable transaction to which
Sec. 6662A applies is
unreasonable unless the tax
preparer believes that the
position is more likely than not
(greater than 50 percent chance)
to be sustained on its merits (Sec.
6694(a)(2)(C))
• This is a higher standard because
substantial authority is perceived
by many to be about a 40 percent
chance of success
117

118. Penalty for Willful or Reckless Conduct
• Sec. 6694 provides for a
penalty on a tax
preparer of the greater
of
– $5,000 or
– 50 percent of the
income received for
preparing the return
(Sec. 6694(b)(1))
118

119. What Can Result in
the Harsher Penalty?
• For either of the
following:
– The willful attempt to
understate the client’s
tax liability or
– A reckless or intentional
disregard of rules and
regulations
(Sec. 6694(b)(2))
119

120. Reduction in Penalty
• The penalty for reckless
or willful conduct under
Sec. 6694(b) is reduced
by any penalty under
Sec. 6694(a) for a
substantial
understatement of the
client’s tax liability due
to an unreasonable
position
(Sec. 6694(b)(3))
120

121. Reasonable Cause and Good Faith
• The penalty does not
apply if the taxpayer
had a reasonable cause
for the understatement
of the client’s tax
liability and the tax
preparer acted in good
faith (Sec. 6694(a)(3))
• The burden of proof is
on the tax preparer
121

122. Summary
• Be sure to follow the instructions
for Form 4797 carefully when
reporting sales or exchanges of
properties used in a trade or
business
• Make sure that a like-kind
exchange meets all the
requirements and report them on
Form 8824
• Report the recognized gain on
installment sales correctly on
Form 6252
• Understand when a discharge of a
debt is included in the amount
realized on a deemed sale of the
property and when it is income
from discharge of indebtedness
122

123. Summary
• Understand when income
from discharge of
indebtedness can be excluded
from gross income and the
effects on tax attributes
• Report deductions for
contributions to IRAs
properly, taking into account
the limits
• Report distributions from IRAs
and other pension plans
properly, especially regarding
the 10-percent additional tax
123

124. Summary
• Report tax preparation fees
applicable to a business, a farm,
or rental property on Schedules
C, F, and E, respectively
• Calculate the penalty for
underpayment of estimated tax
correctly using all available
exceptions on Form 2210
• Calculate the additional child tax
credit correctly
• Document the substantial
authority for questionable
positions taken on a tax return or
disclose the position on Form
8275 or Form 8275-R
124

125. Conclusion
• If you follow the guidance
in this presentation, you
will
– Make fewer mistakes in the
preparation of Form 1040
– Save yourself preparer
penalties
– Save your clients taxes and
penalties
– Have a more productive
and less stressful tax
season
• Sharpen your pencils and
have a great tax season!
125