​​​​​​​​​​You Make the Call

Apr. 18, 2024

Question: Lina filed Form 990, Return of Organization Exempt From Income Tax, by May 15, 2024, which is the due date for Alley Cats Rescue, a tax-exempt organization filing on a calendar year basis. Shortly after, the Form 990 was returned to her along with IRS Letter 2694C indicating there was information missing from her submission. She immediately called the IRS and found out that when information is missing from the Form or Schedules are omitted, the return is sent back to the filing organization and considered “not timely filed” – hence the letter to spur a correction. When she reviewed her submission, she noticed that she did not include Schedule O (Form 990), Supplemental Information to Form 990 or 990-EZ. Was Lina required to file Schedule O with Form 990?

Answer: Yes, Schedule O is a required attachment for all filers of Form 990, as seen in Part IV, Checklist of Required Schedules, Line 38. It is recommended that the schedule be prepared at the same time as the other sections of the Form 990 so that essential explanations are not inadvertently omitted. The specific use of the form is explained in its instructions: 2023 Schedule O (Form 990)​.

An incomplete Form 990 is considered not timely filed, and the penalty is $20 a day for each day the return is late, not to exceed lesser of $12,000 or 5% of gross receipts. If annual gross receipts exceed $1,208,500, the penalty jumps to $120/day with the maximum penalty of $60,000 [§6652(c)(1)(A)].

The IRS recommends that the preparer “… return a complete and accurate return within 10 days of the date of the letter to avoid penalties. The date we receive a complete and accurate return is the date we consider your return filed.”

Apr. 11, 2024

Question: Joe has owned a residential rental real estate property since 1993. He has taken straight-line depreciation, using 27.5 years as the life of the property. He is selling the property in 2024. Does Joe have any potentially ordinary income to report from the gain, or from the gain due to previous depreciation allowed or allowable, known as “depreciation recapture”?

Answer: No. Rental real estate depreciation rates have been mandatorily straight-line since 1987 with residential rentals being depreciated over 27.5 years and commercial property depreciated over 31.5 years or 39 years if placed in service after May 12, 1993. Thus, in nearly all cases, real estate property sold currently was depreciated using straight-line. Therefore, no amount of depreciation is recaptured as §1250 gain, which is taxed at ordinary income rates. However, any gains due to §1250 depreciation are classified as unrecaptured section §1250 gains, which are capped at 25%. Any gains in excess of the unrecaptured section §1250 gains are classified as section §1231 gains.

Apr. 4, 2024

Question: Erek is a retired public safety officer. He separated from service due to disability. He wants to take out $3,000 tax-free from his retirement plan to pay for his Medicare premium. Is he allowed to do so?

Answer: No. If Erek withdrew the funds from his retirement plan to pay for his Medicare, it would be taxable to him. To begin, who is a retired public safety officer? They are law enforcement officers, firefighters, chaplains or members of a rescue squad or ambulance crew who separated from service as a public safety officer with the employer who maintains the retirement plan for them after reaching the normal retirement age. They could also be an officer who separated from service because of disability.

The IRS says retired public safety officers can reduce their taxable income by excluding up to $3,000 from their retirement plan distribution to pay for qualified insurance premiums like accident or health insurance or long-term care insurance. However, it does not include Medicare, which is under title XVIII of the Social Security Act.

Mar. 28, 2024

Question: Pam's roof has been needing to be replaced for several years, and in 2023, she finally sprung for a brand-new metal roof. She paid $70,000 for the double-insulated roof, which is not connected with a solar panel. She came into your office, excited because she heard on the news that she could get a tax credit for some of the roof costs. She has all the pertinent paperwork with her. What do you tell her?

Answer: Unfortunately, there are a lot of sources of misinformation out there. In this case, you must inform Pam that metal roofs no longer qualify for the federal energy efficient home improvement credit. Code §§ 25C(c)(2) and (3), as amended by the 2022 Inflation Reduction Act, removed roofs from the definition of building envelope components. Pam should keep her paperwork in the event of any changes; for 2023, you could assist her in locating any state tax credits, manufacturer rebates or other incentives that may be available.

Mar. 21, 2024

Question: Jess is a cash basis farmer. She owns land that she uses for an active farming business. She entered into an agreement with another farmer to rent some of her land out to him for crops. As payment for the use of the land, they agreed that Jess will receive a percentage of the crops harvested from the land. She materially participates in the production and management of the farm and the crops grown by the leasing farmer. Jess receives her portion of the crops in late 2023 and will use the crops to feed her livestock in early 2024. She must include the fair market value of the crops received in her income. In what year should she include the crop shares in her income, and will that amount be subject to self-employment tax?

Answer: Jess will include the fair market value of the crops received in her 2024 income. Regardless of whether the farmer is cash or accrual basis, the crop shares received as rent must be included in income when the crops are deemed to be converted to cash or cash equivalents [Reg. 1.61-4(a) and (b)]. Because the crop share is used to feed her own livestock, the crop shares are deemed to be converted to cash and included in income at their fair market value when actually fed to the livestock (Rev. Rul. 75-11). Because she materially participates, the rental income received will be reported on her Form 1040, Schedule F and subject to self-employment tax.

Mar. 14, 2024

Question: Mary Ann buys health insurance through the health insurance marketplace, but did not receive a Form 1095-A, Health Insurance Marketplace Statement, showing the months of coverage and premiums paid for the year. She neglected to mention her marketplace insurance to Grace, her tax preparer. Grace e-filed the return without Form 8962, Premium Tax Credit, and the return was rejected. Could the return have been rejected for neglecting to include Form 8962?

Answer: Yes. Form 8962 must be included with the tax return to reconcile Mary Ann’s health insurance payments with the marketplace policy and any advance premium tax credits received. Best practice for Grace, as a tax preparer, would be to include a question that asks about marketplace insurance on her firm’s tax questionnaire.

Previously, returns e-filed without the reconciled advance premium tax credit (APTC) on Form 8962 were not rejected upon filing. Rather, the IRS would correspond with taxpayers by letter, requesting the missing Form 8962 or an explanation for its absence, which simply delayed the processing of the return.

Grace must inform Mary Ann that Form 1095-A is critical when taxpayers are enrolled in Marketplace health insurance and IRS records show that the advance premium tax credit was paid. Mary Ann must provide the form so the rejected return can be corrected. If she does not have it, she can use her HealthCare.gov account to obtain a copy. Grace should resubmit Mary Ann’s return with the completed Form 8962 or a written explanation of the reason for its absence.

More information on how to correct an e-filed return rejected for a missing Form 8962, including frequently asked questions, can be found at https://www.irs.gov/newsroom/how-to-correct-an-electronically-filed-return-rejected-for-a-missing-form-8962​.

Mar. 7, 2024

Question: Robert and Patrice are a married couple who file their returns jointly. Robert, 62, retired last year after working for many years as a teacher. His only source of income for 2023 was his teacher's retirement plan. Patrice, 49, is still working and contributes to her 401(k) plan through her job. For 2023, they are facing a tax bill of nearly $2,000. When meeting with their tax professional, the couple asked if contributing to traditional IRAs would reduce part or all of this debt. Their 2023 MAGI is $125,000, and when their professional went to illustrate the impact funding traditional IRAs might have, the question of "covered by a pension plan" became difficult to answer for Robert's situation.

Our question is: Does Robert receiving his teacher's retirement benefits result in him being considered "covered by a retirement plan” for purposes of traditional IRA deductibility? The answer could eliminate their tax due.

Answer: Per IRS Publication 590A: Situations in Which You Aren't Covered: Benefits from previous employer's plan.

If you receive retirement benefits from a previous employer's plan, you aren't covered by that plan.

Therefore, Robert is not considered to be covered by a retirement plan and, as a non-working spouse over age 50​, he can make a fully deductible contribution of $7,500 by April 15, 2024, and indicate to his IRA trustee that this contribution is for tax year 2023. He can do so because Patrice has earned income for 2023 and is his spouse.

Patrice can also contribute to a traditional IRA for 2023. Still, her deductible portion is limited due to her participation in her employer's 401(k) plan, which meets the definition of "covered by a retirement plan."

Feb. 29, 2024

Question: John Smith registered a Colorado limited liability company (LLC) with the Colorado Secretary of State on June 29, 2014, and it is still in operation. He heard that LLCs must register with FinCEN to report beneficial ownership information (BOI). Is he required to file the BOI report?

Answer: Yes, Mr. Smith is required to file a BOI report with FinCEN before Jan. 1, 2025. Two types of reporting companies are required to file: domestic and foreign reporting companies. Domestic reporting companies refer to corporations, LLCs and any other entities that are created by filing with the secretary of state in the U.S.

Foreign reporting companies are entities formed under the law of a foreign country that filed with the secretary of state to do business in the U.S.

Based on FinCEN regulations, businesses open prior to Jan. 1, 2024, are required to file BOI, and have until Jan. 1, 2025, to complete their initial BOI report filing.

If the business started on or after Jan. 1, 2024, and before Jan. 1, 2025, the owner must file their initial BOI report within 90 days (about three months) of receiving the notice of their effective commencement date. However, if the business is established on or after Jan. 1, 2025, the initial BOI report must be filed within 30 calendar days of formation.

The BOI FAQs Q&A (fincen.gov)​ offer additional information about the BOI reporting process, provides information about exempt filers and list the information necessary to file.

Feb. 22, 2024

Question: Donna got an IRS letter regarding her level of due diligence when preparing a Form 1040 that included an EIC. The IRS Letter 4858 indicated that Donna may not have met her due diligence requirement and that no action need be taken. The letter went on to state that the IRS would continue to monitor the returns she prepares when credits like the earned income credit, child tax credit, additional child tax credit, credit for other dependents or American opportunity credit and head of household are included. Donna thinks she failed to include Form 8867, Paid Preparer’s Due Diligence Checklist, in a paper-filed return, but she still feels she has met her requirements – should she have gotten a letter?

Answer: Donna may get a letter or other attention from the IRS as part of its educational campaign to ensure that preparers are not fraudulently preparing tax returns with credits for ineligible taxpayers. The IRS has a due diligence education program where it may take several actions when it suspects a credit has not been scrutinized properly.

In addition to sending letters, the IRS might call preparers with questions, or even visit preparers for an “educational office visit.” A preparer who is not following the four tenets of due diligence may face penalties for fraudulent or inattentive preparation under §6695(g).

The due diligence tenets that must be met, including filling out Form 8867, when the above credits (and filing status) are included in a return, are:

  1. Document all questions asked that are needed to verify a claim (know the facts)
  2. Make reasonable inquiries to determine eligibility (compute the credit based on facts)
  3. Complete and submit Form 8867
  4. Keep records for three years (Form 8867 and worksheets)

IRS Publication 4687, Paid Preparer Due Diligence, provides additional details about the four tenets and has examples of what could be judged a lack of due diligence by the IRS. Further, an IRS toolkit for due diligence can be found at IRS.gov/toolkit​. The toolkit includes a free due diligence training module and other resources. ​

Feb. 15, 2024

Question: Marcus, a sole proprietor, has been operating a successful bakery for the last few years. He has a high demand for his delicious cookies, and he would like to expand the business by offering delivery services. Marcus has a personal van that he would like to convert into the bakery’s delivery vehicle. Does the vehicle’s title need to be changed to the business’s name to contribute it to the business and begin depreciating it?

Answer: No, Marcus does not need to change the vehicle title to the name of the business. Because sole proprietorships are not a separate business entity, any contributed business assets are not separate from the owner’s personal assets, meaning no taxable transfer has occurred. The van’s basis for depreciation purposes is the lesser of the amount paid for it, or its fair market value when contributed [Reg. 1.167(g)-1].​

Feb. 8, 2024

Question: Cooper is a general partner in a partnership. He has a 40% interest in the partnership, which he has held for more than one year. He decides to sell his entire interest in the partnership to an unrelated party and receives $40,000 from the sale. His outside basis in the partnership is $25,000. The partnership does not hold any hot assets; however, it does hold collectibles that have a basis of $7,000 and a fair market value of $12,000. Assuming that, in the year of sale, Cooper's income will put him in the 15% long-term capital gains bracket, how much gain will he realize from the sale and what will be his tax liability related to the sale of his partnership interest?

Answer: Cooper will have a taxable long-term capital gain on the sale of his partnership interest of $15,000 ($40,000 sale proceeds less $25,000 basis in the partnership). Because the partnership holds collectibles, the portion of his gain related to his share of the collectibles must be taxed at 28%. To determine this amount, you will figure the gain from the deemed sale of collectibles, calculated as the difference between the fair market value on the date of the sale of the partnership interest and the partnership basis in the collectibles. In this case it is $5,000 ($12,000 - $7,000). Cooper's allocable share of the gain from the collectibles, then, is $2,000 ($5,000 x 40% ownership in the partnership). This means that $2,000 of his gain will be taxed at 28%, resulting in $560 of tax.

The remaining portion of his $15,000 gain will be taxed at his normal long-term capital gains rate of 15%. Thus, his total tax related to the sale of his interest is $2,510 ($15,000 gain - $2,000 related to collectibles = $13,000 x 15% capital gains rate = $1,950 + $560 tax from sale of collectibles).

Feb. 1, 2024

Question: Charles, a part-time student who lives at home with his parents, also works at Big Y Supermarket as a cashier. The company offers him a §401(k) plan, with an employer match. Charles loves guitars and wants to buy a new one, but his dad urges him to contribute as much as possible to the §401(k) plan while living at home. With an AGI of less than $20,000, and not his parents' dependent, is there any added boost from the IRS to aid his savings plans?

Answer: Yes. The retirement savings contributions credit, (Form 8880, Credit for Qualified Retirement Savings Contributions) — also known as the saver's credit — provides a government boost by offsetting part of the first $2,000 workers voluntarily contribute to individual retirement arrangements (IRAs), §401(k) plans and similar workplace retirement programs. Eligible taxpayers include anyone over age 17 at the end of the applicable year and who is not a full-time student or allowed as a dependent on another taxpayer's return [IRC §25B(c)].

The credit is also available to eligible beneficiaries of an Achieving a Better Life Experience (ABLE) account who contribute to that account.

The maximum saver's credit is $1,000 ($2,000 for married couples) or 50% of $2,000. For 2023, the credit maximum of 50% occurs for single taxpayers with AGI up to $21,750. The contribution percentage drops to 20% for AGI between $21,751 and $23,750, and then is 10% for AGI up to $36,500 after which it is completely phased out.

The IRS webpage on the retirement savings contributions credit has the full table for other filing statuses.

This credit is a nonrefundable credit that can offset tax including AMT and repayment of the advanced premium tax credit. Recent distributions from a retirement plan or ABLE account reduce the contribution amount used to figure the credit.

Workplace plans that qualify include:

  • Traditional or Roth IRA
  • §401(k) plan
  • §403(b) plan for employees of public schools and certain tax-exempt organizations
  • Governmental §457 plan for state or local government employees
  • Thrift Savings Plan (TSP) for federal employees


Jan. 25, 2024

Question: Joe Williams, a new tax professional, agrees to represent a friend who is not his client, Wanda Round, in an IRS audit of her small business that operates as a sole proprietorship. The IRS is requesting all actual receipts for her claimed business expenses. Wanda explains that she scans her receipts into commercially available software as she receives them and then all physical receipts are shredded. Will the IRS accept printouts from the software as proper substantiation for expenses claimed?

Answer: Yes, if the scanning meets what the IRS has been accepting as digitized or scanned versions of paper documents since 1997 in lieu of paper documents. Rev. Proc. 97-22, §4.01 outlines:

  • Taxpayers must ensure "an accurate and complete transfer of the hardcopy or computerized books and records to an electronic storage media. The electronic storage system must also index, store, preserve, retrieve, and reproduce the electronically stored books and records."

The digitized or scanned versions of a paper document must resemble the paper version. No alterations should be made to the digital document. Any handwritten content may not be recorded using OCR (Optical Character Recognition, a technology that allows computers to read text, for example, text on a scanned memo or text in a photograph) because it would not be searchable.

It is still likely a good idea to archive all original back up documents in paper form. Software or hardware can fail, and electronically saved data can be lost.

For a more detailed discussion of Rev. Proc. Rul 97-22, visit: https://www.irs.gov/pub/irs-tege/rp-97-22.pdf

Jan. 18, 2024

Question: Pastor Smith is retiring from a church where he served as minister for the past 30 years. The church presented him with $8,000 a special occasion cash gift for his retirement. Is this taxable to Smith?

Answer: It depends on whether the gift meets Rev. Rul. 55-422's requirements. If both the church and Smith meet all the following requirements, it will not be taxable to him.

  • The minister is not expected to perform any services in return for the gift
  • The payment was not made based on any mandatory agreement or past practice
  • The minister will no longer provide services to the church
  • There is a far closer personal relationship between the minister and the church than a minimal employment relationship; it requires a deeper connection between the minister and the congregation
  • The minister has been adequately compensated for his past service and the gift is not connected to any of his early years' uncompensated work

To show the extended connection between the minister and the parishioners, it is suggested the gift be given informally by the congregation, rather than an official presentation by the church. Depending on if the pastor was paid on a W-2 or 1099 for this gift amount, either the church or the pastor, or both, will ultimately need to make the decision as to whether the gift is taxable. In addition, if the gift amounts are significantly higher than prior compensation, it could still be classified as compensation.

Jan. 11, 2024

Question: Joey filed a joint return on Form 1040 for 2022 with taxable income of $45,000. His itemized deductions were $26,350, comprised mostly of medical expenses. The standard deduction that he could have claimed was $25,900. Joey's total itemized deductions exceeded the standard deduction by $450 ($26,350 - $25,900). In 2023 he recovered $2,100 of the itemized deductions he claimed in 2022 when insurance reimbursed some of his medical expenses. The amount recovered does not exceed the deduction claimed on Schedule A. What is the amount of taxable income he must report in 2023, the year of recovery?

Answer: Joey will recover the lesser of two amounts: the recovered amount or the amount by which the itemized deductions exceed the standard deduction. In this case, Joey will Include $450 of the recoveries in his 2023 income. This is the smaller of:

  • His recovery of $2,100
  • The amount by which his itemized deductions were more than the standard deduction $450 ($26,350 - $25,900)

Jan. 4, 2024

Question: Cliff works as a furniture salesman. Each year, he receives a W-2, Wage and Tax Statement, from his employer. When he sells a certain number of furniture pieces at the store, he also earns an incentive bonus from the manufacturer. The bonus is reported to him on Form 1099-MISC, Miscellaneous Information. Should this Form 1099 income be reported on a Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship), as self-employment income?

Answer: No. These payments are not considered self-employment income and are not subject to self-employment tax. Manufacturer incentive payments are often referred to as sales performance incentive funding formula (SPIFF) payments. Manufacturers make SPIFF payments to encourage salespersons to influence customers to purchase their products. Under this practice, salespersons are essentially receiving incentive payments from third parties that are not their employers. Therefore, Cliff can report the 1099s as other income on Schedule 1 (Form 1040), Additional Income and Adjustments to Income, Line 8z. Any expenses incurred to obtain these payments are no longer deductible under §67(g), as added by the Tax Cuts and Jobs Act of 2017.

Dec. 28, 2023

Question: Pepé is a casual gambler and went to the casino several times throughout the year. His total gambling winnings for the year are $3,500. On the advice of his accountant, he kept a detailed log of all the transactions related to his gambling. At the end of the year, he determined that he had $5,000 in gambling losses. Can Pepé use his gambling losses to directly offset his gambling winnings and report a net gambling gain of $0 on his tax return?

Answer: No. Pepé cannot net his gambling winnings and losses. Instead, he must report all his gambling winnings as income on his Form 1040, U.S. Individual Income Tax Return, using Schedule 1, Additional Income and Adjustments to Income, Line 8b.

He may then deduct the losses to the extent of the gambling winnings as a miscellaneous itemized deduction not subject to the 2% AGI limitation on Schedule A, Itemized Deductions, using Line 16.

Dec. 21, 2023

Question: Jesse is 53 and has been working with his current employer for 30 years. He has $450,000 in his §401(k) account and all his contributions were made with pre-tax dollars. In July 2023, Jesse took a distribution of $40,000 from his §401(k) account to pay for surgery and medical expenses for himself due to a medical condition. Will Jesse pay the 10% penalty associated with an early distribution?

Answer: No. If a taxpayer takes distributions from a qualified §401(k) plan prior to age 59½, they will be subject to a 10% early distribution penalty. However, the penalty does not apply to distributions made in some situations. Under §72(t)(2)(B), distributions made to pay for medical expenses in the same year they are incurred is one of the situations that qualifies as an exception to the 10% early distribution penalty. Jesse would file Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, to except the distribution from the early withdrawal penalty.

The §72(t)(2)(B) exception is limited to expenses that are allowable medical expenses under §213 and can't have been reimbursed by an insurance company. Jesse does not have to itemize deductions to take advantage of this exception as long as his medical expenses exceed 7.5% of adjusted gross income. 

Dec. 14, 2023

Question: Khalil and Sarah have procrastinated on filing their 2022 returns. When meeting with their tax professional, they were informed that e-filing of personal returns is currently unavailable and will re-open in mid to late January. Eager to get 2022 behind them, the taxpayers want to mail their returns in now. Their tax professional advises against this. Since they owe a substantial amount of tax, will mailing in the returns now save them another month or two of additional penalties and interest for late filing of their 2022 returns versus filing in late January 2024?

Answer: Potentially, the answer is yes. Even though paper processing may take many weeks, or even months, the sooner the taxpayer can get payments submitted the quicker continued late payment penalties and interest charges can be stopped. Filing now may save two months of interest and additional penalties versus e-filing in late January when the system re-opens. E-filing will get the return processed more quickly, but saving money by paper filing now may be worth the extra processing time. The taxpayer could also consider making an electronic payment of the balance owed and wait to file the actual return until e-filing re-opens in January to expedite the return processing. However, the tax preparer should leave it up to the taxpayers to determine whether this is the best route to pursue.

Dec. 7, 2023

Question: Laura is a U.S. citizen and is employed by a foreign hospital in Jamaica, where she works as a physician. Is she required to pay U.S. FICA taxes on the wages she earns working for the hospital? Would a totalization agreement between Jamaica and the U.S. have any impact on her requirement to pay Social Security and FICA taxes on the Jamaican wages?

Answer: No. She is not required to pay U.S. FICA taxes. A U.S. citizen or resident alien employed outside the U.S. by a foreign employer is generally not subject to U.S. FICA taxes unless there is a bilateral social security agreement (also known as a totalization agreement) in place between the U.S. and the foreign country. Since there is no bilateral social security agreement between Jamaica and the U.S., the related provision does not apply to her and has no impact on her U.S. taxes.

A totalization agreement has two purposes. First, it eliminates double social security taxation. Second, it bridges the gap in benefit protection for employees who divide their employment between the U.S. and another country. If there is an agreement between the two countries, the U.S. taxpayer will be subject to either the U.S. FICA taxes or social security taxes in the foreign country, depending on the agreement.

Nov. 30, 2023

Question: Suzanne and Mike Sparks, a married couple, transferred their assets, including rental properties, to a single qualified revocable trust of which they were both considered grantors. As such, the income, expenses and credits were reported on their Form 1040, U.S. Individual Income Tax Return, (MFJ). When Mike died on April 1, 2023, the trust became irrevocable as to the assets of the deceased spouse. For 2023 reporting purposes, the revocable trust would report 100% of its income and deductions for the period from Jan. 1, 2023, to April 1, 2023, and then only Suzanne's trust income and deductions through the end of the year. Now, Form 1041, U.S. Income Tax Return for Estates and Trusts, must be filed to report the irrevocable trust's income for Mike's trust assets for the balance of the year. Since a Form 1041 would also be required for Mike's estate, would they be required to file two Forms 1041 – one for the newly formed irrevocable trust and one for Mike's estate?

Answer: No, as long as they make the §645 election to have Mike's portion of the qualified revocable trust treated as part of the related estate, they can combine the income tax reporting of the qualified revocable trust and estate into one Form 1041.

Mike's executor elected to treat Mike's portion of the trust's assets as part of Mike's estate for income tax purposes. Once the election has been made by filing Form 8855, Election To Treat a Qualified Revocable Trust as Part of an Estate, the box in item G of the heading on Form 1041 (page 1) should be checked. The executor must also attach a statement to Form 1041 providing the name and TIN of each electing trust, and the name and address of the trustee for each electing trust.

Because of this election, the income, deductions and credits associated with Mike's portion of the trust from April 2, 2023, through March 31, 2024 (the year-end of the estate), will be included on the estate's Form 1041 for the same period, and no separate trust tax return will be filed for Mike's portion of the trust. Though Mike's portion of the assets are in an irrevocable trust, only one Form 1041 (for the estate) is required to report the activity on Mike's assets as a result of making the §645 election.

To learn more on trusts, check out our three-part on-demand webinar on forming, operating and terminating a trust.

Nov. 22, 2023

Question: Bill and Ted have each been tenant-stockholders in their local housing cooperative, The Excellent House, for many years. Part of the monthly maintenance fees they pay are applied towards the co-op's annual real estate taxes. Bill and Ted recently heard that these taxes are not subject to the state and local tax (SALT) limitation, which is currently $10,000. Therefore, the taxes could be potentially deducted using Schedule A (Form 1040), Itemized Deductions, in addition to other state and local taxes, despite the $10,000 limit. Is this true?

Answer: No. Deductions for the co-op's real estate taxes are covered under §216(a)(1), which indicates taxes are still subject to the SALT limitations.

The Joint Committee on Taxation said, “[i]t is intended that the limitation apply to the deduction for amounts paid or accrued to a cooperative housing corporation by a tenant-stockholder under section 216(a)(1) (relating to real estate taxes) in the same manner as the limitation applies to real estate taxes under section 164.” Joint Committee on Taxation Staff, General Explanation of Public Law 115-97, JCS-1-18 p. 68 (December 2018). 

Nov. 16, 2023

Question: Tristan owns land with standing timber that he sells as part of his business. He has held the timberland for several years and decided to cut the timber this year. Tristan’s basis in the standing timber is computed as $15 per cord. As of Jan. 1 in the year he is cutting the timber, the fair market value (FMV) is $35 per cord. A logging company will be cutting and hauling the timber at $75 per cord. He will be selling the timber for $200 per cord. Tristan wishes to make the election to treat the cutting as a sale or exchange under §631(a). Under this method, how much of the gain will be taxed as ordinary income and how much will be taxed as capital income on a per cord basis?

Answer: Tristan will have an overall gain of $110 per cord. Of that gain, $20 per cord will be taxed as capital gain, while $90 will be taxed as ordinary income.

The capital gain portion is calculated as follows: $35 FMV - $15 basis = $20 capital gain.

The ordinary income portion is calculated as follows: $200 sales price - $75 cost to have logger cut and haul timber - $35 FMV = $90 ordinary income.

Nov. 9, 2023

Question: Linda has a traditional IRA account with Fidelity Investments. What are the methods of transferring her account to another brokerage firm without incurring taxes and penalties?

Answer: Linda has two choices for rolling over her account from one firm to another. The first choice is to have the assets distributed to her, and then, within 60 days, recontribute all of the funds to a different account. Fidelity Investments will send Linda a check for the funds in her account. As long as the check is made out to the receiving trustee for the benefit of the taxpayer, it is not treated as a distribution to the taxpayer. Linda has 60 days to recontribute the assets to an eligible plan willing to take the contribution. If she misses the 60-day recontribution period, she would be taxed on the distribution and could be subject to an early distribution penalty. In some cases, the IRS may agree to a penalty waiver if the deadline is missed for good cause. Linda may roll over amounts out of her IRA only once within a 12-month period from the date of receipt of the distribution.

The second choice is a “direct rollover” from her IRA to the trustee of the receiving plan (sometimes called a “trustee-to-trustee transfer”). In this method, Linda never receives the plan assets and the trustees of each plan simply transfer the funds.

Nov. 2, 2023

Question: John, age 52, has a traditional IRA worth $100,000. His basis in the IRA is $0 (that is, all contributions were tax deductible). Also, in 2022 he incurred a large capital loss in other non-IRA accounts from a poor investment, which resulted in a $100,000 capital loss carryover to 2023. John's neighbor, Jay, suggested he convert his IRA to a Roth IRA before the end of this year so John can offset the entire $100,000 in income that would normally be recognized in the conversion with the capital losses carried forward from 2022. Is Jay correct?

Answer: No. The Roth IRA conversion represents ordinary income [§408(d)(1), IRS Pub 590-B] while capital losses are only deductible against gains from capital assets [§1211(b)]. If there are no capital gains to offset the capital loss carryforward, the taxpayer is allowed a deduction of $3,000 ($1,500 if married filing separately) against other income [§1211(b)(1) and (2)], but the remainder of the capital losses will be carried forward to 2024 and beyond. The Roth conversion will be fully includable as income. Assuming no other capital gains, $3,000 will be allowed as a capital loss deduction and $97,000 of the capital loss will be carried forward to 2024.

Oct. 26, 2023

Question: Fred is preparing a final Form 1120-S, U.S. Income Tax Return for an S Corporation, for a client. The S corporation uses the accrual method of accounting and its accounts receivable account has a balance of $25,000, which has remained in the account for several years. It has been deemed impossible to collect the balance and is therefore worthless. Can the corporation deduct the accounts receivable as a bad debt expense and, if so, where is it reported on Form 1120-S?

Answer: Yes. The accounts receivable can be deducted as a bad debt expense if the balance is a bona fide debt and is completely or partially worthless. A bona fide debt is defined as a debt based on a debtor-creditor relationship that the debtor is legally obligated to pay back.

Because the debt is an accounts receivable generated in the ordinary course of the S corporation's business operations, meets the requirements of a bona fide debt and has been deemed uncollectible and worthless, it will be considered a business bad debt. As a pass-through entity, the S corporation deducts the bad debt at the corporate level and each shareholder deducts their pro rata share on their individual tax return.

To report the bad debt expense, Fred will enter the amount as a deduction on Form 1120-S, Line 10 under “Bad debts”. The amount is included as part of ordinary business income (loss) on Form 1120-S, Schedule K, Line 1, and in the ordinary business income (loss) reported to the shareholder on Schedule K-1 (Form 1120-S), Shareholder's Share of Income, Deductions, Credits, etc., Box 1.

Oct. 19, 2023

Question: Lina is preparing the Form 1041, U.S. Income Tax Return for Estates and Trusts, and Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions and Credits, for three beneficiaries. Personal information is available for two of the beneficiaries. But the address and taxpayer identification number (TIN) are missing for the third beneficiary, and the individual is not responding to requests for the information. How should Lina file the Schedule K-1 for this absent beneficiary?

Answer: According to the IRS instructions, Lina should recognize that the trust's fiduciary must request and provide a TIN for each beneficiary or face penalties for failure to do so. Individuals are responsible for giving their TINs to the fiduciary when asked. Form W-9 is used to request this information.

Reg §301.6109-1(c) provides instructions for requesting the TIN and preparing an affidavit noting lack of compliance with a TIN request. If there is reasonable cause for the noncompliance, it should be explained in an affidavit signed and attached to the transmittal form.

The K-1 is then prepared without the missing information.

If the request procedure and/or affidavit policy is not followed, a penalty of $50 may be imposed under §6721 for each missing/incorrect TIN as seen in the chart on the IRS website. Note that an additional penalty under §6722 may be imposed if the payee statement is furnished late or fails to include all the required information. To abate the penalty, if one is imposed, respond with a reasonable cause as to why the information is missing and to establish that the fiduciary acted responsibly both before and after the failure occurred.

Oct. 12, 2023

Question: Haroldo, a U.S. citizen, runs a Schedule E residential rental business located entirely in Paraguay. While reviewing his past tax returns, you notice that the business assets have been depreciated using a variety of methods under modified accelerated cost recovery system, general depreciation system (MACRS GDS). Is this correct?

Answer: No. For any tangible business property used predominantly outside the United States during the tax year, the use of the alternative depreciation system (ADS) is required by §168(g)(1)(A). Under ADS, the recovery period for the residential rental property is 30 years.

Oct. 5, 2023

Question: Brian and Cody are the only two shareholders of a C corporation. After operating the business for five years, they have decided to change the business to an S corporation by making a valid election on Form 2553, Election by a Small Business Corporation. They have a net operating loss (NOL) carryforward that was generated from the C corporation. Can the NOL carryforward be carried into the S corporation and continue to be used by the S corporation to reduce its income?

Answer: No. When the corporation makes the election to be treated as an S corporation, it will lose certain tax attributes accumulated by the C corporation, including the NOL carryforwards. This means that the S corporation cannot use any remaining NOL carryforwards it generated as a C corporation to offset S corporation income. However, it can use the NOL carryforward to reduce recognized built-in gains tax [IRC §1363(b); 1371(b); 1374(b)(2) and 1375(b)(1)(B)].

Sept. 28, 2023

Question: Linda inherited an IRA from her brother, Mark, who died at the age of 78. Mark was taking his required minimum distributions (RMDs). Linda is 67 and is still working. She is considered a noneligible designated beneficiary. When must Linda complete her distributions from the inherited IRA account?

Answer: Current rules stipulate that Linda must complete her inherited IRA distribution within 10 years of Mark's death. However, proposed regulations issued in February 2022 suggest that RMDs must be taken annually, rather than simply before the end of the tenth year. The proposed regulations are intended to incorporate the legislative changes included in the SECURE 2.0 Act of 2022. The proposed regulations, once finalized, were originally set to be effective for 2022 and later calendar years. However, in IRS Notice 2023-54, the agency announced that final regulations on RMDs would apply no earlier than 2024. Proposed regulations are not law until finalized, but some advisors suggest that taxpayers who have inherited IRAs should begin taking the distributions annually.

Sept. 21, 2023

Question: A married couple has operated a limited liability company (LLC) for several years. They are the only owners of the LLC and have always treated it as a partnership, filing Form 1065, U.S. Return of Partnership Income. They are not in a community property state. This past July, one spouse died. Should the 2023 partnership return cover all of 2023? If not, what should the LLC do?

Answer: No. The LLC will need to file Form 1065 from the first day of its tax year to the date of death. The surviving spouse will file a Schedule C, Profit or Loss from Business (Sole Proprietorship), for the remainder of the tax year. Because the taxpayers are not in a community property state, they were correct in filing Form 1065 and treating the LLC as a partnership.

The death of a partner in a two-person partnership causes a technical termination of the partnership for federal tax purposes if it results in only one partner remaining. If this occurs, the partnership's tax year closes on the partner's date of death (in this case, July 2023). The surviving partner will file Schedule C on their personal tax filing as a single-member LLC (SMLLC) disregarded entity for the remainder of the calendar year.

This conclusion would not be the case if the deceased partner's estate, as the successor in interest, continues to share in the partnership's profits or losses [Reg. §1.708-1(b)(1)(i)]. The partnership's tax year does not close, and the partner's distributive share of partnership income from the date of death through the end of the partnership tax year is reported on the tax return of the successor in interest [Reg. §1.706-1(c)(2)(ii)] If this is the case, the partnership would be issuing three Schedules K-1, Partner's Share of Income, Deductions, Credits, etc. One would be for the complete year on half (assuming the original partners were 50/50 owners) of the partnership results to the surviving spouse. The other half would be divided between one Schedule K-1 for the partner who passed away for the period Jan. 1 to the day before the date of death and a third Schedule K-1 from the date of death through the end of the year for the estate of the decedent issued to the estate's employer identification number (EIN). When the estate period of administration ends, and assuming the surviving partner is the ultimate successor in interest, leaving only one partner, partnership treatment would end as of that date [§708(b)(1)].

Note: In either scenario, as described, the partnership's EIN continues to be used either by the now SMLLC or as a multi-member LLC with the estate as the successor partner to the decedent.

Sept. 14, 2023

Question: An estate filed Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, just over three months after the return was due. As a result, the IRS imposed a failure to timely file (FTF) penalty under §6651(a)(1) of $450,238 as well as other deficiencies. The estate appealed the deficiency finding in U.S. Tax Court and requested an abatement of the FTF penalty because it made an $11.6 million dollar payment with its timely filed extension. The return showed tax liability of $10.6 million. This resulted in a refund of $1.6 million. The estate felt it should not have to pay the penalty because the extension payment covered the liability and contended that it had reasonable cause for filing late. The Tax Court disagreed, leaving a FTF penalty in place. Was the estate unjustly penalized in this situation?

Answer: No. When the court addressed this issue in Estate of Richard D. Spizzirri v. Comm'r, T.C. Memo. 2023-25, it relied on the strict penalty regime established for late filing of estate tax returns applicable even when full payment is made on time. For each month a federal estate-tax return is late, the IRS must impose a penalty of 5% of the tax due (up to a limit of 25%) unless it is shown the failure to file on time is due to reasonable cause and not willful neglect [§6651(a)(1)].

Although the estate tried to establish that it had reasonable cause for late filing by claiming it did not want to file an incomplete or inaccurate return while litigation was pending with the deceased's fourth wife, the court concluded that the excuse did not constitute a reasonable cause for the delay and let the penalty stand. It said the estate has a duty to file a return based on the best information available. There is no duty to file a return reflecting perfect information of the estate's assets because an estate can file another Form 706 with supplemental information to reflect new information [§20.6081-1(d)]. Therefore, problems with assembling or valuing the estate's assets do not constitute reasonable cause for purposes of avoiding the penalties under §6651.

The full payment issue had no bearing on the assessment of the penalty. Therefore, full payment notwithstanding, the estate tax return was filed three months later than its due date, and a FTF penalty under §6651(a)(1) remained.

Sept. 7, 2023

Question: Barb and Ahna celebrated the completion of the adoption process for their first child in 2023. The child does not have special needs. Their qualified adoption expenses were $7,000. While organizing their paperwork, they discovered they had spent $5,000 on a prior unsuccessful domestic adoption two years ago. They never claimed these 2021 expenses on any tax return. Would the $5,000 still be available to them as a current-year adoption credit?

Answer: Yes. The expenses incurred in an unsuccessful domestic adoption are included with those of the subsequent adoption attempt, regardless of whether the subsequent attempt was successful. The per-child, cumulative adoption credit dollar limitation is $15,950 for 2023. In applying the dollar limit, Barb and Ahna may combine the expenses of the multiple attempts to adopt one eligible U.S. child.

Aug. 31, 2023

Question: Last year, Josh decided to take out a reverse mortgage on his home. He used the loan funds to make substantial improvements to his home. No principal or interest payments were required on the reverse mortgage loan during the year. However, Josh made a $3,000 payment, which consisted of $2,000 applied toward the principal and $1,000 toward the accrued interest. Assuming he is otherwise eligible to itemize on Schedule A (1040), Itemized Deductions, will this payment of interest be a qualified mortgage interest deduction?

Answer: Yes. Although reverse mortgages are generally considered home equity loans, for which the interest is nondeductible for tax years 2018-2025, if the reverse mortgage loan proceeds are used to substantially improve the residence, the interest is deductible as qualified residence mortgage interest when paid. This treatment is allowed even if the interest payment is not actually required to be made at the time of the payment.

Aug. 24, 2023

Question: Joel is an artist who donated a ceramic pot he made to a non-profit organization. The materials used to produce the pot cost Joel $100. The non-profit organization later sold the craft for $5,000. Can Joel deduct the $5,000 on his return as a charitable contribution?

Answer: No. Joel can only deduct $100 as a charitable contribution. Artwork that is created by the donor is considered ordinary income property and not capital gain property. Contributions of capital gain property are deductible in full at their fair market value on the date of contribution. Joel can only deduct his basis in the property as a deduction on his return, not the fair market value of the item. The basis is the cost of materials he used to produce the pot, which was $100.

Aug. 17, 2023

Question: June is a sole proprietor who reports her activity on a Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). Throughout the year, she took an owner's draw from the business. Can she deduct an owner's draw from a business checking account for her personal use? Secondly, must separate payroll taxes be paid on these withdrawals?

Answer: No. For federal tax purposes, a sole proprietor cannot deduct their own salary, or any personal withdrawals made from their own business. This is because a sole proprietor is not an employee of the business (Publication 334, Chapter 8, Page 33).

While accounting for an owner's draw may be important for bookkeeping purposes, it is an equity transaction on the business's balance sheet, which means there is no current income tax impact for an owner taking distributions from their sole proprietorship. For example, there is no line on a Schedule C for an owner's draw. It is not regarded as a business expense for income tax purposes. Sole proprietors report net income from their business activity without consideration for any funds withdrawn by them, nor are these withdrawals subject to income tax or self-employment tax.

Planning tip: Owners of sole proprietorships are also not eligible to be treated as employees and may not receive salary or wages from the unincorporated business. Additionally, it's important to account for when business owners may be forced to make capital contributions back into their business if they are in the habit of withdrawing much of the available cash. These contributions are not considered income to the business, much like the owner making withdrawals is not a deduction to the business.

Aug. 10, 2023

Question: Rafael is a U.S. citizen who owns more than 10% of a foreign corporation. As such, he is required to report information regarding his foreign ownership annually under. §6038(a). He failed to do so by not filing the required Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, for tax years 2019 – 2020 due to disruptions during COVID-19. His refusal to file appears to be a willful and intentional disregard of the filing requirement.

Without review, the IRS promptly and administratively assessed a penalty under §6038(b)(1) of $10,000 for each annual accounting period Rafael did not file Form 5471. He received IRS notices for tax years 2019 and 2020. He still did not file the required Forms 5471 for more than 90 days after the date of the notice of his failure to file. As a result, he was assessed continuation penalties under. §6038(b)(2) of $10,000 for each month or partial month that the failure continued after the 90-day period beginning with the date of the notice. The continuation penalty is capped at $50,000. His total penalty for the failure to file is capped at $60,000 per year, or $120,000 in total. What remedy does Rafael have in the wake of the recent case, Alon Farhy v. Commissioner, 160 T.C. No. 6 (April 3, 2023), that was decided by the U.S. Tax Court, challenging the IRS's right to automatically assess penalties (administratively) under the code section governing Form 5471 penalties (§6038)?

Answer: Rafael will not have to pay. The U.S. Tax Court's decision in Farhy found that, while the Tax Code provides the IRS with the ability to assess penalties, the specific penalty under §6038(b), unlike others in the code, does not authorize the assessment of the penalty it calls for. Therefore, the §6038(b) penalty is not an “assessable penalty”, and only a civil action may force collection as opposed to an administrative assessment. Essentially, because this code section falls outside of the sections in Subchapter B of Chapter 68 of Subtitle F, entitled “Assessable Penalties,” and because it has no language linking its penalty provision to any other authorization to assess and collect penalties, the IRS does not have authority to assess and collect this penalty.

This decision is expected to have a broad reach and will affect most Form 5471 filers, namely category 1, 4, and 5 filers. It will not affect category 2 and 3 filers, who are subject to penalties under §6679, which remains assessable.

Aug. 3, 2023

Question: Dovydas, a longtime U.S. citizen, originally emigrated to the U.S. from Lithuania. As a result of Nazi persecution during World War II, a portion of his family's property was unfairly seized; the family never regained this land. Dovydas recently received word that the Lithuanian government is planning to make a restitution payment for the seizure and Dovydas will receive $100,000 sometime in 2023. Will this be taxable on his 2023 federal income tax return?

Answer: No. The restitution payment will be neither taxable nor reportable. After the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001, the IRS issued Tax Tip 2002-38, which said: “Holocaust survivors, their heirs or estates will receive the full benefit of any restitution payment made by governments or industry. Restitution payments are excluded from federal taxes and should not be included as income or listed anywhere else on federal tax returns.”

July 27, 2023

Question: Troy, Chuck and Adam are general partners in a domestic partnership. Each quarter, they each receive a $10,000 guaranteed payment for services provided to the partnership. This quarter, they have agreed that the partnership will transfer property to Adam instead of paying cash to him for his guaranteed payment. The property being transferred has a fair market value of $10,000 and an adjusted basis of $6,000. How will this transfer of property to Adam be treated, and where on the Form 1065, U.S. Return of Partnership Income, will the transfer be reported?

Answer: Although still considered a guaranteed payment to Adam, the distribution of property to a partner as part of a guaranteed payment is considered a sale of the property at fair market value and must be reported on the partnership's Form 4797, Sales of Business Property, or Form 8949, Sales and Other Dispositions of Capital Assets/Schedule D, whichever is appropriate. Therefore, the partnership will recognize taxable gain on the property of $4,000 ($10,000 FMV less $6,000 adjusted basis). Because it is considered a guaranteed payment for services provided to the partnership, the partnership will also be able to deduct the full amount of the guaranteed payment, the $10,000 fair market value of the property transferred to Adam, on Form 1065, Line 10. The partnership will also report the guaranteed payment to Adam on his Schedule K-1 (1065), Partner's Share of Income, Deductions, Credits, etc., Line 4a. Adam's outside basis in the partnership will not be affected because guaranteed payments do not affect outside basis; however, he will have basis in the property distributed to him that is equal to the taxable compensation recognized by him. Therefore, his basis in the property is $10,000.

July 20, 2023

Question: Our client, Sara, does consulting work for a private company, which gave her 1 million options at a $0.01 strike price. Sara will only have 90 days to exercise the shares once leaving the company. Though the 409a valuation reflects a stock price of $0.01, the shares currently have a market value of $0.50. What are the tax results if Sara were to exercise her options?

Answer: The type of stock options Sara received will determine the tax consequences. She will need to use the option agreement to verify whether these are qualified incentive stock options or non-qualified stock options. However, incentive stock options are generally not granted to non-employees. Therefore, your client probably received a non-qualified stock option.

Non-qualified stock options are a type of employee stock option where you pay ordinary income tax on the difference between the exercise price, which, in this case, is $0.01, and the FMV of the stock when the option is exercised, which would be $0.50. When the client sells the stock, they will then be taxed at capital gains rates for the difference between $0.50 cost basis and the price actually received upon sale. Depending on how long the client holds the stock between the time they exercise it and sell it will determine whether the gain will be subject to short term or long-term capital gains tax.

July 13, 2023

Question: My client made substantial purchases of U.S. savings bonds for his children, titled in their names. He would prefer to report the bonds' accrued interest annually while the children are in lower tax brackets, knowing the other option is to wait to report until the bonds' final maturity. Since there will not be a 1099-INT, Interest Income, issued each year, how do I determine the annual interest earned? Also, when the bonds are cashed in, how do I inform the IRS that the bond interest was previously reported by the children?

Answer: In the absence of a Form 1099-INT, use Treasury Direct's savings bond calculator to calculate the annual interest to report for paper bonds. For bonds that are in a TreasuryDirect account, the yearly interest will be displayed in the account information.

When the bonds are ultimately surrendered (cashed in), Treasury will issue a Form 1099-INT for the full amount of interest earned during the entire holding period of the bond(s). For full disclosure, the amount of interest on the Form 1099-INT should be reported on the taxpayer's Form 1040, Schedule B, Interest and Ordinary Dividends. A second entry should then be made on the Schedule B as "U.S. Savings Bond Interest Previously Reported" and enter amounts previously reported as a negative entry.

Tip: A common question among taxpayers is how long to retain tax records. In this scenario, it is suggested that the taxpayer retain all returns where accrued interest was reported. These can be used to support the subtraction when the bonds in question are actually surrendered, which might be as long as 20 years (or more) later. Tax professionals are encouraged to discuss this optional reporting alternative with their clients during their annual meetings.

July 6, 2023

Question: Rich and Tina are married and filing a joint return. Daniel qualifies as their dependent. The couple’s modified adjusted gross income (MAGI) is $167,000. After scholarships available for Daniel’s first year at UW-Green Bay, Rich and Tina paid qualified tuition and fees of $3,000. They want to claim the refundable American opportunity tax credit (AOTC), which is 100% of their first $2,000 of qualified education expenses and 25% of the next $1,000, for a tentative AOTC of $2,250. The refundable portion of the credit is capped at 40%. However, Rich and Tina’s AOTC phases out because their MAGI is more than $160,000. What is their total allowable credit, the nonrefundable portion and the refundable portion?

Answer: Their allowable AOTC credit is computed as follows: With $3,000 of qualified tuition expense, the $2,250 tentative credit x [$180,000 (upper MAGI limit) - $167,000 (taxpayers’ MAGI) / $20,000 (the difference between the minimum and maximum limit)] = (0.65) x ($2,250) = $1,463 (total).

In this case the refundable credit would be 40% of $1,463, or $585; the nonrefundable portion is $878.

June 29, 2023

Question: Your clients, Brian and Angela, have three children under age 17. They fell on some hard times and were unable to work at all during 2022. Their only income was $480 in royalties for some karaoke tracks they created. Thus, they have no tax liability for 2022. The couple does plan to file a joint income tax return for 2022, however. Assuming they meet all other requirements, will they still be eligible to claim the child tax credit for 2022?

Answer: No. They are not eligible to claim the child tax credit for 2022. Apart from 2021, the child tax credit is nonrefundable. Its refundable counterpart, the additional child tax credit, can’t be claimed by the couple because it requires earned income of $2,500 to qualify [§24(h)(6)] and the couple only earned $480 in 2022.

June 22, 2023

Question: John has been living with Jane all year and provides all financial support for her. Jane does not work, is not a relative and depends completely on John. No one else resides with them in the same household and John does not provide support for a parent who lives outside the home. Can John claim head of household (HOH) on his return?

Answer: No, John cannot file as HOH because he doesn't satisfy all the requirements for the HOH filing status. To qualify, John must meet all the following requirements:

  • Be unmarried or considered unmarried on the last day of the year
  • Have paid more than half the cost of keeping up a home for the year
  • Have a qualifying person who lived with him in the home for more than half the year (except for temporary absences, such as school)

Jane is not a qualifying person; therefore, John does not satisfy the requirements for filing as HOH. A qualifying person includes a:

  • Child (such as a son, daughter or grandchild who lived with you more than half the year and meets certain other tests)
  • Relative who is your father or mother
  • Relative other than your father or mother (such as a grandparent, brother or sister who meets certain tests)

June 15, 2023

Question: Alfred incurred a net operating loss (NOL) for 2021. His 2022 return is on extension with a due date of Oct. 15, 2023. His business has been slow to recover from the economic fallout of the recent pandemic, so his 2022 income was low. But he has great prospects and expectations for success in 2023. He wants to know if he can skip applying the 2021 NOL against 2022 income so that more of the NOL might be saved for 2023, when he anticipates a significant increase in income.

Answer: No. Unfortunately, under IRC §172(b)(1)(A)(ii)(II), “in the case of a net operating loss arising in a taxable year beginning after Dec. 31, 2017, [losses shall be carried forward] to each taxable year following the taxable year of the loss [emphasis added].”

To calculate the NOL for the current year and any remainder available to carry forward to future years, use the worksheets provided in IRS Publication 536Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.

As a reminder, the Tax Cuts and Jobs Act (TCJA) eliminated carry back of NOLs. The original NOL changes made under TCJA, as illustrated above, were delayed by legislative action for tax years 2018 through 2020. For NOLs incurred after 2020, carrying the NOL forward is the only option. While the carryforward years are unlimited, the amount of any NOL carryforward is limited to 80% of the taxable income in the carry-forward year.

June 8, 2023

Question: Lee and Linda, age 80 and 75, are married filing jointly and receive combined annual Social Security benefits of $20,000. Lee is a math tutor at the local community college and Linda works as a part-time bookkeeper. This results in other taxable income of $40,000 for the year. Although the amount always comes as a surprise to Linda when she prepares the couple's taxes, what is the maximum amount of their Social Security benefits that would be taxable for 2022?

Answer: Up to 85%, or $17,000, of Lee and Linda's benefits would be taxable for 2022. To arrive at this number, they would add one-half of their Social Security benefits to their other combined income. This amount is then compared to the 2022 base amount of $32,000 plus $12,000 (MFJ). In the case of Lee and Linda, the total of one-half of the taxpayers' benefits and all other income equals $50,000 ($10,000 + $40,000), which is more than the base amount ($32,000 + $12,000), which is $44,000 (MFJ). Since the maximum percentage of Social Security income that is taxable jumps from 50% to 85% when the couple's base amount exceeds $44,000, 85% of their Social Security benefits may be taxable.

June 1, 2023

Question: Three years ago, Ralph purchased a small business that he operates as a sole proprietorship. As part of the purchase, Ralph bought a franchise and a patent. He has been amortizing both §197 intangibles over 180 months. Ralph still holds the franchise, but recently sold the patent at a loss. Can he take this loss as a tax deduction?

Answer: No. Ralph cannot currently deduct the loss on the sale of the patent. No loss is recognized on the disposition of an amortizable §197 intangible asset that was acquired in a transaction with other amortizable §197 intangible assets until all the intangible assets purchased in the transaction are disposed of or become worthless. After selling the patent, Ralph will instead add the remaining basis of the patent to the remaining basis of the franchise and will continue amortization over the period remaining on the retained franchise.

May 25, 2023

Question: Frank and Mercy divorced on Jan. 11, 2018, but continued to live together through 2021. Frank paid alimony to his ex-spouse in 2021. Does Mercy pay taxes on the alimony, and can Frank deduct the alimony payments?

Answer: No. Mercy will not pay taxes on the alimony payments and Frank will not be able to deduct the payments. Generally, alimony payments under pre-2019 divorce decree are deductible by the payer and includable as income by the recipient. However, there are requirements that must be met for these to occur. One of the requirements is that the payee and the payer cannot be members of the same household at the time the payments were made. Because the two were still living together at the time, these payments will not count as taxable income to Mercy and will not be deductible for Frank.

May 18, 2023

Question: When the IRS issued Rev. Proc. 2015-13, it gave taxpayers the opportunity to correct missed or incorrect methods of depreciation as an automatic accounting change using Form 3115, Application for Change in Accounting Method, through a §481(a) adjustment. Can a tax professional leave the annual depreciation expense off a taxpayer's return and “save” these deductions for a later year in which an accumulation of deductions would best serve the taxpayer? Would knowingly or purposely omitting annual depreciation deductions and picking them up in a later year under §481(a) create legal or ethical implications for paid preparers?

Answer: No. You cannot intentionally omit a taxpayer's annual depreciation deductions so that the taxpayer can use them in a year in which they would be more advantageous. Circular 230, Regulations Governing Practice before the Internal Revenue Service, requires tax return preparers be knowledgeable about the returns they prepare. Every tax professional knows that depreciation is an annual deduction that accounts for the natural deterioration of an asset. Intentionally omitting the deduction could be considered a violation of Circular 230 §10.21, Knowledge of client's omission; §10.22, Diligence as to Accuracy; §10.34, Standards with respect to tax returns and documents, affidavits, and other papers for Tax Return Positions known to be potentially unreasonable; or §10.35, Competence.

Correcting missed depreciation due to an honest oversight is the reason why §481(a) was added to the tax code. Intentionally omitting depreciation to maximize deductions in another tax period goes against the Circular 230 standards for tax preparers and is likely inviting risk to your continuation in the profession. The §481(a) adjustment should be used by a tax preparer to provide knowledgeable salvation to the novice taxpayer who missed depreciation due to ignorance. It should not be used as an intentional disregard of the law disguised as a planning tool.

May 11, 2023

Question: Sue operated a wholesale business as a sole proprietorship, reporting income and expenses on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). During COVID-19, the business failed. However, she still must make payments on bank debt for an inventory loan and a line of credit for the business. Can she deduct any of those payments of former business expenses on her current Form 1040, U.S. Individual Income Tax Return?

Answer: Yes, Sue's interest expense on this debt can be reported on Schedule C (Form 1040) as an expense attributable to a prior business activity [Dowd v. Comm'r, 68 T.C. 294 (T.C. 1977)]. The original use of the debt proceeds determines the character of the interest expense and how it may be reported. Presumably, if Sue has self-employment (SE) income from other sources, she can also use the loss from this Schedule C (Form 1040) to reduce the income subject to SE tax.

May 4, 2023

Question: Pedro lives in Spain. He owns real estate in the U.S. and receives rental income of $12,000 during the year. Pedro is unmarried, has never been to the U.S., and meets the definition of a nonresident alien. The rental income was his only U.S.-sourced income. Must Pedro file a U.S. tax return and, if so, is he allowed to claim the standard deduction?

Answer: Yes, Pedro will be required to file a tax return using Form 1040-NR, U.S. Nonresident Alien Income Tax Return. Since the real estate is in the U.S, he has U.S.- sourced income that must report on a federal income tax return.

Because Pedro is considered a nonresident alien and is not married to a U.S. citizen or resident with whom he is making an election to be treated as a U.S. resident, he is not eligible to claim the standard deduction; his allowable standard deduction is $0.

April 27, 2023

Question: Mary passed away in 2020 at the age of 80. She had a traditional IRA account from which she had been withdrawing her required minimum distributions (RMDs). Her daughter Lucy, who was a designated beneficiary, wants to know the tax implications of inheriting the IRA and her options for distributions.

Answer: As a designated beneficiary, Lucy has two options for the IRA she inherited from Mary.

Option 1
As a non-spouse beneficiary, Lucy may choose to roll over Mary's IRA when it is transferred in a direct trustee-to-trustee transfer to another traditional IRA if the new IRA is in Mary's name for Lucy's benefit. Since Mary was required to take RMDs at the time of her death, Lucy must then take RMDs over her life expectancy and distribute the remaining balance by the end of the 10th year following the year of Mary's death (2030). 

Option 2
Lucy can liquidate or cash out the plan completely and pay ordinary income taxes on the distribution for the year in which she withdraws the money.

April 20, 2023

Question: I filed my client's 2022 personal return electronically the evening of April 18 (approximately 6 p.m. CDT). I was out of the office April 19. When I returned to the office today, I discovered the return had been rejected due to an error. Will my client be facing late filing penalties when I resubmit the returns?

Answer: Probably not. In most cases, if an electronically submitted tax return is initially rejected by the IRS, there is an opportunity to correct the error and retransmit it. In your case, even though the rejection was discovered after the April 18 filing deadline, you will be provided an additional five days (from April 18) to fix the error and retransmit the return. That's five calendar days, not five business days so the return needs to be retransmitted and accepted by April 23 to be considered a timely filed return.

If, for some reason, the error that resulted in the rejection is too complex to resolve via electronic filing or cannot be fixed when resubmitting electronically, you'll need to print out the return, have the taxpayer sign the paper copy and mail it to the IRS with all necessary filing documents such as Forms W-2. You should also complete and attach Form 8948, Preparer Explanation for Not Filing Electronically, to the return and include the e-file rejection codes on the form as well as the date(s) it was submitted electronically. This return should be postmarked within the five-day grace period from April 18.

April 13, 2023

Question: Bob and Nancy signed their Form 8879, IRS E-File Signature Authorization, without reviewing their completed Form 1040, U.S. Individual Income Tax Return. Their preparer e-filed their Form 1040, which was rejected because of an input error, which the preparer corrected. The change raised their tax liability by $12. Do Bob and Nancy need to sign a new Form 8879 before the preparer can resubmit their return?

Answer: No. New signatures are not needed when the change in tax liability is less than $14. Rejected electronic individual income tax return data can be corrected and retransmitted without new signatures if changes don't differ from the amount on the original electronic return by more than $50 to “Total income” or “AGI,” or more than $14 to “Total tax,” “Federal income tax withheld,” “Refund” or “Amount you owe.” However, per Publication 1345, Authorized IRS e-file Providers of Individual Income Tax Returns, the ERO (preparer) must give copies of the new electronic return to the taxpayers.

April 6, 2023

Question: Nick is a single taxpayer who recently started using a wheelchair due to a medical condition. He had an elevator installed in his home so he could continue to live there. The cost of the elevator was $3,000. A recent home appraisal determined that the elevator had increased its value by $1,000. Can Nick claim a medical expense deduction on his Schedule A (Form 1040), Itemized Deductions, for the elevator and, if so, how much can he deduct?

Answer: Yes, Nick will be allowed to deduct the elevator as a medical expense on his tax return. Capital expenditures for the permanent improvement of property can qualify as a deductible medical expense if they are directly related to the medical care of the taxpayer, their spouse or their dependent. The deduction for such capital improvements is limited to the excess of the cost of the expenditure over the increase in the value of the improved property. Therefore, the allowable medical expense deduction on Nick's Schedule A (Form 1040), Itemized Deductions, for the elevator would be $2,000 ($3,000 cost - $1,000 increase in the value of the home).

March 30, 2023

Question: Mark owned a rental property and passed away in August 2022. His wife, Rita, did not hold an ownership interest in the property and inherited it when her husband died. They did not live in a community property state. Does the property's basis get stepped up to the fair market value at the time of Mark's death?

Answer: Yes, the property gets stepped up to the fair market value at the time of death. The property was 100% owned by Mark and, as a result, the full basis is stepped up to the fair market value of the property at the time of his death. If the property was community property, both halves of the spouses' property obtain a basis equal to fair market value.

March 23, 2023

Question: I'm finding conflicting information regarding federal tax credits for two- and three-wheeled vehicles on the internet. Can I claim the federal tax credit for a two-wheeled vehicle acquired in 2022 or not?

Answer: No. The federal tax credit provided for in §30D(g) for two- or three-wheeled plug in electric drive vehicles expired at the end of 2021 and was not extended. However, if you acquired the two-wheeled vehicle in 2021, but placed it in service during 2022, you may still be able to claim the credit for 2022.

The credit is 10% of the cost of any qualified two-wheeled plug-in electric vehicle placed in service by the taxpayer during the taxable year; it cannot exceed $2,500. As an aside, e-bikes, for example, generally achieve a speed of no more than 28 MPH and, therefore, would not have met the definitions for the credits outlined.

March 16, 2023

Question: Charles and Stephanie are married and file a joint Form 1040, U.S. Individual Income Tax Return. Stephanie works and has a salary of $141,000. Charles, a stay-at-home grandad, does not work outside the home and is receiving Social Security ($25,000 in 2022). Their total income on Line 9 of their 1040 is $166,000. Stephanie has a retirement plan through her employer. Can Charles make a deductible contribution to an IRA in 2023?

Answer: Yes. Charles can make an IRA contribution to a Kay Bailey Hutchinson IRA by using Stephanie's earned income to make the contribution. Even though his wife is an active participant, the couple's combined AGI is below $218,000, which is the income threshold for MFJ IRA contributions.

Stephanie's salary is over the contribution limit of $136,000, and since she has a plan at work, she cannot make a deductible IRA contribution. She is considered an “active participant” in her company plan and is subject to a contribution limitation on that basis.

March 9, 2023

Question: Nicholas is an ordained minister. During the year, he performed services as a chaplain for the U.S. armed services. He received a Form W-2, Wage and Tax Statement, from this employment with wages reported in Box 1, as well as Social Security and Medicare wages and withholding reported in Boxes 3 through 6. Should Nicholas have received a W-2 with Social Security and Medicare withholding or should he be subject to self-employment tax under the general reporting rules for ministers?

Answer: Normally, when an ordained minister receives compensation for performing ministerial duties, the wages are reported on Form W-2, Box 1, and are not considered Social Security or Medicare wages, so those items will not be reported on Form W-2 in Boxes 3 through 6. Instead, they will be reported by the minister as self-employment income. However, services performed by a minster as an employee of the United States, the District of Columbia, a foreign government or any of their political subdivisions are not treated as ministerial services and will be subject to Social Security and Medicare withholding, reported in Boxes 3 through 6 of the W-2 and not subject to self-employment tax [Reg. 1.1402(c)-5(c)(3)]. Thus, the services Nicholas performed as an armed forces chaplain will be treated similarly to services performed as a civil servant and not as a minister in the exercise of a ministry. The W-2 from the armed forces will report the wages in Box 1, and Nicholas is subject to Social Security and Medicare withholding, reported in Boxes 3 through 6.

March 2, 2023

Question: Ben and Mary are divorced. Their divorce agreement was executed in August 2018. Under the terms of their divorce agreement, Ben continued to make alimony payments through 2020. Can Ben deduct the 2020 alimony payments?

Answer: Yes. Ben can deduct the 2020 alimony payments. They are taxable income to Mary because the divorce agreement was executed before Jan. 1, 2019. The alimony payments are made under the divorce agreement and are not voluntary payments.

For divorce or separation agreements executed after Dec. 31, 2018, alimony is not deductible by the payor spouse nor included in the income of the recipient spouse. Additionally, alimony payments are not deductible nor included in income if the couple executed a divorce decree or similar agreement prior to 2019 and modified it after Dec. 31, 2018, to expressly provide that alimony received is not taxable income to the recipient spouse.


Alimony payments under a divorce decree or similar instrument executed before Jan. 1, 2019, are treated by the Internal Revenue Code as a shift of income from the payer to the payee. The payor can deduct the alimony while the payee must recognize the payments as income.

Feb. 23, 2023

Question: Bill, a practitioner from Georgia, asks if his clients must include special, one-time refunds received from the state in 2022 as reportable income on their 2022 federal returns. He found the guidance provided by the IRS on Feb. 10 to be confusing.

Answer: It depends on a number of factors specific to the taxpayer. For Georgia taxpayers, special refunds are considered a refund of, and based on, the taxpayer's tax liability in the state. With that in mind, to determine whether the payment should be included in income, you need to find out if the taxpayer received an economic benefit from state taxes when they filed their 2021 federal return. Taxpayers who claimed the standard deduction did not, so these taxpayers can be excluded from our discussion.

For those Georgia taxpayers who itemized their deductions, the answer is a bit more clouded. The confusion arises from the federal state and local tax (SALT) limitation of $10,000. For instance, if a taxpayer had $7,500 in state withholding reported on their federal Schedule A (Form 1040), Itemized Deductions, and $3,500 of property taxes, the SALT limitation would allow the entire $7,500 in state withholdings, but only $2,500 of the property taxes under the $10,000 SALT limitation.

For the purposes of our example, assume the taxpayer's other deductions, such as mortgage interest and charities, when coupled with the SALT limitation of $10,000, provided them with a 2021 hypothetical itemized deduction of $27,000. The standard deduction for 2021 was $25,100. Therefore, the taxpayer's benefit from itemizing was $1,900. The Georgia special 2022 refund for a married couple was $500; therefore, the $500 is reportable on the 2022 federal return because of the economic benefit derived from itemizing in 2021.

Let's look at a second example. Use the same circumstances as above, but after calculating all allowable deductions, the taxpayer's 2021 itemized deductions were $25,250. There is a $150 benefit for itemizing ($25,250 - $25,100 standard deduction), so only $150 of the $500 Georgia special refund is includable on the taxpayer's 2022 federal tax return.

A third illustration: The taxpayer's state taxes were $15,000. The SALT limitation only permitted a deduction of $10,000. The taxpayer was still able to itemize to the tune of $27,000. While this provided an economic benefit of $1,900, could an argument be made that only 67% of the state taxes paid provided an economic benefit ($10,000 SALT limitation divided by $15,000 actually paid)? That would mean only 67% of the $500 special refund is includable in income, which would be $335. That seems like a reasonable conclusion.

For taxpayers in Georgia, Massachusetts, South Carolina and Virginia, the special refunds are refunds of state tax liability and need to be reconciled for economic benefit, the same as usual. Again, this only impacts taxpayers who itemize deductions. As the Tax Policy Center recently stated, less than 10% of taxpayers are eligible to itemize since the enactment of the Tax Cuts and Jobs Act, so these payments will impact a small number of your clients. Be aware, however, and refer to the IRS guidance since 21 states provided some form of economic relief in 2022 and they are not all the same.

Feb. 16, 2023

Question: Jason's surfing business in Sarasota, Fla., was destroyed on Sept. 29, 2022, during Hurricane Ian, a federally declared disaster. As Jason prepared his 2022 return and calculated his casualty loss, he noticed 2022 gross receipts were much less than in 2021. Can he amend that previously filed 2021 income tax return so that he can claim the 2022 casualty loss in a year where he had more income?

Answer: Yes. Jason may claim his disaster loss in the preceding year according to IRS guidance in Publication 547, Casualties, Disasters and Thefts. He will fill out Section D, Part 1 on the 2021 Form 4684, Casualties and Thefts, and include it with his 2021 Form 1040-X, Amended US Individual Income Tax Return. By filling out Form 4684, he “elects” to take the casualty loss for the disaster in the preceding year. He must file the amended 2021 return no later than six months after the regular date for filing his original 2022 return, without extensions (April 18, 2023).

Feb. 9, 2023

Question: John is working on preparing a Form 990, Return of Organization Exempt From Income Tax, for a local 501(c)(3) nonprofit organization. While working through the return, John notices the organization has some rental income from real estate. After interviewing the president of the organization, he discovers the rent is from a house that was donated to the organization. They charge a flat monthly rental fee for the use of the property and the property is not debt-financed. None of the rent collected was for the lease of personal property. Must John include the rental income in the unrelated business income calculation for this nonprofit?

Answer: No. Rents from real property are excluded in the unrelated business taxable income (UBTI) calculation as long as:

  • The property for which the rents are collected is not debt-financed.
  • Not more than 50% of the total rent received or accrued was attributable to personal property.
  • The determination of the amount of the rent does not depend in whole or in part on the income or profits derived by any person who leased the property.

Feb. 2, 2023

Question: Jada owns a sole proprietorship. In 2023 she purchases a vehicle eligible for the vehicle clean energy credit. She intends to use the vehicle partly for business purposes and partly for personal purposes. Is Jada eligible for the vehicle clean energy credit since the vehicle is used both personally and for business purposes?

Answer: Jada is eligible for the full credit amount. However, since the vehicle will be used for both personal and business purposes, an allocation must be made. The percentage of business use is determined by dividing the number of miles the vehicle is driven during the year for business purposes or for the production of income (not including any commuting mileage) by the total number of miles the vehicle is driven for all purposes. The business portion is included as a credit under §38(b) while the personal portion is claimed as a credit under §30D(c)(1).

Jan. 26, 2023

Question: Larry is a long-time tax professional who, after hearing all the advertising hype regarding employee retention credit (ERC) refunds, has determined that one of his clients qualified for the ERC in both 2020 and 2021. The client is an S corporation, which kept its employees on the payroll during the qualifying time frame and met the other requirements for claiming the credit. Therefore, Larry plans to claim the ERC for his client. His question is: When is the ERC claimed? Is it when the money is received or is it claimed on the amended returns for the tax periods in which the ERC credit applies?

Answer: Larry will claim the ERC on amended tax returns for the tax periods in which the ERC applies and the client qualifies. ERC claims are made via filing Form 941-X, Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund. The entity's tax returns for the period being claimed must be amended to reflect the ERC as a reduction in payroll expense [Notice 2021-20; Notice 2021-49].

Claiming the ERC for 2020 and/or 2021 requires the filing of amended Forms 1120-S U.S. Income Tax Return for an S Corporation, which will decrease the payroll expense by the amount of the calculated ERC. The amended Forms 1120-S will then report an increase in the net profit (or a reduction in an originally reported net loss), causing amendments to the Schedules K-1, Shareholder's Share of Income, Deductions, Credits, provided to each of the shareholders for the years the ERC is claimed.

Issuing amended Schedules K-1 will also require each of the shareholders to amend their personal Forms 1040, U.S. Individual Income Tax Return, for both 2020 and 2021. Filing these amended Forms 1040 will likely result in additional tax due since the originally reported net profit will be increased or an originally reported loss will have been reduced. It's likely the IRS will assess interest to these same shareholders for the increased tax owed. While we recommend filing an appeal of these assessments, it's unclear whether the IRS will consider these explanations as reasonable cause.

Jan. 19, 2023

Question: Eli, age 67, had a small amount of W-2 wages in 2021, investment income below the threshold amount for claiming the earned income credit (EIC) and adjusted gross income (AGI) of $16,250. Therefore, he was eligible for the EIC in 2021. In 2022 he still had a part-time job at the local hardware store where he earned $11,250 and had investment income of $1,500, which resulted in an AGI of $12,750. Is Eli eligible to claim the EIC in 2022?

Answer: No. While Eli's AGI was below the maximum amount of $16,480 for claiming the childless EIC in 2022 [Rev. Proc. 2021-45], he is above the age limit. The American Rescue Plan Act of 2021 removed the upper age limit for taxpayers claiming the EIC in 2021. Those age limits (taxpayers between the ages of 25-64) are back in place for 2022, making him ineligible.

Jan. 12, 2023

Question: Joan is a single taxpayer and died on June 17, 2022. Prior to her death, she established an HSA account and did not name a beneficiary for the account. As a result, Joan's estate became the beneficiary. On the date of her death, Joan's health savings account (HSA) had an account balance of $6,000. She did not have any outstanding qualifying medical bills. Does the account balance become taxable income in the year of death? If it is taxable, is the income reported on Joan's Form 1040, U.S. Individual Income Tax Return, or on her estate's Form 1041, U.S. Income Tax Return for Estates and Trusts?

Answer: Yes, Joan's HSA balance will be treated as taxable income. Except in the case of a surviving spouse being named the beneficiary of an HSA account, the account balance on the date of death will be treated as taxable income to the account's designated beneficiary. When there is no named beneficiary, or the account holder's estate is the beneficiary, the account balance is treated as income in respect of a decedent (IRD) and is taxable to the account holder on their final Form 1040. Thus, Joan's final Form 1040 will report the $6,000 account balance as of the date of her death as income and will be liable for any tax due on the amount [IRC Sec. 223(f)(8)(B)(i)(II)].

Jan. 5, 2023

Question: Charles was flagged for identity theft by the IRS in 2021. The IRS sent him Letter 5071C to verify his identity. During the validation process, the IRS asked Charles for the adjusted gross income (AGI) from his 2021 return and up to two prior years. Charles has yet to file tax returns for 2019 and 2020. Is there an alternative way to satisfy the IRS's request for prior year returns while he is working on getting the delinquent returns filed?

Answer: Yes. Charles has two options: 

1. Under a special instruction, when a prior year's return has not yet been processed, the taxpayer may enter $0 (zero dollars) for the prior year's AGI. 

2. If Charles's identity cannot be verified online or over the phone, he can schedule an appointment and bring the documents listed below to his local IRS office for in-person verification: 

  • The 5071C or 6331C letter 
  • The tax return referenced in the letter (the Form 1040 series return) 
  •  A prior year's income tax return, other than the year in the letter 
  •  Supporting documents that he filed with each year's tax return (Form W-2, Form 1099, Schedule C or F, etc.) 

Dec. 29, 2022

Question: Nada operates an S corporation. She has one child, Alex, who is under the age of 18. She heard that if you hire your children to work for the business, you can write off the wages paid to them. Those wages are also not subject to Social Security taxes or Medicare taxes. Does this same exemption from FICA taxes apply for S corporation shareholders who employ their children?

Answer: No. Wages paid to the children of C corporation or S corporation shareholders are subject to FICA taxes. Wages paid to children under the age of 18 by either sole proprietorships owned by the child's parent or partnerships/LLCs whose only owners are the parents of the child are not subject to Social Security and Medicare tax.

Regardless of which type of entity the taxpayer operates, wages paid to the children of one or more of the owners are deductible, as long as the pay is reasonable for the work performed.

Dec. 22, 2022

Question: Rob's CPA firm relies on organizers and quick phone conversations to verify missing or uncertain information. Preparers jot down notes, which may or may not land in the client's tax folder. Source documents are not scanned or copied. Is Rob performing due diligence regarding his clients' tax information?

Answer: No. Organizers alone are not adequate due diligence. The Office of Professional Responsibility has taken the position that preparers can't blindly rely on tax organizers when it is logical and obvious to ask certain questions. Due diligence requires healthy skepticism in questioning client facts and circumstances. It also requires proper documentation of those questions by scanning and filing the answers, along with the client's source documents.

Dec. 15, 2022

Question: James received a Form 1099-C, Cancellation of Debt, reporting a foreclosure on his rental property. The date in Box 1 is Feb. 3, 2022. Box 2 shows the amount discharged is $41,000. Box 5 is checked “yes,” indicating he was personally liable for repayment of the debt. Box 6 has Code G (decision or policy to discontinue collection) and the fair market value (FMV) in Box 7 is $19,000. James's basis in the rental property is $25,000. How does he report the information from Form 1099-C on his tax return?

Answer: James will report two transactions: A sale and canceled debt income. Foreclosures are reported as a sale of the property. Since James is personally liable for repayment of the debt (recourse debt), the sales price is the FMV (Box 7).

James will report the sale on Form 4797, Sale of Business Property. The net profit or loss from the transfer of the rental property is determined by subtracting the cost basis or purchase price less depreciation from the sales price.

Next, you must determine if James has taxable or excludable canceled debt by verifying whether he is insolvent or solvent. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, includes an insolvency worksheet that can be used to determine whether a taxpayer is insolvent. James can exclude the canceled debt from gross income to the extent he's insolvent. The amount of excludable canceled debt is reported on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and reduces the taxpayer's tax attributes. The tax attribution reductions will apply Jan. 1 of the year following the year of debt cancellation. However, if James is solvent, the canceled debt is reported on Schedule E as rental income in the year it's canceled. This treatment applies because the income is reported on the form the cancellation pertains to.

Dec. 8, 2022

Question: John is a retired minister and has been receiving a pension from the church from which he retired. The pension specifically designates a housing allowance which is equal to the historical amount of his actual housing expenses when he was an active minister. His actual expenses for maintaining the home are lower than the fair rental value of the home and qualify to be excluded from his income as a retired minister. In December of last year, John died. His widow, Mary, is continuing to receive John's housing allowance. Mary has asked how the housing allowance will be treated for tax purposes now that John has passed away. Mary has never worked as a minister. Can Mary keep excluding the housing allowance from income?

Answer: No. Mary can't exclude the housing allowance from her income. While the housing allowance is excludable from income for ministers under §107 and not subject to self-employment tax if paid to a retired minister, the housing allowance becomes taxable income to a surviving spouse. Only surviving spouses who receive their own housing allowance for services performed as a minister may continue to exclude the housing allowance payments.

Dec. 1, 2022

Question: Mary and Lina, both tax preparers and CPAs, disagree on whether a tax pro must have a signed engagement letter from their client. Is the letter mandatory?

Answer: A signed engagement letter is not mandatory, but it is highly recommended because it clarifies three important aspects of the client relationship:

  1. The job. An engagement letter clearly communicates the job details to the client. It describes the professional work to be performed, and a description of work that is not included. For instance, for multi-state situations, mentioning the need for a client’s approval before preparing a state’s return puts the risk of non-compliance on the client in the event of an audit.
  2. Fees. The letter explains fees, with a formula or method of computing the fee that is easily understandable to avoid unpleasant surprises. Estimating charges up front with an agreement to discuss or negotiate changes helps clients feel they are being treated fairly.
  3. Liability. As an enforceable contract, the letter provides your insurance carrier with some limits on claims for procedural errors or missed elections. If the letter specifies that the S corporation election is to be handled by the client, and it’s never filed, having that information in the letter clarifies potential liability.

A good letter should contain six elements: The identity of the client (is it an entity or individual?), the period covered, expected client responsibilities, reliance on client records and assurances, the scope of services and the fee arrangements.

A signature signifies acceptance by the client, so be sure to have them signed.

Nov. 23, 2022

Question: Your client, Mark, is the sole owner of an S corporation. He lives in a non-community property state with his wife and daughter. Mark would like to gift some of the stock in his S corporation to his daughter this year. He would like to give the maximum amount possible without triggering a reportable gift transaction. When he gifts the stock to his daughter, can he and his wife elect to split the gift between them to double the annual gift tax exclusion amount?

Answer: Yes. To qualify for gift-splitting, three requirements must be met [§2513(a)]:

  1. The spouses must be legally married to each other at the time the gift is made. Gifts made prior to divorce or death of a spouse are eligible as long as the surviving spouse (or either spouse, in the case of a divorce) does not remarry during the tax year.
  2. Both spouses must be U.S. citizens or residents on the date of the gift.
  3. One spouse may not create a general power of appointment in the other spouse over the property transferred.

Because Mark and his wife meet all three requirements, they may elect gift-splitting in this case, even though Mark is the sole owner of the S corporation stock.

Nov. 17, 2022

Question: Charlie is the sole beneficiary of a supplemental needs trust (SNT) funded by his grandmother. The trustee, a professional trust company, directly paid a ticket vendor for Charlie's seat at the next big game between Charlie's favorite football team and their No. 1 rival. Before paying the expense on Charlie's behalf, the trustee determined that doing so would not conflict with the terms of the SNT or Charlie's ability to continue receiving specific government benefits.

The trustee hired you to prepare Form 1041, U.S. Income Tax Return for Estates and Trusts, for the SNT. Is the direct payment to the ticket vendor treated as a distribution, even though it was not paid to Charlie?

Answer: Yes. Expenses paid for Charlie by the SNT are treated as distributions to Charlie. A payment made for a beneficiary's personal benefit is an “other amount properly paid or credited or required to be distributed” or a “Tier 2 distribution” under §661(a)(2). These distributions are reported on Schedule B (Form 1041), Line 10. The distribution can be included in Charlie's gross income to the extent any taxable distributable net income remains after required income (Tier 1) distributions, if any [Reg. §1.662(a)-3(c)].

Nov. 10, 2022

Question: Your client decided to do a like-kind exchange. However, she did not use a qualified intermediary. Instead, she took the money from the sale and waited to purchase a replacement property later. Can she report this as a like-kind exchange?

Answer: Unfortunately, the answer is no. That is because she received the proceeds from the sale of the relinquished property (referred to as “constructive receipt”). [§1031(b)]

She may still qualify to defer recognizing the gain by reinvesting in a Qualified Opportunity Fund (QOF) within 180 days of the first sale. For more information, see the IRS's webpage on investing in Qualified Opportunity Funds.

Nov. 3, 2022

Question: Sal and Debbie filed married filing separately (MFS) on their 2019 and 2020 Forms 1040, U.S. Individual Tax Returns. Neither is a nonresident alien. In 2021, they filed a Form 1040 together as married filing jointly (MFJ). They would now like to go back and file jointly for 2019 and 2020. Can they amend the 2019 and 2020 returns to change their filing status to married filing jointly?

Answer: Yes. Generally, when separate returns are filed, spouses can file an amended return to change filing status if it is done within three years of the original due date (excluding extensions) of the separate returns [Reg. 1.6013-2(b)].

One exception applies when a taxpayer petitions the Tax Court for a redetermination after receiving a notice for deficiency for the tax year in question. In this case, the amended return to change the filing status from MFS to MFJ must be filed prior to filing the petition.

Another exception applies when spouses are legally separated at year-end under a valid decree and are considered unmarried; they then must file single or head of household rather than MFS. Also, if a spouse refuses to sign a return, MFJ is not an option for the other spouse.

Changing from MFJ to MFS has more restrictions. If a joint return is originally filed, separate returns replacing it must generally be filed by their due dates (rather than the extended time period of three years) [Reg. 1.6013-1(a)(1), CCA 201411017]. Spouses who file jointly with an intent of amicably splitting the refunds or credits may end up with one spouse jumping ship to MFS to claim the kids and the credits, and the refund for themselves.

Married taxpayers may choose to file either MFJ or MFS, regardless of whether their tax estimates were prepared based on the assumption they'd be filing jointly or separately [Reg. 1.6654-2(e)(5)(ii)].

Oct. 27, 2022

Question: Your client engaged in a qualified §1031 exchange. He was told that to defer taxation on the entire gain from the sale, all he needed to do was reinvest the realized gain into the replacement property. Is this correct?

Answer: Unfortunately, the client was given incorrect information. A quick, accurate explanation is that the taxpayer would need to buy replacement property equal to the sales price of the relinquished property minus any exchange expenses. The taxpayer would be taxed on the lesser of the gain realized or boot received.

Here is a simple example. If your client's relinquished property sold for $200,000, he would need to acquire replacement property for at least $200,000 minus exchange expenses for the exchange to potentially be completely tax-deferred. For instance, if exchange expenses are $10,000 (selling expenses of relinquished property plus qualified intermediary fee), then as long as the purchase price of his replacement property is $190,000, he won't pay any tax unless he increased his debt during the exchange in order to pay nonexchange expenses or obtain cash at the end of the exchange.

If he followed the incorrect advice and only reinvested realized gain, let's say $100,000 ($200,000 sale price of relinquished property minus $90,000 adjusted basis minus $10,000 exchange expenses), he would have taxable boot of $100,000.

Even this simple example can present complications that can impact the tax treatment of the transaction. For more information, join us Nov. 8 or 9, 2022, for our live webinar, Completing Form 8824, Like-Kind Exchanges. It will be available as an on-demand webinar at a later date.

Oct. 20, 2022

Question: Janet's husband, Greg, serves in the military and has received active-duty orders to be stationed in Guam. Janet relocated to Guam only because Greg was ordered there. Both Janet and Greg are U.S. citizens and share the same U.S. tax residence. While living in Guam, Janet secured a job with a Guam employer. Will she be required to file a Guam tax return for her wages at this job?

Answer: No. Because Janet only moved to Guam due to Greg's military orders and they have the same tax residence, the tax treatment of her wages is governed by the Military Spouses Residency Relief Act of 2009 (MSRRA). According to the MSRRA, her wages will only be taxed in the country where her tax home is located, regardless of where the services were performed. In Janet's case, since her tax home is in the United States, her wages will only be taxable there and she will not file a Guam tax return for those wages.

To qualify for this treatment under MSRRA, the civilian spouse of an active duty servicemember must meet one of the following requirements [Notice 2010-30]:

  • Is accompanying their servicemember spouse to a military duty station in American Samoa, Guam, the Northern Mariana Islands (NMI), Puerto Rico, or the U.S. Virgin Islands and claim a tax residence in one of the 50 states or the District of Columbia under MSRRA
  • Is accompanying their servicemember spouse to a military duty station in one of the 50 states or the District of Columbia and claim tax residence in a U.S. territory under MSRRA

Oct. 13, 2022

Question: Sherri, age 64, is near retirement age but wants to continue working. Her employer sponsors an HDHP (high deductible health plan) with an HSA (health savings account). Although eligible for Social Security and Medicare at age 65, she heard that HSA contributions might be prohibited or limited if she enrolls in Medicare or retires. If Sherri stays working after turning 65, can she still participate in the employer-sponsored health care plan and HSA?

Answer: Yes, if she is otherwise eligible, she may still contribute to her HSA. Rules under §223(c)(1) prohibit individuals from contributing to an HSA starting the month they are entitled to benefits under Medicare. Yet, mere eligibility for Medicare does not disqualify Sherri from contributing. Enrolling in Medicare, however, would disqualify her.

Oct. 6, 2022

Question: Boyd received a legal settlement from a former employer for employment discrimination involving a wrongful termination lawsuit. The settlement documents emotional distress but not physical injury or sickness. Is the settlement considered taxable income to Boyd?

Answer: Yes, this legal settlement is taxable income to Boyd. It is not eligible for income exclusion under §104(a)(2) because the settlement was not paid to Boyd on account of personal physical injuries or sickness.

When entitled, §104(a)(2) provides that gross income does not include the amount of any damages (other than punitive damages) received on account of personal physical injuries or physical sickness, whether by suit or agreement, regardless of whether the amounts were received as a lump sum or as periodic payments. The U.S. Tax Court’s Aug. 30, 2022, decision on Dern v. Comm’r (T.C. Memo. 2022-90) emphasizes that emotional distress shall not be treated as a physical injury or physical sickness.

With personal injury awards or settlements, the burden is on the taxpayer to prove the settlement was paid to compensate for physical injuries or physical sickness. While a settlement agreement may provide a payment to compensate for personal injuries, it must also specify that the payment is for physical injury or sickness.

Sept. 29, 2022

Question: Your client’s spouse, a U.S. citizen, passed away in February 2022. The deceased spouse’s gross estate is estimated to be valued around $4 or $5 million, which is under the current exclusion amount ($12.06 million for decedents passing in 2022). You are aware that the basic exclusion amount is set to return to $5 million (adjusted for inflation) for tax years beginning on or after Jan. 1, 2026. Therefore, you want to recommend that the surviving spouse file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, to transfer the deceased spouse's unused exclusion (DSUE) amount to the surviving spouse (i.e., to make a portability election). Form 706 is a long, complicated form, with six distinct parts in the body, and more than a dozen accompanying Schedules that may be required. If the surviving spouse is only filing Form 706 to elect portability, must the entire form (plus schedules) be completed?

Answer: Generally, yes. However, regulations provide some relief for estates that are electing to transfer DSUE and are not otherwise required to file Form 706 because they are below the filing threshold.

Under Reg. §20.2010-2(a)(7), executors of estates not otherwise required to file Form 706 will not need to report the value of property qualifying for the marital or charitable deduction. Such executors can instead estimate the total value of the property eligible for the marital or charitable deduction. This estimate must be based on good faith, and due diligence must be exercised in determining the value of all assets includable in the gross estate.

Property qualifying for this simplified reporting is listed and described on the appropriate schedule of Form 706. However, a specific dollar value is not reported either on the schedule or on Lines 1 through 9 of the recapitulation in Form 706, Part 5. The total estimated value of these assets is reported on Form 706, Part 5, Lines 10 and 23, based on a range of dollar values provided in the Form 706 instructions.

Sept. 22, 2022

Question: Your client moved overseas and is asking you to prepare his tax return. The client is a U.S. citizen now living in France. Should you file a Form 1040, U.S. Individual Income Tax Return, or Form 1040-NR, U.S. Nonresident Alien Income Tax Return?

Answer: You will file Form 1040, U.S. Individual Income Tax Return. Form 1040-NR is for individuals who are nonresident aliens. Form 1040 is for U.S. citizens or resident aliens regardless of whether they reside inside or outside the U.S.

Sept. 15, 2022

Question: Dr. Erickson's medical practice has an EIN with her business manager listed as the responsible party. Medicare payments are linked to that EIN and the practice runs smoothly using the EIN. When the business manager parted ways with the practice, Dr. Erickson thought she could just change the responsible party linked to the EIN from the business manager's name to hers. Can Dr. Erickson change the responsible party for the EIN?

Answer: Yes. The IRS allows employers to change the responsible party by filing Form 8822-B, Change of Address or Responsible Party – Business, mailed to the address in the instructions (do not attach to a tax return). A responsible party controls, manages or directs the funds and assets of the business. This form will properly notify the IRS that the responsible party for the business's EIN is now Dr. Erickson. She will list both the old and new information on the form to reflect the change. Form 8822-B should be filed within 60 days of when the transfer occurs. If Dr. Erickson had purchased or inherited the business a sole proprietorship, however, she would have had to get an entirely new EIN.

Sept. 8, 2022

Question: Asha and Malik have been married several years with three school-age children. Due to COVID-19 complications, Asha died in mid-June 2021. Malik does not wish to file married filing joint (MFJ) as the surviving spouse for Asha's 2021 final tax return. If Asha's 2021 final tax return uses the filing status of married filing separate (MFS), can the 2021 final return claim their children as qualifying dependents based on the period when Asha was alive?

Answer: No. Asha's final Form 1040, U.S. Individual Income Tax Return, may not claim the children as qualifying dependents because they do not meet all of the dependency tests. 

In general, the requirements of filing a return where the taxpayer has not been in existence for the entire taxable year are the same as filing a return for a taxable year of 12 months ending on the last day of the short period [Reg §1.443-1(a)(2)]. 

To claim children on the decedent's MFS return, the children need to meet the requirements of the support and residency tests for more than half the calendar year, not the partial year Asha was alive during the tax year (§152). The full calendar year is the test period, not the partial year that the decedent was alive. Even if the decedent had income after death used to support the children for the balance of the calendar year, that income could not be used to meet the test because the estate and decedent are considered different taxpayers by IRS so it would be the estate furnishing support, not the decedent.

Sept. 1, 2022

Question: Mark is serving in the military on active duty in a combat zone. He has received $50,000 of qualified nontaxable combat pay and plans to contribute to an individual retirement account (IRA). Although the combat pay is nontaxable, must he include it as compensation when determining the compensation-based limitations of his contribution to the IRA?

Answer: Yes. Although qualified combat pay is excluded from income under §112, for purposes of determining the compensation-based limit on contributions to an IRA under §219(b)(1)(B), the nontaxable combat pay is included in compensation. Therefore, a military taxpayer's IRA contribution is the lesser of the dollar limit for an IRA deduction for the tax year, or the amount of combat pay excluded from income under §112 plus taxable compensation for the tax year.

Aug. 25, 2022

Question: Denzel and Devan are looking forward to the upcoming football season. Due to the proximity of their residence to the stadium, they make extra money by renting out a spare room in their home for the eight regular home games and two pre-season games for $200 per night. How do they report this $2,000 in rental income for the year on their tax return?

Answer: Under IRC §61, gross income means all income from whatever source derived, unless there is an exception. Since they are renting out their property for less than 15 days during the year, the short-term rental income is exempt from income tax under §280A(g)(1), commonly referred to as the “Augusta rule” after the Masters golf tournament in Augusta, GA. Therefore, this income does not need to be reported on Schedule 1, nor Schedule E, of their Form 1040, U.S. Individual Income Tax Return.

Aug. 18, 2022

Question: Emily's annual employer benefits renewal period has arrived, and the health care options include a health savings account (HSA) or a flexible spending account (FSA) for health care. To help in determining her better option, Emily, age 49, asks you if both the HSA and FSA cover the same types of qualified medical expenses when all other requirements are met. What do you tell Emily?

Answer: No, qualified expenses are different for each account. While qualified medical expenses [§213(d)] are generally the same for both an HSA and FSA, qualified long-term care expenses (Notice 2004-50) can only be reimbursed from an HSA.

Eligibility of children's health expenses differs depending on age and status as a qualified dependent. A child must be a qualifying child dependent of Emily to have an HSA-qualified expense. Emily may also use HSA funds for tax-free qualified expenses of a spouse or other individuals who meet the qualifying relative dependency rules.

With an FSA, adult children who have not turned age 27 as of the end of the tax year don't need to qualify as a dependent for their qualified expenses to be covered [Prop. Reg. §1.125-5(k)(1)]. Like the HSA, Emily may also use FSA funds for tax-free qualified expenses of a spouse or other individuals who meet the qualifying relative dependency rules.

FSA-qualified expenses expire if not timely submitted for reimbursement because FSAs are an annual “use or lose it” option unless the employer's plan document allows a carryover grace period. Unused HSA funds carry over to the next year and the owner can take a non-medical expense distribution subject to the 20% penalty tax [§§ 223(f)(4), 220(f)(4)(A)] when distributed prior to reaching their Medicare eligibility age. As long as qualified medical expenses were incurred after the HSA was established, a current year distribution to pay or reimburse the expenses is allowed (Notice 2004-50).

Aug. 11, 2022

Question: Heather and Charlie, a married couple who are both U.S. citizens residing in a non-community property state, want to gift their daughter $100,000 in 2022 toward the purchase of a condo on Maui. Can they file a joint gift tax return so they can claim their combined total $32,000 annual exclusion?

Answer: No. Heather and Charlie must each file a separate Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, to claim their own $16,000 exclusion ($32,000 combined total). If the gift was made by either Heather or Charlie alone, under §2513, they may still elect to treat a gift made by one spouse as two equal gifts totaling the amount of the single gift with half being given by each spouse. This gift-splitting makes the annual exclusion available to each spouse to offset the total gift. Each spouse consents to the gift-splitting by checking the box on Form 709, Line 12, providing details on Lines 13 through 17 and having the consenting spouse sign the consent on Line 18 of the other spouse's return. Instructions for Form 709 state that the couple should file both gift tax returns together in the same envelope to avoid IRS correspondence.

Each spouse reports the entire value of each gift made during the year on Form 709, Schedule A (Part 1, 2 or 3), separately listing gifts made by each spouse. Half the gift to be split is entered on Part 1, 2 or 3, Column G, to represent the consenting spouse's share of the total gifts made by both spouses. The donor's share of the total gifts, the sum of the values in Column H, is entered on Part 4 (Taxable Gift Reconciliation), Line 1.

Aug. 4, 2022

Question: Is there any penalty relief for the failure to timely pay penalty when an employer files for a refund for the employee retention credit (ERC) and, as a result, must amend either the 2020 or 2021 tax return to reduce the wage deduction by the amount of the ERC for the year?

Answer: Yes. The IRS has specifically mentioned penalty relief in Notice 2021-49 which says, “To the extent that an employer files an adjusted or amended return to reflect these clarifications and consequently owes additional tax, any penalties for failure to timely pay or deposit tax will not apply if the taxpayer can show reasonable cause and not willful neglect for those failures.” See page 20 at the end of the opening paragraph for Section IV.

Furthermore, the IRS has issued IR-2022-89 on April 18, 2022, reminding taxpayers of penalty relief related to claims for the ERC. It refers to the penalty relief mentioned in Notice 2021-49 and reminds taxpayers that they may also qualify for administrative relief from penalties for failing to pay on time under the IRS's First Time Penalty Abatement program.

July 28, 2022

Question: The Bonsai Club of Westerly, a §501(c)(3) organization, neglected to file its Form 990-N, Electronic Notice (e-Postcard), for three years. Consequently, the IRS revoked its tax-exempt status. Tom, the club's treasurer, wants to get the status reinstated. What should he do?

Answer: The Bonsai Club must apply for reinstatement of its tax-exempt status using Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. This is the same form used initially to request non-profit status. A streamlined version of Form 1023, also exists, Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. Use the Form 1023-EZ Eligibility Worksheet to determine eligibility. If the application is approved, the entity's date of reinstatement will generally be the filing date of the application.

July 21, 2022

Question: Your client's commercial rental property caught on fire and the client received a $950,000 insurance check to repair the damage. Since the market for commercial office buildings has decreased with the transition to remote employees, the client decided to not use the insurance proceeds to restore the building, pocketed the money and sold the building as is for $200,000. The fire, the insurance payment and the sale all occurred in the same tax year. The client assumes that the $950,000 insurance proceeds are a nontaxable windfall without reporting a casualty loss and that they only need to report the $200,000 received for the sale. Does the client have to include the $950,000 of insurance proceeds on their tax return as well as the sale of the property?

Answer: Yes, the client reports the fire casualty insurance proceeds received and reports the sale. When a taxpayer receives insurance proceeds without restoring the property or replacing it with similar property, a gain is recognized [Reg. §1.1231-1(e)].

Since the client sold the fire-destroyed rental as is and pocketed the insurance proceeds received for the fire damage without restoring the building, the transaction is reported as two separate transactions: a business casualty loss and the sale of business property.

For the business fire casualty loss, complete Form 4684, Casualties and Thefts, using the adjusted cost basis to determine gain/loss from the insurance proceeds. The results flow directly onto Form 4797, Sales of Business Property, and from there to Schedule D, Capital Gains and Losses.

To report the sale on Form 4797, use the adjusted cost basis again to determine the gain from the $200,000 received from the buyer.

July 14, 2022

Question: Robert owns a small Schedule C consulting business with no employees. He owns a 2018 Honda Civic that he uses solely for that business and does not own or lease any other vehicles for that business. He placed the vehicle in service on June 1, 2019. Since placing the vehicle in service, he has used the standard mileage method for deducting his vehicle expenses on his Schedule C. With the rising costs of fuel and repairs, Robert feels it would be more beneficial to use the actual method of deducting his vehicle expenses. Can he change from the standard mileage method to the actual method of deducting vehicle expenses on his Schedule C?

Answer: Yes. Robert can change from the standard mileage to the actual method of deducting his expenses. He will need to determine the number of miles driven each year and multiply the number of miles for the year by that year's depreciation component of the standard mileage rate (Rev. Proc. 2019-46). He will then reduce the basis of the vehicle (but not below $0) by the depreciation component of each year. If there is remaining undepreciated basis, Robert will depreciate the remaining basis of the vehicle using the straight-line method over the remaining life of the vehicle. He can't depreciate the vehicle if his basis has been reduced to $0 through the depreciation component of the standard mileage deduction since the vehicle will be deemed to have been fully depreciated during its use under the standard mileage method.

July 7, 2022

Question: Friends Houa (11) and Sua (11) voluntarily enrolled in Girl Scout summer camp for one week in July. Both girls' parents normally work during the day. However, due to her parents' vacation, Sua will stay overnight at Houa's house during the week. Can either set of parents claim the camp expenses on Form 2441, Child and Dependent Care Expenses?

Answer: While Houa's parents can claim the camp expenses, Sua's parents cannot. Under §21, the child and dependent care credit is available to taxpayers who incur and pay child and dependent care expenses to allow the taxpayer (and spouse, if married) to work, given that the primary purpose of the expenses is for the child's well-being and protection [Reg. 1.21-1(d)(1)]. Houa's parents meet the qualifications. Sua's parents do not qualify to take the credit since they are on vacation. The “vacation exception” under Reg. 1.21-1(c)(2)(ii) does not apply since the caregiving arrangement of a voluntary summer camp does not require the taxpayer to pay for care during their absence.

June 30, 2022

Question: Mary separated from her husband Joe in 2018. They have not divorced. Mary moved to another state with their minor child. For several years, Joe filed joint federal tax returns (MFJ) without including Mary's income or having her consent. Mary has come to you for advice and wants to know what her options are in this situation. She also wishes to file her own returns. What can Mary do?

Answer: First, determine Mary's status. Is she an injured spouse, innocent spouse or other? Injured spouse occurs when a joint refund is used to satisfy a debt owed solely by the other spouse. Innocent spouse is a request for absolution on a tax return that was filed by both parties where one spouse understates the tax and the other spouse claims they had reason to not know about it. Mary is neither. However, Mary is a victim of fraud that Joe committed when he essentially signed Mary's name on a joint tax return. So, what is the remedy that will allow for Mary to file her own return? Should Mary:

  • Complete a paper return?
  • File Form 14039, Identity Theft Affidavit?
  • File a police report?
  • File a report with the Federal Trade Commission?
  • Request an actual copy of the fraudulent return on Form 4506, Request for Copy of Tax Return, with $43 enclosed?
  • Check credit reports and other financial statements?
  • Put a credit freeze on accounts?
  • Get an IP Pin from the IRS by using the online tool or Form 15227 (the IP PIN application)?

Although Mary's situation could get more complex if Joe failed to pay the liability on the fraudulent return, for now, the best answer for her is to obtain an IP PIN so she can file her own original return. She can use the married filing separately (MFS) status. However, given the fact that she moved to another state with the minor child, she can probably file as Head of Household (review the section “considered unmarried”).

Note: The fact that her estranged husband used her information to file the fraudulent MFJ return may force her to file her proper return in paper form since the IRS will likely conclude a return has already been filed using her name and Social Security number and may reject an electronically filed return.

June 23, 2022

Question: Your client self-prepared their 2019 and 2020 tax returns. Both 2019 and 2020 had a non-farming net operating loss (NOL). The client did not make an election to forgo the NOL carrybacks.

Since NOL carrybacks arising in 2019 and 2020 are subject to the five-year carryback rules, the NOL will be required to be carried back to 2014 and 2015 (respectively). For purposes of amending the returns to carry back the NOL, are 2014 and 2015 considered closed years?

Answer: No. For the purpose of carrying the NOL back, 2014 and 2015 are not considered closed years. Since 2019 and 2020 are within three years from when the tax return is due or, if later, two years from when a tax was paid, the statute of limitations for credit or refund under§6511 considers the NOL carryback years as open years [§ 6511(d)(2)(A)].

June 16, 2022

Question: In past years, Lisa has claimed the self-employed health insurance deduction on her Form 1040, U.S. Individual Income Tax Return, for her Schedule C (Form 1040), Profit or Loss From Business, dog grooming business. She qualifies for Medicare this year and wonders if payment of her Medicare premiums for Parts A, B, C and D may also qualify as deductible health insurance premiums. What do you tell her?

Answer: Yes, Lisa's voluntary Medicare premiums qualify as self-employed health insurance, which she may deduct. The Form 1040 instructions (pages 89-90) add a nuance indicating that Medicare premiums paid voluntarily in the taxpayer's name “to get health insurance that's similar to qualifying private insurance” can be used to figure the deduction. Most people do not pay for Part A premiums; the coverage derives from Medicare tax deductions from employment. However, it is possible to purchase Medicare Part A coverage with monthly premiums. Further clarification of this issue is in a 2012 Chief Counsel Advice Memo, [CCA201228037], which affirms that Medicare is “medical care” and is similar to private health insurance premiums.

The CCA includes “all parts” of Medicare as deductible. For example, If Lisa had a spouse or a dependent under age 27, the coverage that extended to them is deductible as well. If Lisa failed to deduct the premiums on her current year's return, she could even amend a return (assuming the year in question is still open) to claim a refund.

June 9, 2022

Question: Nazish just realized that she inherited money from her mother in India. The funds are in an Indian bank account with a balance over $10,000 USD. She did not report it on her 2021 Form 1040, U.S. Individual Income Tax Return, nor did she file a 2021 FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Her accountant filed her 2021 Form 1040 in June 2022. Can Nazish still correct the inadvertent omission of this account on her Form 1040 and timely file the FBAR?

Answer: Yes, Nazish can correct her Form 1040 and timely file the FBAR for 2021. She can amend her Form 1040 to include interest from the bank account on Schedule B, where she will correctly answer “Yes” to both questions under Part III, Line 7a, indicating that she did have signatory authority over a financial account in a foreign country. She'll include the name of the foreign county (India) for question 7b.

Although the FBAR is required to be filed annually by April 15, the return is automatically extended to Oct. 15, with no extension form required to obtain the additional time to file. Even though she did not file an extension, as long as the FBAR is submitted by Oct. 15, her return will be considered timely filed for 2021. The FBAR is not an IRS form and can only be filed electronically through the BSA E-filing system, unless an exemption is granted by calling the FinCEN Regulatory Helpline, which will send a paper version of the return.

June 2, 2022

Question: Zoe is the child of Theo and Camille. All three have bank accounts in the foreign country where Camille grew up. The parents have been adding to Zoe's bank account every year, and the bank account now exceeds $10,000. Zoe is not required to file a Form 1040, U.S. Individual Tax Return. Because Zoe is a minor with no income tax filing requirements, Theo and Camille came to you asking if they can report Zoe's foreign bank account on their own Report of Foreign Bank and Financial Account (FBAR, FinCEN Form 114) filed. What do you tell them?

Answer: No. Theo and Camile cannot include Zoe's bank account on their own FBAR filing. Zoe is not personally exempt from FBAR filing requirements and is responsible to file an FBAR regardless of age. If a child's age prevents them from filing and signing their own FBAR for any reason, the child's parent, guardian, or legally responsible person must file and sign it on the child's behalf.

The FBAR online instructions clearly state that regardless of age or capacity, a U.S. child is not excused from their FBAR filing obligation if the child meets the filing requirements. If the parent electronically signs for the child's FBAR, in Item 45, Filer Title, enter “Parent/Guardian filing for child.”

May 26, 2022

Question: Joe and his two friends enjoy placing wagers on horse races. Joe has established an online betting account with one of the prominent gambling websites. For the Kentucky Derby, they pooled their funds and placed some bets, including the longshot that went off at 80 to 1 odds. Lo and behold, the following February, Joe received a Form 1099-K, Payment Card and Third Party Network Transactions, for $27,000. Because they had pooled their funds three ways and split the winnings evenly, how does Joe handle showing the income allocable to his two friends?

Answer: Generally, if you receive a Form 1099 for amounts that actually belong to another person, you are considered a nominee recipient. The nominee recipient, not the original payer, is responsible for filing the subsequent Forms 1099 to show the amount allocable to the other owners.

Furnish subsequent Forms 1099 by following these steps:

  • Prepare the same type of Form 1099 for each of the other owners, showing the amounts allocable to each. These forms will be sent to each owner and the IRS as well.
  • On each new Form 1099, list yourself as the “payer” and the other owner as the “recipient.” On Form 1096, Annual Summary and Transmittal of U.S. Information Returns, list yourself as the “Filer.”
  • Send the new Form 1099 along with Form 1096 to the IRS Submission Processing Center for your area. To find the address, reference the 2022 General Instructions for Certain Information Returns.
  • Mail each owner their Form 1099.

Note that a spouse is not required to file a nominee return to show amounts owned by the other spouse.

May 19, 2022

Question: Your client has 401(k) plans with two different employers and over-contributed to his plans. These were pre-tax deferrals. The return has been extended, and you have just discovered the excess contributions. How can this be fixed?

Answer: The excess pre-tax deferral is included on Line 1 of Form 1040, U.S. Individual Income Tax Return.

Whether a corrective distribution can be made depends on the timing. The regulations indicate “not later than the first April 15 (or such earlier date specified in the plan) following the close of the individual's taxable year, the individual may notify each plan under which elective deferrals were made of the amount of the excess deferrals received by the plan” [Reg. §1.402(g)-1(e)(2)(i)].

After April 15 (or an earlier date if specified in the plan), the excess cannot be withdrawn and will be taxed again when it is allowed to be distributed (e.g., client retires) [Reg. §1.402(g)-1(e)(8)(iii)]. Regardless of whether the taxpayer can make a corrective distribution, the excess pre-tax deferral must be included in income for the year of deferral.

May 12, 2022

Question: Your new clients, James and Charles, brought in their Forms W-2, Wage and Tax Statement, and interest statements. They also brought the documentation for their NFT (non-fungible token) activity. You know that NFTs are digital ownership rights that cannot be replicated and are considered property for federal income tax purposes, but you need additional time to research the issue. You extended their returns and now have to determine whether their activity generated taxable income and, if so, how much and what kind.

James purchased two Ethereum (ETH) coins on the Ethereum blockchain for $7,500 in November 2021. He traded the ETH coins in December 2021 for an NFT of his favorite Knick's basketball player that was valued at $8,000.

Charles was awarded two NFTs as tokens in the “play to earn” (P2E) game Axie Infinity in December 2021. He doesn't know the fair market value (FMV) of his NFTs as of the award date.

How do you calculate the results of these two activities to finish their 2021 tax returns?

Answer: Most NFT platforms do not provide investors with basis information, so James was helpful when he brought in the FMV details of his trade. With the FMV information, finishing his return is a straightforward process that uses a simple calculation mirroring the treatment of a stock trade. Essentially, James traded property (the ETH coins) for other property (the NFT). To calculate his gain or loss, you recognize the difference between the initial cost of the ETH coins and the FMV of the NFT on the date the trade occurred. That difference is $500. Since James held the ETH coins for only a month before trading them, his gain is recognized as a short-term capital gain at ordinary income rates.

On the other hand, Charles only knows that he was awarded two tokens in Axie Infinity's in-game currency on Dec. 1, 2021. He provides that the Axie tokens sold for 0.016 or $44.97 on Dec. 1. Since he has two tokens, Charles had $89.94 of miscellaneous income from playing the game that is reportable on Schedule 1, Additional Income and Adjustments to Income, Line 8z, as “Other income.”

May 5, 2022

Question: During the “great resignation,” Ronnie received a $10,000 retention bonus from her current employer as an incentive to stay instead of accepting another job offer. If Ronnie leaves before the end of two years following receipt of the bonus, the employer requires it to be repaid. After a year, Ronnie feels sticking with her current employer was not the best decision and is looking to change jobs again. She comes to you to discuss the tax consequences of repaying the retention bonus. What do you tell Ronnie?

Answer: The situation Ronnie is facing is sometimes referred to as a “clawback.” When the repayment is over $3,000, the §1341 Claim of Right Adjustment allows for a current year credit or deduction, whichever is more beneficial. Section 1341's purpose is to make the taxpayer whole again as if the income received and repayment made had never occurred. Report the amount in the year of repayment, but not by filing Form 1040-X, Amended U.S. Individual Income Tax Return, for the year the employee included the bonus in income.

For 2021, report a §1341 amount as a credit for repayment of amounts included in income from earlier years on Line 13d of Schedule 3 (Form 1040), Additional Credits and Payments. In the space next to the box, write “IRC 1341.” The credit amount is calculated as the tax that would not have been paid if the bonus income had not been included in the year received. However, if claiming an itemized deduction for the repayment amount on Line 16 of Schedule A (Form 1040), Itemized Deductions, generates a better tax benefit, choose this method instead.

April 28, 2022

Question: Michelle Daily finally won her dispute with the Social Security Administration. Her permanent disability claim was settled in 2021. Upon receiving her SSA-1099, Social Security Benefit Statement, she noticed that $6,000 in legal fees was deducted from her benefits, but not from the taxable amount reported in Box 3 of Form SSA-1099. Can the legal fees be deducted on her 2021 Form 1040, U.S. Individual Income Tax Return?

Answer: No. Generally, most legal fees are no longer deductible on Form 1040 except for unlawful discrimination claims that violate specific laws. Legal expenses to produce or collect taxable income are miscellaneous itemized deductions, subject to the 2% of AGI limit, which are disallowed for tax years 2018-2025.

April 21, 2022

Question: Is this a tax-free inheritance if a beneficiary receives a distribution from a decedent’s traditional IRA or retirement plan?

Answer: Traditional IRAs and retirement plans are income in respect of a decedent (IRD). Even though distributions from these accounts are an inheritance, IRD does not receive a step-up in basis [§1014(c)]. Distributions to a beneficiary are only tax-free to the extent the decedent had unused basis in the traditional IRA or retirement plan. Basis results from the decedent’s nondeductible contributions. Otherwise, a distribution to a beneficiary from a traditional IRA or retirement plan is taxable income even though it was inherited.

April 14, 2022

Question: James, age 20, and Charles, age 19, are brothers who each inherited IRAs from their deceased mother. Both are college students without scholarships, and their wealthy dad pays more than half of their support. In 2021, each brother took an IRA distribution of $59,562, which is well over the kiddie tax unearned income threshold of $2,200. Each of them also has earned income of $7,500. James attended school for five months, from August to December 2021, and is considered a full-time student. Charles, however, is not considered a full-time student since he enrolled in only 11 credits as opposed to the 12 that the university requires for full-time status. Do the brothers have to file Form 8615, Tax for Certain Children Who Have Unearned Income?

Answer: It depends on which brother you're looking at. The relevant tests for kiddie tax filing are three-fold for this fact pattern:

  • Age
  • Full-time status as students
  • Amounts of unearned and earned income
Unearned income qualifies both. Their earned income suggests they will file their own tax returns. Their differing statuses as full-time students is where their situations diverge. As a full-time student, James qualifies as his dad's dependent and meets the criteria for filing Form 8615. He will pay tax on the IRA distribution at his wealthy dad's higher tax rate. Dad files as head of household. Charles, on the other hand, with the same taxable income, is not a full-time student, is not a qualifying child under age 24 and is not subject to kiddie tax. Publication 17, Your Federal Income Tax (For Individuals), stipulates that full-time status is determined by the school's criteria for full-time attendance.


April 7, 2022

Question: Robyn quit her job after signing with a publishing company to begin a business career writing books as an independent contractor, not just a one-time publication. She landed a lucrative publishing contract for a book series that spans several years, and the publishing company pays royalties to Robyn reportable on Form 1099-MISC, Miscellaneous Income. Plans for a home office were already underway when Robyn paused to consult with you for tax purposes. Is Robyn’s royalty income reportable on Schedule E, Supplemental Income and Loss?

Answer: No. Robyn’s royalty business income is reported on Schedule C, Profit or Loss from Business (Sole Proprietorship), not on Schedule E. Taxpayers who are in the normal course of their business of being a writer report their business income on Schedule C and are subject to self-employment (SE) tax. If Robyn had just a one-time publication with no other plans for future writing contracts and no profit motive, the argument could be made that this is not subject to SE taxes and could be reported on Schedule E. Robyn’s deductible expenses on Schedule C include qualified creative expenses and a home office deduction if all the home office requirements are met. Qualified creative expenses are those Robyn pays or incurs as a writer in her trade or business and which would be deductible for the tax year [§263A(h)(2)]. A writer’s qualified creative expenses are exempt from the general §263A uniform capitalization (UNICAP) rules applicable to book publishers.

March 31, 2022

Question: In 2020, a married couple filed a joint return (noncommunity property state). Included in the return was a coronavirus-related distribution from the husband’s §401(k) account reported on Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments. The income was spread over three years and the proper withholding was reported. As a result, a significant refund was generated. There is no withholding for the subsequent two years. In 2021 the couple divorced. Because the original return with the one-third distribution was reported on a joint return, does the wife, who is not the owner of the §401(k), have reporting requirements or a tax liability for the two remaining reportable distributions?

Answer: No. Form 8915-F is individual to the account owner. Each spouse is required to file their own Form 8915-F. There is no joint form. The instructions for the form specifically state, married filers. If both taxpayers are required to file Form 8915-F, file a separate Form 8915-F for each spouse. If the taxpayers are each filing a Form 8915-F, the $100,000 limit on qualified disaster distributions and the election to include all qualified disaster distributions in income (and not spread them over three years) are determined separately for each spouse. Therefore, because the distribution was not hers, she will not file Form 8915-F for 2021.

March 23, 2022

Question: Does a taxpayer who did not previously qualify as a real estate professional, but now qualifies under §469(c)(7)(B), report their long-term rental income on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship), instead of Schedule E (Form 1040), Supplemental Income and Loss?

Answer: No. Qualifying as a real estate professional under §469(c)(7)(B) does not change the schedule where the taxpayer reports the activity; it changes the nature of the income (loss) from passive to nonpassive. Therefore, if a rental activity would not normally be reported on Schedule C (Form 1040), its nature does not change because the taxpayer now qualifies as a real estate professional. 

To learn more about whether a taxpayer qualifies for the real estate professional status, see our blog titled, How do you determine if a taxpayer is considered a real estate professional?

March 17, 2022

Question: Mark received an extension to file Jolie's Form 1040 and e-files the return with an asset schedule on June 1, 2022. On June 10, 2022, Jolie noticed Mark neglected to allocate the land portion of a building's purchase price. The depreciation of the entire building at 27.5 years (residential real estate) allows excess depreciation for Jolie, the owner. What remedy can Mark use to properly allocate the purchase price to both land and building and correct the depreciation on her return?

Answer: Mark can paper file a superseding return by Oct. 17, 2022, to correct the depreciation error since he initially extended the return. A superseding return corrects the initial return, and those corrections are incorporated into the original return. If the superseding return is filed on or before the original due date, including valid extensions, it is deemed filed on the last day prescribed for filing. Write “SUPERSEDED” at the top of the return. Note that if the return was filed to correct an irrevocable election, such as married filing joint to married filing separate or electing §179, the return is invalid and not considered a superseding return [(IRM) (10-01-2021)]. Also, note that the IRS recently stated the original return, not the superseding return, controls the statutory periods for assessment and refund. Thus, the periods for the IRS to make an assessment and the taxpayer to claim a refund will begin to run on the original due date of April 15, even if that day falls on a weekend or holiday (IRM) (10-1-2021). Even though a superseding return is considered “the return” for many reasons, it is still viewed as supplementing an already-filed return for purposes of statutes of limitation. Superseding returns are more fully defined and discussed in IRM (10-01-2021).

March 10, 2022

Question: Scott has a §1031 like-kind exchange transaction and could not complete it before the end of the tax year. He purchased the replacement property early in the next year. How does Scott report the transaction if it meets all other requirements for a like-kind exchange?

Answer: Scott’s situation of relinquishing his property in one tax year and not receiving the replacement property until the following year is referred to as “straddling tax years.” A §1031 like-kind exchange transaction begins on the relinquished property’s transfer date. Therefore, the like-kind exchange is reported on Form 8824, Like-Kind Exchanges, for the first tax year of the straddle and not the tax year in which the transaction was completed. Scott should file an extension for the first tax year since the due date for the return may fall before the end of the general 180-day exchange period. The exchange period ends on the earlier of the 180th day after the transfer or the date the taxpayer’s return is due, including extensions. Extending the tax return for the year Scott relinquishes the property allows him to take advantage of the full 180-day like-kind exchange period because the extension should push the return’s due date beyond that period [Reg. §1.1031(k)-1(b)(2)(ii)].

If the like-kind exchange failed, then, because it straddled two tax years, Scott may still be able to defer income recognition to the following tax year using the installment method with Form 6252, Installment Sale Income, under the safe harbor rules. Failure can occur when a qualified intermediary used for an exchange is unable to find suitable replacement property, the property received is a trade-down from the property given up or if cash is received after the 180-day period expired. When payment is received in the year after the year the property is relinquished, using the installment method for the cash payment defers recognition of the gain until the year payment is received.

March 3, 2022

Question: James and Mary’s financial advisor told the couple that selling their life insurance policy may be a good option for them. After thinking it over, they decided to sell it. Bill, an unrelated purchaser, paid James and Mary $25,000 for their policy. How should Bill report this transaction?

Answer: Bill must furnish James and Mary with Form 1099-LS, Reportable Life Insurance Sale. This is an informational form used by the acquirer in a reportable policy sale to report the acquisition. A sale is reportable when, like Bill, the acquirer has no substantial family, business or financial relationship with the seller. James and Mary recognize taxable income on the sale to the extent the sales proceeds exceed their adjusted basis (total premiums paid). Bill must file Form 1099-LS with a Form 1096, Annual Summary and Transmittal of U.S. Information Returns, by Feb. 28 of the following year (March 31 if filed electronically). This form identifies the seller (James and Mary), who acquired the policy (Bill) and how much they (Bill) paid. If state law allows James and Mary to cancel the transaction, Bill must also issue a corrected Form 1099-LS within 15 days of cancellation.

Feb. 24, 2022

Question: A couple electronically filed a married filing joint return on Feb. 9, 2022. Each spouse signed the return. If they later decide to file separate returns for 2021, how long do they have to make this change?

Answer: Most taxpayers have until April 18, 2022, to make this change. Taxpayers in Maine or Massachusetts have until April 19, 2022, to file their returns due to the Patriot’s Day holiday in those states. For any taxable year a joint return has been filed, the spouses cannot make separate returns after the time for filing the return of either has expired [Reg §1.6013-1(a)(1)]. Changing the tax return before the filing deadline is referred to as filing a superseding return.

Feb. 17, 2022

Question: James and his brother Charles are both full-time students hoping to claim the earned income tax credit (EIC) in 2021, now that the credit percentage for childless workers has increased dramatically. Both brothers had wages in 2021 and neither are dependents of another taxpayer. James is 28, and Charles is 21. Are they eligible for the EIC?

Answer: Three important changes to the EIC guidelines make this credit a potentially exciting option for both brothers. First, for 2021, childless workers and couples, younger workers and senior citizens now qualify for the EIC. Filers who are at least 19 years old, have no qualifying children and have earned income below $21,430 or $27,380 (MFJ) may be eligible for the credit. Second, the credit amount has increased for this filing group. The current maximum credit of $1,502 nearly triples the former credit amount of $538. Although certain unhoused individuals, or those formerly in foster care, are also now potentially eligible, full-time students under age 24 are not. That means Charles, the 21-year-old student, will not qualify for the credit even though his earned income would qualify him. Third, the credit can be based on earned income from 2019 if it is higher than in 2021. Note that unemployment income is not considered earned income for this purpose. James worked part-time in 2021 and qualifies for the EIC, even though he is a student, because he is over age 23. Charles must also choose whether to use 2019 as his earned income year. The IRS earned income and earned income tax credit tables show that his 2019 earned income of $19,800 qualifies him for an EIC of $253, while his 2021 income of $6,450 yields a credit of $983. James will use his 2021 earned income to claim the higher amount and Charles will not receive the credit.

Feb. 10, 2022

Question: Howard and Marion claim their college son and high school daughter as dependents on their tax return. They were not eligible for the recovery rebate credit (RRC) on their 2020 tax return and did not receive the third round of economic impact payments (EIP 3) during 2021 because their adjusted gross income (AGI) was over $185,000. However, in 2021 their AGI decreased below $150,000, and they asked you if the change in circumstances makes them eligible for the 2021 RRC and what the credit amount is for their various family members. What do you tell them?

Answer: Good news! An AGI of not more than $150,000 is the key to eligibility for the full RRC on the 2021 Form 1040, U.S. Individual Income Tax Return. For 2021, the credit amount has also increased to $1,400 for each family member since the same amount is received for both parents and each qualifying dependent, including those age 17 and older, unlike the 2020 RRC.

Feb. 3, 2022

Question: Heritage Income Tax Service has been in business for about 25 years. Mr. Bush has been the sole owner and president since the inception of the business. When e-filing became prominent, he applied for and received an EFIN. It was issued to him after completing fingerprinting, suitability verification and any other requirements at the time. Coming into tax season 2021, Mr. Bush suddenly passed away. Over the years, the business grew and about 1,200 returns were completed annually by four tax preparers. Mrs. Bush, who was vice president, intends to continue the business. Can she simply continue to use the same EFIN issued to Mr. Bush?

Answer: No. When Mr. Bush passed, his EFIN became void. If the business structure changes or a different tax identification number (TIN) becomes necessary, a new EFIN application must be submitted. Mr. Bush was the sole owner, and his TIN was associated with the business. With his passing, his EFIN can no longer be used. Since it takes at least 45 days to obtain a new EFIN, the tax office may suffer a significant interruption in business.

Jan. 27, 2022

Question: In 2022, if an employer is filing 2021 Form 941-X, Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund, to claim the employee retention credit (ERC) for a quarter in 2021, will the refund be taxable income in the year received?

Answer: No. Instead, if the employer has not filed its 2021 business income tax return, the employer reduces the wage expense by the amount of ERC claimed on Form 941-X. If the employer already filed its 2021 business income tax return, the employer amends its business income tax return to reduce the wage expense by the amount of the ERC claimed on Form 941-X (Notice 2021-49, Sec. IV). However, the employer does not have to reduce the deduction for the employer’s portion of the Social Security and Medicare taxes by any portion of the credit (Notice 2021-20, Q&A 60). Furthermore, the employer does not have income from the portion of the credit that reduces the employer’s applicable employment taxes nor the refundable portion of the credit (Notice 2021-20, Q&A #61)

Jan. 20, 2022

Question: James, a single taxpayer, wants to invest part of his refund instead of directly depositing all of it into his bank. How can he allow the IRS to directly invest his refund and what are his choices?

Answer: Form 8888, Allocation of Refund (Including Savings Bond Purchases), allows for direct deposit in up to three accounts at a United States bank or other financial institution, a mutual fund, traditional (including SEP IRAs) or Roth IRA, or a health savings account. James enters both a routing number and an account number for each allocation, only for accounts he owns; he may not direct deposit into someone else’s account (such as his tax preparer’s). For a financial institution, he marks the box for “checking” or “savings.” If he is allocating to an IRA, he notifies the trustee or custodian of his account to which year the deposit should be applied.

Assuming James files before the April 15 deadline, he can have the refund deposited into his traditional IRA as a contribution for the current tax year. He can also select a Treasury Direct online account to buy up to $5,000 of electronic Series I Bonds or buy treasury securities. The paper version of these bonds is also available exclusively through the refund purchase process. He may request up to three different savings bond registrations. Each registration must be a multiple of $50, and the total of the three registrations (Lines 4, 5a, and 6a) can’t be more than $5,000 (or his refund amount, whichever is smaller). One space is for his amount (and his spouse, if MFJ). A second and third space is for him, his spouse or someone else. In the latter case, he would enter the individual’s name for the bond registration. He may also add a co-owner or beneficiary under the second and third choices. New for 2021 filing season, even if he files a late return, he may have his refund directly deposited.

Jan. 13, 2022

Question: Jack and Diane attempted to make a rollover to a traditional IRA for $325,000 as a tax-free event. The IRS examined the return and determined it was a taxable event. This resulted in $135,000 of assessed tax liability. The IRS collected the assessment through two levies in June 2013. Jack and Diane disagreed with the IRS's characterization of their attempted rollover. On the last day to file a timely refund claim, their tax preparer, John, placed their claim in the regular mail using a U.S. postage stamp. A few months later John checked the status of the claim and the IRS indicated it had no record the claim was received. John then forwarded a copy of the original file for refund. The IRS denied the claim on the basis that this claim was not timely filed. Do Jack and Diane have recourse?

Answer: No. While §7502 provides an exception to the physical delivery rule, if a document is postmarked before the deadline and received after the deadline, there is no proof the claim was mailed prior to the due date for the claim for refund. If the claim was mailed via registered mail or certified mail, or with an authorized private delivery service, this would establish the document was in fact postmarked by the due date, even if the IRS never received the document or the has no record of receiving it. Without proof of the postmarked date, Jack and Diane have no recourse with the IRS. However, they may have recourse against their tax preparer.

Jan. 6, 2022

Question: Jackie and Lina are S corporation shareholders. Lina left the S corporation when Jackie bought out her stock. Lina provided seller financing over five years to Jackie. Lina heard that tax rates are increasing in the following tax year and is interested in reporting all the gain on the stock sale in the year sold. Is Lina required to report the sale of stock on Form 6252, Installment Sale Income?

Answer: No, Lina is not required to report the stock sale on Form 6252 if the election is made to opt out of using the installment method. While generally receiving one payment in a tax year after the year of sale requires the installment method of reporting, using the election to forego it allows Lina to accelerate income tax gain recognition in the year of sale. To make the election, Lina reports 100% of the gain in income in the year of the stock sale on the timely filed tax return, including extensions. Do not use Form 6252 to elect out. Failure to timely elect out with reasonable cause is approved on a case-by-case basis by IRS authority. A change in tax law, such as increased income tax rates, is not considered reasonable cause by IRS.

Dec. 30, 2021

Question: Jessica and Nathan, a divorced couple, have one child, Lillian, age 4. Jessica and Nathan alternate tax years for claiming Lillian as a dependent. In 2020 Jessica claimed Lillian and received advanced child tax credit (CTC) payments totaling $1,800 in 2021. When Jessica files her 2021 tax return, her AGI is $50,000 with a filing status of single, since she is not the custodial parent in 2021. She heard about the repayment protection and asked how much, if any, of the advanced CTC she will have to repay. Does Jessica qualify for the repayment protection? How much will she have to pay back?

Answer: Yes, Jessica qualifies for partial repayment protection. Single taxpayers who have an AGI between $40,000 and $80,000 will qualify for partial repayment protection. The safe harbor amount available is $1,500, which is calculated by taking the safe harbor amount of $2,000, reduced by 25% or $500. The 25% is determined by the excess amount above the AGI safe harbor $10,000 ($50,000 - $40,000) divided by the lower limit of $40,000. Jessica will have to repay $300 ($1,800 - $1,500) of the advanced CTC payments.

Dec. 22, 2021

Question: George is a single taxpayer who owns virtual currency investments and is curious about the tax implications of his two hard forks and one airdrop transaction during the year. The first hard fork results in the creation of 60 units of a new virtual currency, which are airdropped into George’s account. He immediately obtains dominion and control of the airdropped units. The new units have an FMV of $350 per unit at the time of the airdrop and an FMV of $100 per unit at the end of the year. The second hard fork results in the creation of 20 units of virtual currency, with no airdrop. The units have an FMV of $100 per unit at the time of the hard fork and an FMV of $150 per unit at the end of the year. Does George have taxable income resulting from these transactions and what is his basis in the units received?

Answer: Yes, George will have taxable income resulting from these transactions. The first hard fork creates taxable ordinary income to George because it was followed by an airdrop. His taxable income from the airdrop is $21,000 (60 units x $350 FMV on date of the airdrop). No taxable income results from the second hard fork because there was not an airdrop following the hard fork. His basis in the new units created by these transactions equals the amount of taxable income recognized, giving him a $21,000 basis in the 60 airdropped virtual currency units and a $0 basis in the additional 20 units created in the second hard fork transaction. The FMV at the end of the year is not relevant.

Dec. 16, 2021

Question: Bob (62) and Barb (65) meet with their tax preparer in December 2021 to assess whether there are any year-end planning opportunities they can address in preparation for filing their 2021 income taxes in a few months. Bob and Barb are both working, and although Barb turned 65 on Aug. 19, 2021, she is planning to delay receiving Social Security benefits until she turns 67. They are both covered under Bob’s HDHP (high-deductible health plan) family insurance plan through his work, and Bob thus far has contributed $6,000 to his HSA through his cafeteria plan. Barb had an unexpected hospital stay in October 2021, and just enrolled in Medicare Part A in December 2021, prior to the meeting. Their tax preparer advises them that they can contribute more money to an HSA for 2021. How much does the tax preparer advise Bob and Barb to contribute to maximize their HSA tax benefit for the year? 

Answer: Bob is eligible to contribute an additional $2,200 to his HSA: $1,200 to meet the $7,200 annual family limit for 2021, and $1,000 for his “catch-up” contribution, since he is over the age of 55 [§223(b)(3)]. Barb is also eligible to open her own HSA and contribute $583.33, representing her pro-rata amount of her eligible “catch-up” contribution. Although she enrolled in Medicare in December, Medicare’s look-back period for Part A allows her coverage to be retroactive back to Aug. 1, 2021. She is not eligible to contribute to an HSA while enrolled in Medicare [§223(c)(1)(A)(ii)]. Therefore, her limit is (7/12) x $1,000. However, her duplicate coverage for the last five months of the year does not change Bob’s contribution limit for the family plan [§223 (c)(4)]. Together, Bob and Barb were able to put aside an additional $2,783.33 tax free for 2021. Note, they have until April 18, 2022, to make these additional contributions (Notice 2004-2, Sec. III, Q&A 21, 2004-2 IRB 269).

Dec. 9, 2021

Question: Haruto's Aunt Akira made him the sole beneficiary of her estate after learning she is terminally ill. Haruto immediately gifts some of his assets to Aunt Akira upon hearing the sad news. When gifted, the assets’ basis was $5,000 and the fair market value (FMV) was $200,000. Aunt Akira’s terminal illness claims her within three months and all her assets pass to Haruto, including the assets he gifted to her three months ago. What is the basis of the assets to Haruto that he gifted to Aunt Akira three months before she died from the terminal illness?

Answer: Haruto’s basis remains $5,000 for the assets that he gifted to Aunt Akira three months before she died. He does not receive a basis step-up to FMV. Step-up basis is denied when a decedent acquires an asset by gift within one year of death, and that asset goes back to the donor. When this happens, the basis remains the decedent’s basis immediately before death and is not stepped-up [§1014(e)]. Congress enacted §1014(e) as an anti-churning rule to prevent the cycling of assets through the terminally ill to obtain an income tax FMV basis.

Dec. 2, 2021

Question: Ethan purchased one acre of undeveloped land near a shopping plaza about five years ago, with hopes of selling it for a profit in the future. He has paid $15,000 in property taxes on the parcel each year. Ethan currently has an NOL carryover; therefore, the property taxes he paid this year give him no tax savings. Ethan would like to see if there is anything he can do to capitalize the property taxes paid this year. Is that possible?

Answer: Yes, pursuant to §266, Ethan can elect to capitalize the property taxes paid this year on one acre of land. By making this election, the taxes paid will increase his basis in the land. When Ethan sells the land, the taxable gain on the sale will be smaller due to his increased basis that resulted from the capitalized taxes.

To make this election, Ethan will attach a statement to his Form 1040, U.S. Individual Income Tax Return. The attachment needs to mention §266 describing the cost of the property taxes Ethan paid.

Nov. 24, 2021

Question: Jon bought a house for $210,000 and used it as his principal residence from 2010 to 2018. From 2019 until 2021, he rented the house to tenants and claimed depreciation deductions of $20,000. In 2021, he plans to exchange the house for $10,000 of cash and a townhouse with a fair market value of $460,000 that he will rent to tenants. Since Jon used the house as a principal residence for two out of the last five years, can he qualify for both §§121 and 1031?

Answer: Yes. Jon’s example is from Rev. Proc. 2005-14, Example 1, and continues below.

Jon’s exchange of a principal residence that he rents for less than three years, for a townhouse intended for rental and cash, satisfies the requirements of both §§121 and 1031. Section 121 does not require the property to be the taxpayer's principal residence on the sale or exchange date. Because Jon owns and uses the house as his principal residence for at least two years during the five-year period prior to the exchange, he may exclude gain under §121. Because the house is investment property at the time of the exchange, he may defer gain under §1031.

Under Section 4.02(1) of Rev. Proc. 2005-14, as Jon’s preparer you will apply §121 to exclude $250,000 of the $280,000 gain before applying the nonrecognition rules of §1031. The remaining gain of $30,000 is deferred, including the $20,000 gain attributable to depreciation, under §1031. Although Jon receives $10,000 of cash (boot) in the exchange, he is not required to recognize gain because the boot is taken into account for purposes of §1031(b) only to the extent the boot exceeds the amount of excluded gain.

These results are illustrated as follows:

  • Amount realized - $470,000 
  • Less adjusted basis - (190,000) 
  • Realized gain - $280,000 
  • Less gain excluded under §121 - (250,000) 
  • Gain to be deferred - $30,000

Jon’s basis in the replacement property is $430,000, which is equal to the basis of the relinquished property at the time of the exchange ($190,000) increased by the gain excluded under §121 ($250,000) and reduced by the cash he receives ($10,000).

Rev. Proc. 2005-14 has six examples that further demonstrate the interaction of §§121 and 1031. This revenue procedure was issued before nonqualified use was enacted into law. However, Jon escapes nonqualified use because the rental activity took place during the five-year period after he used it as his principal residence [§121(b)(5)(C)(ii)(I)]. Lastly, the instructions to Form 8824, Like-Kind Exchanges, indicate how to fill out Form 8824 using the benefit of the §121 exclusion.

Nov. 11, 2021

Question: Aiyanna received COVID-19 relief payments directly from her Native American government tribe. Are the tribal COVID-19 payments reported as taxable income?

Answer: No. Generally, the COVID-19 relief payments individuals receive from their Indian tribal government are not included in gross income and will not result in taxable income to them if the payments are used for reasonable and necessary personal, living, family or funeral expenses. Aiyanna should not receive a Form 1099-MISC for the payments because they are not subject to §6041 information reporting requirements.

Various COVID-19 relief provisions that benefit tribes and tribal members allow tribes to provide emergency relief payments to tribal members and their families for necessary expenses resulting from the COVID-19 pandemic. These provisions are found in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the Consolidated Appropriations Act, 2021 (CAA) and the American Rescue Plan Act of 2021 (ARP).

Nov. 11, 2021

Question: Pauline received a Form 1099-C, Cancellation of Debt, reporting a foreclosure on her rental property. The date in Box 1, date of identifiable event, is Feb. 13, 2020. Box 2 shows the amount discharged of $41,000. Box 5 is checked “yes,” indicating she is personally liable for repayment of the debt. Box 6, identifiable event, has Code G, decision or policy to discontinue collection, and the FMV in Box 7 is $19,000. Pauline’s adjusted basis in the rental property is $25,000. How does she report the information on Form 1099-C on her tax return?

Answer: Pauline will have two reporting transactions, a sale and cancellation of debt (COD) income. Foreclosures are reported as a sale of the property. Since Pauline is personally liable (Box 5) for repayment of the debt (recourse debt), the sales price is the lower of FMV (Box 7) or the balance of the discharged debt (Box 2). Pauline reports the sale on Form 4797, Sale of Business Property. The net profit or loss from the transfer of the rental property is determined by subtracting the adjusted basis from the sales price ($19,000 sales price less $25,000 adjusted basis).

Next, you determine if Pauline has taxable or excludable COD by verifying whether she is insolvent or solvent. Use the worksheet in Pub. 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (For Individuals), to determine whether a taxpayer is insolvent. If Pauline is insolvent, the amount of excludable COD is reported on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and reduces tax attributes. The tax attribution reductions will apply Jan. 1 of the year following the year of debt cancellation. However, if Pauline is solvent, the COD is reported on Schedule E, Supplemental Income and Loss, Line 3, as rents received in the year it is cancelled. This treatment applies because the income is reported on the tax form to which the cancellation pertains.

Nov. 4, 2021

Question: Your client, Sue, is a single taxpayer and likes to use virtual currency periodically. She asks you about the tax implications of some recent virtual currency transactions she made. She transferred some virtual currency with a $600 FMV and $450 basis from one virtual currency wallet account owned solely by Sue to another virtual currency wallet account also owned solely by Sue. She also recently did some consulting work for a company and was paid with virtual currency for those services. The virtual currency she received had a FMV of $400 on the date she was paid. At the end of the year, the virtual currency is worth $500.

How much taxable income will Sue have from her virtual currency transactions during the year, will the income be ordinary or capital, and is any of it subject to self-employment tax?

Answer: Sue will have $400 of taxable income resulting from her virtual currency transactions.

Normally, virtual currency is viewed as property for tax purposes. However, when virtual currency is received for the performance of services, it is treated as ordinary income and subject to any applicable payroll or self-employment taxes that a cash payment would be subject to.

The transfer of the virtual currency from one wallet or account owned by Sue to another account or wallet also owned by Sue is a nontaxable event even if she receives a Form 1099 or other informational reporting. The virtual currency Sue received from the performance of consulting services will be taxable as ordinary income to her and subject to self-employment tax. The amount taxable to Sue will be the FMV (in U.S. dollars) of the currency on the date it was paid. The value of the currency at the end of the year is irrelevant.

Oct. 28, 2021

Question: Rob moved his accounting firm’s office when he downsized in 2021. He knows he has to notify the IRS about the address change. He hopes he can update the mailing address on his preparer tax identification number (PTIN), his electronic filing identification number (EFIN), and his employer identification number (EIN) all at once, either by calling the IRS or by some other means. What is the best way for Rob to update this information given that the IRS phone service is currently overtaxed?

Answer: Rob will have to change his address for each ID number separately for each IRS account by contacting each business unit to make the address change. Ideally, he will use online services to make the changes.

Rob can change his PTIN address using his online account when he does his annual PTIN registration. He will select “Manage PTIN Account Information” to update his address.

Rob’s best option for an EFIN address change is to register for the IRS e-services online registration and information retrieval system. Rob would create an account online through a registration process that requires him to verify his identity. He must have an email address, a Social Security number or individual tax identification number, a financial account number linked to his name (credit card, mortgage, student or auto loan), and, ideally, a mobile phone number linked to his name to facilitate registration. His e-services account also permits him to retrieve client account transcript information if he has a properly executed Form 2848, Power of Attorney, or Form 8821, Tax Information Authorization, on file. If Rob chooses, he may instead call the e-help desk toll-free number at 866-255-0654 to notify the IRS of his address change.

The IRS urges practitioners to protect their EFIN and to use the online services method to monitor and update personal information. The IRS will deactivate the EFIN of a provider when it receives undeliverable mail and will reject all e-filed returns until the updates are made.

The CAF Unit updates your address when you send in Form 2848 or Form 8821 with the “Check if new: Address” box is checked off.

Enrolled agents will have to fax or mail their address change.

Finally, Form 8822-B is used for a business to change its address relating to its EIN. Form 8822-B should be mailed to the appropriate address listed on the form.

Oct. 21, 2021

Question: Billy took out a reverse mortgage on his principal residence to provide himself additional income during his retirement years. Billy died and Laura, his beneficiary, paid off the balance of the reverse mortgage so she wouldn’t lose the house. Laura asks you if she can take a deduction on her personal tax return for the Form 1098, Mortgage Interest Statement, issued to the estate when she paid off the reverse mortgage. What do you tell Laura?

Answer: No, the reverse mortgage interest reported on Form 1098 to the estate is not deductible on the beneficiary’s personal return. A reverse mortgage is like a home equity loan. Billy took out a mortgage against the equity of his house and then used the loan proceeds to pay for personal living expenses. Billy did not use the reverse mortgage proceeds to purchase, construct, acquire or improve his principal residence [§163(h)(3)(B)]. Interest tracing deems that the loan is for personal expenses; therefore, the interest reported on Form 1098 is not deductible as qualified residence mortgage interest expense under TCJA, which changed the rules on the type of mortgage interest that qualifies as a deductible expense. Generally, a deduction is not allowed for interest paid on a reverse mortgage; however, an estate is allowed a deduction on the principal and accrued interest it pays on the reverse mortgage of a decedent's home [§2053(a)(4)].

Oct. 14, 2021

Question: Cooper and Penelope are married with two children. Cooper is a U.S. citizen living in Spain with both children, who are green card holders with valid Social Security numbers (SSNs). Penelope is a green card holder with a valid SSN living in the United States. When they file married filing jointly (MFJ) on their Form 1040, U.S. Individual Income Tax Return, can they claim the children as dependents?

Answer: Yes, on their MFJ tax return, the couple can claim their children as dependents under the qualifying child rules [§152(c)].

The dependents section of the instructions for Form 1040 provides a step-by-step worksheet for taxpayers who are unsure whether a dependent qualifies.

One of the general rules for dependent status is that a dependent must be a U.S. citizen or national, or a resident of the United States. Residency requires that the child has the same principal place of abode as the taxpayer (resides with the taxpayer) for more than half the tax year. An individual will not fail this test because of temporary absences due to illness, education, business, vacation, military service and other special situations. If it’s reasonable to expect the individual will return to live at the place of dwelling after the absence, it is termed temporary. [Prop. Reg.1.152-4(c)(2)].

If an individual sleeps at the taxpayer’s principal place of abode, regardless of whether the taxpayer is present or sleeps in the company of the taxpayer when not sleeping at the taxpayer’s principal place of habitation, the individual is regarded as residing with the taxpayer (for example when on vacation) [Prop. Reg.1.152-4(c)(3)].

Oct. 7, 2021

Question: Jack is a retired firefighter. He receives a $20,000 taxable distribution from a qualified §457(b) plan during 2020. He also receives a $15,000 taxable distribution from a §401(k) plan. During the year, Jack pays a total of $5,000 in health insurance premiums for himself and his wife. Of this amount, $2,800 is for his health insurance premium and $2,200 is for his wife’s premiums. He pays the premiums by taking $2,500 from each of his retirement plan distributions and sending them directly to the health insurance provider. He makes the election to exclude health insurance premiums for retired public safety officers. How much of the insurance premiums qualify for the exclusion, and what will his taxable distribution be from each plan?

Answer: Jack may exclude from income $2,500 of his retirement plan distributions that he used to pay qualified health insurance premiums. By making the election, Jack may exclude from income up to $3,000 per year of qualified retirement plan distributions that are used to pay insurance premiums paid for himself, his wife and any dependents; however, to qualify, the premiums must be paid directly from a qualified government retirement plan to the insurance provider. Code §414(d) defines a qualified plan under this exclusion as a qualified trust, a §403(a) annuity plan, a §457(b) plan or a §403(b) annuity. Therefore, the amount paid from the §401(k) plan will not qualify. Instead, Jack should pay at least $3,000 of the premiums from his §457(b) retirement plan to take full advantage of this exclusion. His taxable distribution from the §457(b) plan will be $17,500 ($20,000 - $2,500) and his taxable distribution from the §401(k) will be $15,000.

Sept. 30, 2021

Question: Gina is a nonresident alien who is an Italian citizen. She resides in Italy and is eligible for Italy-U.S. treaty benefits. Gina worked for years with an Italian-based company with no fixed base in the U.S. In 2020, she worked 300 days total: 150 days in Italy and 150 days in the U.S. Does she need to file U.S. Form 1040-NR, U.S. Nonresident Alien Income Tax Return, to report her U.S. wages?

Answer: No. Because she is an Italian qualified resident, she is exempt from U.S. taxation due to treaty relief. Article 15(2) of the U.S.- Italy Tax Treaty provides that employment income is not taxable by the United States if (1) the employee is not present in the United States more than 183 days in the fiscal year, (2) wages are paid by an employer who itself is not a United States resident and (3) the wage is not borne by a U.S. permanent establishment or fixed base maintained by the nonresident employer.

Sept. 23, 2021

Question: Your client took a distribution of $100,000 from IRA 1, and on the same day took a distribution of $60,000 from IRA 2. They are now asking you if they can pool the two amounts and transfer the $160,000 into IRA 3 within 60 days. Can your client do this without violating the one-per-year rollover rule?

Answer: No, the client cannot transfer the two co-mingled amounts into IRA 3 without violating the one-per-year rollover rule. The 60-day rollover rule applies from the time the first IRA withdrawal is made, not the date the rollover is completed [§408(d)(3)(B)]. The 60-day rollover rule applies on an aggregate basis to all IRAs held by the taxpayer (excluding conversions of a traditional IRA to a Roth IRA and trustee-to-trustee transfers) and is applied on an aggregate basis. Therefore, an individual cannot make a tax-free rollover of an IRA distribution to another IRA if the individual has already made a tax-free rollover involving any of the individual’s IRAs in the previous one-year period.

In this case, your client’s withdrawal from IRA 1 triggered the 60-day countdown. Since the taxpayer rolled over IRA 1 into IRA 3 within 60-days, their $60,000 withdrawal from IRA 2 was a second distribution and was, therefore, not eligible to be rolled over tax-free using the one-per-year rollover rule.

Sept. 16, 2021

Question: Joan and Rowland filed their Form 1040 jointly for the duration of their marriage as married filing jointly. Rowland died in early 2020 and Joan remarried in late 2020. Does Joan file her 2020 federal tax return with Roland or with her new husband?

Answer: Joan will file her Form 1040 with her new husband. They will file married filing jointly or married filing separately. When your spouse dies during the tax year, the surviving spouse is considered married for the whole year for federal tax purposes, unless the surviving spouse remarries. If the taxpayer remarries before the end of the tax year, the taxpayer will file a joint return with the new spouse.

Sept. 9, 2021

Question: Sean, a U.S. citizen living and working in England, is reporting Schedule C income on Form 1040 for the calendar year. The British tax year ends March 31, 2021. He paid 100% of his British income tax on his Schedule C income in August 2021. Would he claim the foreign tax credit in tax year 2021 using Form 1116, Foreign Tax Credit (Individual, Estate, or Trust)?

Answer: Ordinarily, a calendar year, cash basis taxpayer takes the foreign tax credit in the tax year in which the tax is remitted to the foreign government. However, he may elect to take the credit on the accrual basis, which is binding for all subsequent years [Reg. §1.905-1(a)] and determinable at the close of the taxpayer’s foreign tax year, in this case March 31, 2021. The foreign taxes are considered accrued in the U.S. tax year within which the taxpayer's foreign tax year ended.

Since Sean’s foreign tax was neither paid nor fixed and determinable at the end of calendar year 2020, the foreign tax credit is available only in 2021.

Sept. 2, 2021

Question: Gaia is a U.S. citizen who lives and works in Israel. She meets the bona fide resident test. Under §911, she elects to exclude her foreign earned income of $96,000 from U.S. taxation on Form 2555, Foreign Earned Income Exclusion. Can she also claim the foreign tax credit on Form 1116, Foreign Tax Credit, for income taxes she paid to Israel?

Answer: No. Because Gaia is using Form 2555 to exclude her foreign earned income, she cannot use Form 1116 to claim the foreign tax credit on that same income. Once Gaia elects to exclude her foreign earned income, she cannot take a foreign tax credit for taxes on income she excluded or could have excluded. If she does, one or both choices may be considered revoked [§911(d)(6)]. However, she can choose to take a foreign tax credit on any amount of foreign earned income that exceeds the amounts she excluded under the foreign earned income exclusion.

To use Form 1116, the taxpayer must have foreign tax liability that was either paid or accrued during the current tax year, the tax must be assessed on income, must be imposed on the taxpayer as an individual and must have originated legally in a foreign country.

There may be situations where it would be more beneficial to use Form 1116 to claim the credit instead of using Form 2555. For instance, people may prefer to use the credit if they live in a high-tax area, such as the United Kingdom.

To learn more, attend our upcoming Foreign Tax Days – Individual Topics and Business Topics.

Aug. 26, 2021

Question: Fred and Jan are married, live in a community property state and plan to file separate returns. Jan earns $30,000 in wages from her employer. Fred is self-employed, earning $50,000 in net profit from his Schedule C business. How much income will each spouse report on their separate tax returns? Will each be subject to self-employment tax on their share of the Schedule C business income?

Answer: Because they live in a community property state, each reports half of all income from both spouses. Jan reports $15,000 of her wages and $25,000 of Fred’s Schedule C business net profit, making her income $40,000. She will be liable for the federal income tax on the full $40,000. She will not be liable for self-employment tax for her half of Fred’s business income. Fred also reports $40,000 of income ($15,000 of Jan’s wages plus $25,000 of his business income). He will be liable for federal income taxes on his $40,000 of income and will be liable for self-employment tax on the full $50,000 of his business profits.

To learn more on this topic, register for our Community Property - U.S. and Abroad on-demand webinar.

Aug. 19, 2021

Question: After Ally’s Social Security disability benefits finally kicked in during 2020, she repaid the $33,000 of disability she previously received in 2019 from a third-party disability insurance provider. Because Ally previously paid tax on the disability income she received in 2019, how is the 2020 repayment reported on her tax return?

Answer: The repayment is reported in 2020, the year of the repayment, not on an amended 2019 tax return. Since the repayment exceeds $3,000, Ally can deduct the full amount on Schedule A, Line 16 or apply the §1341 claim of right doctrine. The idea is to put Ally in the same position that she would have been in had the income never been received and the repayment never been made. Under the §1341 claim of right doctrine, Ally’s repayment results in a tax reduction in the form of a 2020 “payment” equivalent to the tax paid in 2019, attributable to the $33,000 of disability received. This tax difference is reported as a payment on 2020 Schedule 3 (Form 1040), Line 12d, with “IRC 1341” entered in the space next to the line.

Aug. 12, 2021

Question: In the tests to determine if the client qualifies as a real estate professional for tax reporting purposes, is the client’s spouse’s participation included?

Answer: It depends on which part of the real estate professional test you are applying. To be classified as a real estate professional by the IRS, one must pass annual qualification tests. No, the spouse’s participation cannot be included in testing the activity to qualify the client’s activity as a real property trade or business, which is part of the first test for qualifying as a real estate professional. However, yes, a spouse’s participation can be included for the “material participation” test even if no joint tax return is filed or the spouse has no ownership activity in the client’s real property trade or business [§469(h)(5), Reg. 1.469-9(c)(4)].

To learn more, register for our Preparing Taxes for Real Estate Professionals on-demand webinar.

Aug. 5, 2021

Question: Our client used Kickstarter to set up crowdfunding to start a new business. Are those crowdfunding funds taxable income to the client?

Crowdfunding is the practice of funding a project or venture by raising many small amounts of money from a large number of people, often by gathering online contributions. Popular online platforms include GoFundMe, Kickstarter, Indiegogo, LendingClub, Wefunder and Patreon.

Answer: It depends. The consideration contributors receive, or don’t receive, in exchange for their contributions to the client’s Kickstarter business endeavor project can vary widely. There are various models that a client may choose and the one used impacts tax reporting and whether the crowdfunding funds will be taxable income to the client. The typical models are lending, equity, reward, pre-purchase and donation. Therefore, sometimes nothing is received except the personal satisfaction of helping launch a cause or a creative endeavor in which the contributor believes. Other times, the contributor receives something in exchange for the contribution.

As the lending model name implies, crowdsource funding involves loaning funds to the business. When the equity model is used, the contributor receives an ownership interest in the business. With a rewards model, typically the value of the rewards received by a contributor increases in proportion to the contribution. A pre-purchase model results in the contributor receiving the business project’s resulting product. The donation model provides nothing in return to the contributor and is not taxable.

In general, money received without an offsetting liability (such as a repayment obligation) that is neither a capital contribution to an entity in exchange for a capital interest in the entity nor a gift is includible in income. The facts and circumstances of a particular situation must be considered to determine whether the money received in that situation is income. This means that crowdfunding revenues generally are includible in income if they are not (1) loans that must be repaid, (2) capital contributed to an entity in exchange for an equity interest in the entity or (3) gifts made out of detached generosity and without any “quid pro quo.” However, a voluntary transfer without a “quid pro quo” is not necessarily a gift for federal income tax purposes (INFO 2016-0036).

Because facts and circumstances are key for the client to avoid taxable income reporting, whether crowdfunding funds are taxable income to the client’s new business depends on the structure of the crowdfunding project.

July 29, 2021

Question: A new client owns rental property they purchased over ten years ago. They are planning to sell it but have not previously claimed depreciation on the property. When we report the sale on Form 4797, the form requests the depreciation allowed or allowable since acquired. Do we calculate the depreciation they should have claimed in the past and include it on Form 4797 to report the sale, or do we report $0 depreciation since none was ever claimed?

Answer: In the year of sale, report on Form 4797 all depreciation that should have been claimed in the past plus any for the current tax year being filed. The key here is that you also need to complete Form 3115, Change in Accounting Method, to report the missed depreciation discovered at the time of sale. The Form 3115 results in a negative §481(a) adjustment for missed depreciation that is taken in the current tax year in which the rental is sold. Show the “§481(a) adjustment” on the other expense line of their Schedule E.

NATP members have access to a comprehensive white paper on Form 3115 for missed depreciation that includes an example with an illustrated Form 3115.

July 22, 2021

Question: Tom and Larry are a legally married same-sex couple attempting to have a child through an unrelated surrogacy. When they file their tax return, can they claim on Schedule A the medical expense deduction for costs they paid for egg retrieval, in vitro fertilization (IVF), the surrogate's childbirth expenses and other expenses related to the surrogacy?

Answer: No. A male couple may only deduct as medical expenses costs directly incurred to have a baby related to the medical care of themselves, their spouse or their children, for expenses that exceed 7.5% of AGI. For IRS purposes, the term “medical care” means amounts paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body [§213(d)(1)(A)].

Tom and Larry do not have any underlying medical condition or “defect” preventing either from naturally conceiving children for which the costs incurred were meant to affect. The surrogate is not their dependent. Therefore, the IRS identifies their costs of attempting to have a child as nondeductible personal expenses (§262). If any of the paid costs incurred were to actually impact Tom’s or Larry’s own bodies and all other requirements were met, those costs would be eligible to be deducted on Schedule A [PLR 202114001].

July 15, 2021

Question: Zuri owns a small, non-farm business and asked you, as the tax preparer, whether the business was required to claim all expenses to show a lower self-employment income from the business. What do you tell Zuri?

Answer: Yes, Zuri must report all business expense deductions. A business owner who does not fall under the exception of certain farm operators may not pick and choose expenses to report on their business tax return and must claim all their allowable deductions, including depreciation (Rev. Rul. 56-407).

July 8, 2021

Question: Sue and Matt are married, and Sue is in the military. In 2014, after buying a house in the U.S., Sue was stationed overseas in a foreign country under government orders of official extended duty. In 2021, they sold their U.S. house. Are they eligible for the §121 exclusion of gain from sale of principal residence?

Answer: Maybe. There is a military exception for the §121 exclusion of gain from sale of principal residence that allows suspending the five-year test period for ownership and use of the home by up to 10 years for a total of up to a 15-year test period when on “qualified official extended duty.” If all the special military exception rules apply, the taxpayer applies the §121 rules using that extended period instead of the regular five-year test period.

The five-year test period for ownership and use of a home can be suspended during any period the taxpayer or spouse serves on qualified official extended duty as a member of the Armed Forces §121(d)(9). This means that a taxpayer may be able to meet the two-year use test even if, because of their service, they did not actually live in the home for the required two years during the five-year period ending on the date of sale.

An individual is on official extended duty when they are either at a duty station at least 50 miles from their main home or while living in government quarters under government orders [§121(d)(9)(C)] for a period of more than 90 days or an indefinite period.

The suspension period cannot last more than 10 years, which allows for a total testing period of 15 years. Additionally, the five-year suspension period can apply to only one property at a time. The choice to suspend the five-year period is revocable at any time. Presumably, this is done by filing an amended return for the year of sale or exchange of the residence to include the gains from the sale of the property.

Often, military personnel rent their homes while on military duty. The rental of the property impacts the gains eligible for the exclusion. First, the exclusion cannot be claimed to the extent of depreciation adjustments attribution to periods after May 6, 1997 [§121(d)(6)].

July 1, 2021

Question: A U.S. corporation hires employees from the Dominican Republic who want to be paid in U.S. dollars. The payments are made directly to these employees who perform services in the Dominican Republic for the U.S. corporation. Is there a federal income tax withholding requirement for the wages paid?

Answer: No, there is no federal income tax withholding requirement for the wages paid to these employees. These wages are for services performed outside the U.S. and these employees are nonresident aliens. If the services had been performed within the U.S., generally, compensation for providing services in the U.S. is treated similarly to that of resident aliens and U.S. citizens [§ 861(a)(3)].

June 24, 2021

Question: Mariana and Luis regularly contribute $600 cash annually to their favorite charity and ask you if they may take the above-the-line deduction for the $600 on their 2020 tax return for which they file MFJ. What do you tell them?

Answer: No, they may not claim all $600. For 2020, Mariana and Luis are allowed to deduct up to $300 of cash qualified charitable contributions as a deduction before AGI if they claimed the standard deduction [§62(a)(22)]. For 2020, whether filing as single or MFJ, the amount is still only $300, not $600. For 2021, a similar provision would allow a deduction of up to $600 for MFJ filers as a deduction from AGI [§§ 170(p) and 63(b)(4)]. To verify their favorite charity is a qualified organization to receive deductible contributions, use the IRS Tax Exempt Organization Search tool. The Coronavirus Aid, Relief, and Economic Security Act changed the law for 2020 charitable contributions, and for 2021 the Consolidated Appropriations Act, 2021 changed the law.

June 17, 2021

Question: Erin’s 2020 Form 1040 was extended. She is eligible for the child tax credit (CTC) and will claim the credit on her 2020 return. If Erin’s tax return does not get filed until October 2021, is she eligible for the advance CTC payments in 2021?

Answer: Yes, advance payments will be estimated from information included in an eligible taxpayer’s 2020 tax returns, or their 2019 returns if the 2020 returns are not filed and processed yet.

For tax year 2021, families claiming the CTC will receive up to $3,000 per qualifying child between the ages of 6 and 17 at the end of 2021. They will receive $3,600 per qualifying child under age 6 at the end of 2021.

Advance payments of the 2021 CTC will be made regularly from July through December to eligible taxpayers who have a main home in the United States for more than half the year. The total of the advance payments will be up to 50% of the CTC.

June 10, 2021

Question: In March 2020, Roberta lost her full-time job and was no longer able to afford the rent on her apartment in New York City. Roberta decided her best option was to move into her childhood home with her elderly parents. During the first three months of 2020, Roberta earned $12,000 (as reported on her W-2), most of which was used for her living expenses until May 2020, when she moved to Kansas. When her parents file their 2020 tax return, due in October, can they claim Roberta as a qualifying relative?

Answer: No. Although the parents may have provided over half of Roberta’s support for 2020, her W-2 wages exceed the threshold amount. A qualifying relative must meet four requirements, one of which is gross income for the year has to be less than the exemption amount without regard to the reduction to zero for 2018-2025 ($4,300 for 2020) (Rev. Proc. 2019-44).

June 3, 2021

Question: Cesar is a plumber, with a Schedule C business. On May 6, 2020, his son, Cesar Jr., who is 10 years old was diagnosed with coronavirus by a test approved by the Centers for Disease Control and Prevention. Cesar was told by his doctor to quarantine since he was exposed and to care for his child until further notice. Cesar was unable to work for 60 days since he was taking care of his child. Cesar’s tax preparer is reading about Form 7202 and is wondering, does Cesar qualify for the sick leave credit for certain self-employed individuals?

Answer: Yes. Cesar can claim the refundable credit for the applicable days on his 2020 tax return. He can do so by filing Form 7202, Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals, which is attached to his Form 1040.

The credit is limited to the lesser of 100% of average daily self-employment income or $511 per day ($5,110 in total) if the self-employed individual is:

  1. Subject to a federal, state, or local quarantine or isolation order related to COVID-19
  2. Advised by a health care provider to self-quarantine due to concerns related to COVID-19; or
  3. Experiencing symptoms of COVID-19 and seeking a medical diagnosis

The qualified sick leave equivalent amount is limited to 67% of average daily self-employment income or $200 per day ($2,000 in total) if the self-employed individual is:

  1. Caring for an individual who is subject to a federal, state, or local quarantine or isolation order related to COVID-19, or who has been advised by a health care provider to self-quarantine due to concerns related to COVID-19
  2. Caring for a child whose school or place of care is closed, or childcare provider is unavailable due to COVID-19 precautions; or
  3. Experiencing a substantially similar condition specified by the government

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