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Please note that the question and answer provided does not take into account all options or circumstances possible.

April 28, 2016

Question: You have a new client with a Form 1099-MISC reporting a large amount in Box 2, Royalties. Upon further investigation you find out this royalty income is from a book the client authored. Is this income subject to self-employment taxes?

Answer: That depends. Royalty income reported in Box 2 of Form 1099-MISC does not tell us what we need to know to make this determination. According to Rev. Rul. 68-498, when an individual writes only one book as a sideline and never revises it, he or she would not be considered to be regularly engaged in an occupation or profession, and his or her royalties from the book are not treated as net earnings from self- employment. In contrast, if an individual prepares new editions of the book from time to time, and writes other books and materials, such activities reflect the conduct of a trade or business, and the income is includible in computing net earnings from self-employment.

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April 21, 2016

Question: If a taxpayer is under age 59½ and converts either a traditional IRA or qualified plan to a Roth IRA, is the taxable amount of the conversion subject to the 10% additional tax?

Answer: No. The conversion itself is not subject to the 10% additional tax [§408A(d)(3)(A)(ii)]. Form 1099-R should report the conversion using distribution code "2" in Box 7.

However, if any portion of a Roth conversion is distributed within five years of the conversion, that​ amount will be subject to the 10% additional tax, even if the distribution itself is nontaxable [§408A(d)(3)(F); Reg. §1.408A-6, Q-5].

For example, a taxpayer has $5,000 of basis in his only Roth IRA. The taxpayer converts $10,000 from a traditional IRA to this Roth IRA and includes the $10,000 as income. If the taxpayer withdraws $15,000 from his or her Roth within five years of the conversion, $10,000 will be subject to the 10% additional tax, even though the distribution is not subject to income tax.

April 14, 2016

Question: Jackson graduated from Marquette University in May 2015. Prior to graduation, he was a full-time student from January 3 through May 22. After graduation, he started working as a marketing assistant and was eligible to participate in his employer’s 401(k) plan. During the year, he made 401(k) contributions of $2,000 and had an adjusted gross income of $18,750. Since this is the first time he has participated in a retirement plan, he does not have any distributions from other plans. Can Jackson claim a credit on Form 8880, Credit for Qualified Retirement Savings Contributions, for his contributions to the 401(k) plan?

Answer: No. Jackson cannot claim a credit for retirement contributions on Form 8880 because he was a student. For this purpose, students include individuals who, during some part of each of five months during the year, are (a) enrolled at a school that has a regular teaching staff, course of study and regularly enrolled body of students in attendance, or (b) taking an on-farm training course given by such a school or a state, county or local government. A student is a full-time student if he or she is enrolled for the number of hours or courses the school considers to be full-time. Since Jackson was enrolled full-time at Marquette University from January through May, he cannot claim a credit for retirement contributions on Form 8880.

April 7, 2016

Question: Robert filed his partnership Form 1065 timely. Later, he discovered additional income and expenses that he failed to give to the preparer. An amended form needs to be filed for the partnership. When do you use a Form 1065X or check Box G(5) on Form 1065 to file an amended return for a partnership?

Answer: The answer depends on whether the amended return is filed electronically or on paper. If the return can be electronically filed, complete Form 1065 and check Box G(5) to indicate you are filing an amended Form 1065. Attach a statement identifying what lines were changed, the correct amount to report on that line and a reason for each change. If any of these changes affect the partners, also file amended Schedules K-1 for each partner and check the box “Amended K-1” at the top of the Schedule K-1. If the amended return will be filed on paper, complete Form 1065X, Amended Return or Administrative Adjustment Request (AAR). Attach any new forms, statements or schedules when amending the partnership return to identify items of income, deduction or credits.

March 31, 2016

Question: Must a taxpayer have earned income in order to make HSA contributions?

Answer: No. Although §219(f) requires a taxpayer to have earned income in order to make IRA contributions, there is no such requirement for HSA contributions under §223.

March 24, 2016

Question: John purchased 10 acres of land in 2000 for $75,000 and held it for investment. In 2010, the city condemned the land for the expansion of a highway. The city paid John $25,000 and he retained the rights to remove the gravel until 2015. John reported the sale of the land in 2010 using his basis in the land to determine gain or loss. John sold the gravel from the 10 acres in 2015 for $20,000. Is the gain from the sale of the gravel reported as capital gain or ordinary income?

Answer: John will report the gain from the sale of the gravel as ordinary income on his Form 1040. The basis in the gravel will be $0 resulting in the entire $20,000 reported on Line 21 as other income. The income is not subject to self-employment tax because John is not in the trade or business of selling gravel. John is also entitled to a deduction for depletion on Line 21. John reports the gain as ordinary income because he holds an economic interest in the gravel even after the condemnation [J.W. Sparkman, T.C. Memo 1972-201].

March 17, 2016

Question: A taxpayer explains to you that he sold his fully depreciated, 100% business-use vehicle for $10,500 and then purchased another vehicle for $10,500. The vehicle he purchased is used 100% personally. Does this qualify as a like-kind exchange and, thus, any gain is deferred?

Answer: No. This transaction does not qualify as a like-kind exchange under §1031 for two reasons; 1) the property acquired is not held for business or investment use, and 2) the transaction is not an exchange, rather a sale and purchase. Under §1031 the following requirements must be satisfied:

  1. The form of the transaction is an exchange.
  2. Both the property transferred and the property received are held either for productive use in a trade or business or for investment.
  3. The properties transferred and received are like-kind property.
  4. Since the taxpayer sold the vehicle and received cash and then purchased a personal-use vehicle, the taxpayer does not qualify under §1031 to defer the gain.

March 10, 2016

Question: Stacie is a single taxpayer with no dependents, has household income of $41,000 and works for a small employer that does not offer any group health plan benefit. She tells you she didn’t have health insurance all year because she couldn’t afford it. After doing some research online and discovering that if the lowest cost bronze plan through the marketplace available to her is more than 8.05% of her income, she is exempt from the penalty, she’s not concerned about the penalty for not having coverage. She shows you a printout from healthcare.gov proving that the lowest cost bronze plan for her age and zip code is $298 per month or $3,576 annually. This annual cost is 8.7% of Stacie’s household income. Does she qualify for the unaffordable exemption making her exempt from the individual shared responsibility penalty for not having health insurance all year?

Answer: No. It is true that the lowest cost bronze plan for Stacie is indeed more than 8.05% of her household income, but this is an irrelevant fact in determining if the unaffordable exemption applies for Stacie. This is because, whether coverage is affordable is based on what Stacie would have actually had to pay out-of-pocket had she enrolled in the lowest cost bronze plan, which may or may not have been $3,576.

Stacie’s household income falls between 100% and 400% of the federal poverty level. Therefore, she was eligible for the premium tax credit. Based on Stacie’s household income she would have received a $55 per month premium tax credit. Her out-of-pocket amount for the lowest cost bronze plan would have been $243 per month or $2,916 annually. This is 7.1% of Stacie’s household income. She cannot claim the unaffordable exemption and is subject to the shared responsibility penalty for the entire year.

Use the worksheet in the instructions for Form 8965 on page 11 to determine what a taxpayer’s out-of-pocket cost would have been. Essentially, you are hypothetically calculating what the taxpayer’s premium tax credit would have been to arrive at the actual figure to compare to household income.

March 3, 2016

Question: John is a tax professional with a client who files Form 1120. His client filed for an extension, and it is now the last day in the extension period to file the tax return. The client still has not provided any information to John. The client requests he file a zero tax return and amend it later to include the information, and assures John that everyone does this. Is this acceptable?

Answer: No. While this is done in practice by some professionals, there are multiple issues in doing so. The first one is an ethical issue. When a tax professional is signing the tax return, he or she is signing that the tax return is accurate and complete. By filing the tax return with zeroes, John is willingly filing a return he knows to be inaccurate. Furthermore, this practice is typically done to avoid failure-to-file penalties; however, legally this tactic is not valid. In order to avoid the failure-to-file penalties, the return must be a valid return. A valid return is one where all the following is met:

  • There is sufficient data to calculate tax liability.
  • The document purports to be a return.
  • There is an honest and reasonable attempt to satisfy the requirements of the tax law.
  • The taxpayer executes the return under penalty of perjury.

This is known as the “Beard Formulation,” which is used by the court to determine what a valid return is [Beard v. Commissioner, 82 TC 766]. Without a valid return, the return is deemed not filed; thus, failure-to-file penalties can apply. Furthermore, the intent to deceive the government to avoid the failure-to-file penalties can, under certain circumstances, be considered an indicator of fraud.

February 25, 2016

Question: Bonnie and Clyde are married. They have an adult son, Dylan, who is between jobs and has moved back home with them. Dylan has no income for 2015 and no health insurance. Dylan meets all the requirements to be a qualifying relative for Bonnie and Clyde. However, because Dylan has no health insurance Bonnie and Clyde do not want to claim him as a dependent to avoid paying the shared responsibility payment for him. Can Bonnie and Clyde simply ignore Dylan and not report him on their tax return so they will not be responsible for his shared responsibility payment?

Answer: No. An individual is a taxpayer’s dependent for a tax year if that individual satisfies the definition of dependent under §152, whether or not the taxpayer actually claims the individual as a dependent. If no one claims the individual as a dependent, the taxpayer with priority under the tiebreaker rules of §152 for claiming the dependency is liable for the shared responsibility payment.

Therefore, since Dylan is a qualifying relative of Bonnie and Clyde, whether they claim him as a dependent or not, they are responsible for a shared responsibility payment because he did not have health insurance.

The instructions to Form 8965, Health Coverage Exemptions, have steps and worksheets to calculate the shared responsibility payment. In step 1, questions 2, 3 and 4, there is a clear reference to dependents claimed or could have been claimed.

February 18, 2016

Question: An accrual basis C corporation gave Hannah a bonus on February 15, 2016, based on services performed during 2015. Hannah is a cash basis shareholder/employee who owns 40% of the C corporation’s stock, while her father owns the remaining 60%. Can this bonus be deducted on the C corporation’s 2015 Form 1120, U.S. Corporation Income Tax Return?

Answer: No. In general, an accrual basis corporation can accrue and deduct bonuses paid within 2 ½ months of year-end. However, if an accrual basis corporation pays a bonus to a related taxpayer who uses the cash method of accounting, the bonus cannot be deducted until the year the cash basis taxpayer receives the bonus and includes it in income [§267(a)(2)]. For this purpose, a related taxpayer includes an individual who owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation [§267(b)(2)]. Furthermore, an individual is treated as owning stock that is owned, directly or indirectly, by the individual’s family. Family includes only brothers and sisters, a spouse, ancestors (parents and grandparents) and lineal descendants (children and grandchildren). Hannah is treated as if she owns her father’s stock, so she is treated as owning 100% of the stock. Since Hannah is a related taxpayer, the C corporation cannot deduct the bonus until 2016 when Hannah includes the bonus in her income.

February 11, 2016

Question: Ben and Sarah are your clients. Their daughter, Marissa, is 22 years old and a full-time college student who earns $13,000 per year. The cost allocable to providing her a place of abode where she is temporarily absent during the school year is $16,000. Her parents also pay $24,500 for her college tuition, books, meal plan and room and board. Marissa uses the money she earns for gas, clothing, entertainment, etc. She does not provide over 50% of her own support. Ben and Sarah’s AGI is too high to obtain a benefit for her exemption or the American opportunity credit. They would like to let Marissa claim herself so she can obtain tax benefits they are not able to get due to their high AGI. Can they do this?

Answer: No. In cases where someone is the qualifying child of more than one person, there is some room for planning. That is not the case here. Marissa is Ben and Sarah’s qualifying child, and no one else’s, so they are the only ones eligible to claim her dependency exemption. If Ben and Sarah would like to forgo the dependency exemption, this allows Marissa to claim the nonrefundable portion of the American opportunity credit [Reg. §1.25A-1(f)(1)]. Marissa is not allowed to claim her own exemption in this case (no one gets the benefits).

February 4, 2016

Question: Ole and Lena have two homes, one in Wisconsin and the other in Arizona. The home in Wisconsin has a mortgage of $300,000, which is all acquisition debt. The home in Arizona has no mortgage and is worth $500,000. Ole wants to refinance the Arizona home and pay off the Wisconsin home’s debt. Lena is not so sure this is the best tax move and asks for your advice. What do you tell her?

Answer: From a tax standpoint, Lena is correct. Since the Arizona home is paid off, any mortgage on the home would be considered home equity debt. As such, Ole and Lena would only be able to deduct the mortgage interest on up to $100,000 of the new debt. The interest on the excess $200,000 is traced to a personal expense of the taxpayer under Reg. §1.163-8T and is nondeductible. To be qualified mortgage interest, the debt must be secured by the residence [§163(h)(3)(B)(i)(II)]. Since the Wisconsin residence does not secure the debt, the interest on that debt is not qualified mortgage interest under §163(h)(3).

However, despite the inability to deduct the full amount of interest on their tax return, there may be financial gain by refinancing based on the interest rates and other non-tax factors.

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