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) 21.6.7.4.10 (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) 25.6.1.6.15 (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 21.6.7.4.10 (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:
- Subject to a federal, state, or local quarantine or isolation order related to COVID-19
- Advised by a health care provider to self-quarantine due to concerns related to COVID-19; or
- 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:
- 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
- Caring for a child whose school or place of care is closed, or childcare provider is unavailable due to COVID-19 precautions; or
- Experiencing a substantially similar condition specified by the government
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