Please note that the question and answer provided does not take into account all options or circumstances possible.
This week's question is brought to you by Kris Siolka, EA, from our Tax Knowledge Center.
March 5, 2015
Question: Your client is a U.S. Citizen working for a foreign embassy in Washington DC. He is an employee but did not receive a Form W-2. How is his income reported? Is he subject to self-employment tax on this income?
Answer: Since he is an employee, report the income on Form 1040, Line 7 as foreign earned compensation (FEC). He is subject to SE tax, because he is working for a foreign government in the U.S. Taxpayers who are U.S. citizens working in the U.S. must report self-employment income under the Self-Employment Contributions Act (SECA). Self-employment tax is computed on Schedule SE, Self-Employment Tax, and reported on Page 2 of the Form 1040.
However, U.S. citizens working for foreign governments and organizations outside of the U.S. are not subject to self-employment tax. U.S. citizens working in the U.S. must pay self-employment tax because the foreign government or organization is not liable for the employer’s portion of the contribution to the U.S. social security system. Taxpayers who are not “self-employed” for any other federal tax purposes may not claim deductions for expenses on Schedule C and are not qualified to establish a Simplified Employee Pension (SEP) Plan. There is no allowable deduction on line 28 of Form 1040 for contributions to any such plan.
February 26, 2015
Question: Jared, age 22 and a full-time student at XYZ University, received a grant for his school expenses. His parents are eligible to claim him as a dependent on their tax return. The parents are wondering if Jared can choose to include the grant in his income so they can take a higher education credit. Is this possible?
Answer: This is possible. Before 2014, this wasn’t entirely clear. In 2014, the IRS clarified that this was possible in some situations [Reg. 1.25A-5(c)(3)]. The instructions to Form 8863,
Education Credits (American Opportunity and Lifetime Learning Credits), were revised to include a section called Coordination with Pell grants and other scholarships or fellowship grants. There are still, however, some items that the taxpayer and tax preparer must consider.
- Not all scholarships or grants qualify for this choice. The scholarship or grant must be one that qualifies as a tax-free scholarship and the terms of the scholarship or grant must allow the money received to be used for expenses other than qualified education expenses. The IRS does not specify the scholarships or grants that qualify. Therefore, the taxpayer must get the terms of the scholarship or grant and determine if it can be used on expenses other than qualified education expenses.
- The IRS changed the instructions to Form 8615,
Tax for Certain Children Who Have Unearned Income, to include taxable scholarships or grants as unearned income. Therefore, including the taxable scholarship or grant in the student’s income could subject the student to kiddie tax.
The possibility of including a tax-free scholarship or grant in income is a good benefit, but some planning is required in some situations.
February 19, 2015
Question: Dan was divorced in 2013 and has two children who live primarily with his former spouse, Janice. Janice agreed to let Dan claim the children as dependents in even years. As such, she waived her right to claim the children on a properly executed Form 8332,
Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent. Dan paid for the children’s day care expenses and he is looking forward to claiming the child and dependent care tax credit and head of household filing status on his 2014 tax return. Can Dan claim these child-related tax benefits?
Answer: No. Under no circumstance can a noncustodial parent claim these benefits. Therefore, regardless of whether the custodial parent actually claims the dependency exemption, the child remains the custodial parents qualifying child for the following four tax benefits:
- Head of household filing status.
- Child and dependent care tax credit.
- Earned income tax credit.
- Tax-free dependent care assistance benefits.
Assuming that the noncustodial parent meets all of the criteria under Reg. §1.152-4(b), the noncustodial parent becomes eligible to claim the following deductions and credits only. The custodial parent is ineligible to claim only these benefits whether or not the noncustodial parent claims them.
- Dependency exemption deduction.
- Child tax credit.
- Education tax credits.
- Student loan interest deduction.
- Tuition deduction.
February 12, 2015
Question: Parents and son are German citizens and are full year residents of the U.S. The parents are in the U.S on an L-1 and H-1 visa respectively and the son is on an F-1 student visa and attends a local college. The son is under age 24, a full-time student, and he does not provide more than 50% of his own support. The parent’s joint modified adjusted gross income (MAGI) is $100,000 and they paid $10,000 for tuition and books for their son. Can the parents claim their son as a dependent and the American Opportunity Tax Credit (AOTC)?
Answer: No. Students with an F-1 visa, regardless of how long they are in the U.S. are considered non-resident aliens. To be eligible as a dependent, the qualifying child or relative must be a U.S. citizen, national, or resident alien of the U.S., Canada or Mexico [§1.152-2(a)(1)]. As long the son is in the U.S. on an F-1 visa, he is a nonresident alien and cannot be claimed as a dependent. Therefore, the parents are ineligible for the AOTC.
February 5, 2015
Question: Your client's household income is less than 100% of the federal poverty level (FPL) and he qualifies for Medicaid. The taxpayer did not enroll for Medicaid in 2014. He was not eligible for coverage on the exchange, nor did his employer offer insurance. Assuming he is not the dependent of another and his income is above the filing threshold, can he use the unaffordability exception to be exempt from the individual mandate?
Answer: Yes. Affordability partly depends on whether the taxpayer has access to an employer-sponsored plan. If the taxpayer does not have access to an employer-sponsored plan, then you determine affordability based on the cost of the lowest-cost bronze plan after reducing the cost by a theoretical premium tax credit allowed by §36B. Since the taxpayer's income is under 100% of the FPL, the taxpayer does not qualify for a credit, therefore, coverage is very likely to be more than 8% of his household income and unaffordable. This is confirmed by the Form 8965 instructions, Page 11, Line 6, 11 and 12.
January 29, 2015
Question: A C corporation has a large net operating loss (NOL) carryover and estimates it will have very little net income over the next couple of years. The sole shareholder would like to know if there is any way to claim this NOL deduction on his personal income tax return. For example, can he make an S election for this C corporation, so the NOL carryover is passed through and deducted on the shareholder’s income tax return?
Answer: Unfortunately, an NOL carryover arising in a C corporation year cannot be carried over to an S corporation year [§1371(b)(1)]. Thus, it cannot be passed through and deducted on the S corporation shareholder’s income tax return. However, an NOL carryover arising in a C corporation year can offset any net recognized built-in gain of the S corporation [§1374(b)(2)].
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