You Make the Call
Please note that the question and answer provided does not take into account all options or circumstances possible.
November 14, 2019
Question: Jonathan received a Form 1099-C,
Cancellation of Debt, reporting a foreclosure on his rental property that happened in 2018. The date in Box 1 is Feb. 13, 2018. Box 2 shows the amount discharged is $41,000. Box 5 is checked “yes” indicating he is personally liable for repayment of the debt. Box 6 has Code G, Decision or Policy to Discontinue Collection, and the FMV in Box 7 is $19,000. Jonathan’s basis in the rental property is $25,000. How does he report the information on Form 1099-C on his tax return?
Answer: Jonathan will have two reporting transactions, a sale and cancellation of debt income (CODI). Foreclosures are reported as a sale of the property. Since Jonathan is personally liable for repayment of the debt (recourse debt), the sales price is the lower of FMV (Box 7) or the principle balance of the debt before discharged.
Jonathan 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 form the sum of sale price and depreciation.
Next, you must determine if Jonathan has taxable or excludable (CODI) by verifying if he is insolvent or solvent. There is a worksheet in Publication 4681 that can be used to determine whether or not a taxpayer is insolvent. The amount of excludable (CODI) is reported on Form 982,
Reduction of Tax Attributes Due to Discharge of Indebtedness, and reduces tax attributes. The tax attribution reductions will apply January 1 of the year following year, the year of debt cancellation. However, if Johnathan is solvent, the CODI is reported on Schedule E as rental income in the year it’s cancelled. This treatment applies because the income is reported on the form the cancellation pertains to.
November 7, 2019
Question: Jack’s 2017 return was examined, and the auditor determined that there were several questionable business deductions. After further review of the return, both you and Jack agree that there were questionable items deducted. Even though a few items claimed as business expenses cannot be supported, most of the expenses deducted can be substantiated by Jack. What options are available if the auditor rejects all expenses deducted on the business return?
Answer: Jack has a few options available. Asking to speak with a supervisor is at the top of the list if the auditor seems unreasonable or biased within the situation. Another option is to request an Audit Reconsideration with the appropriate service center through written correspondence. Also, the request can be obtained by calling the IRS 800 number. The IRS will respond with a list which contains the requested information to reconsider the disputed deductions. This process should delay collections if the supporting information is provided to the IRS within 30 days from the date of contact.
While the audit is in process, Jack can request the auditor file a Technical Advice Memorandum (TAM) if the circumstances involved have not been addressed or if lack of uniformity exists for similar facts and circumstances. Only the agent or director can file a TAM. Jack will be provided a copy that he can modify by submitting a supplementary statement to the national office. If the audit is closed and the reconsideration does not produce the desired results, Jack can file an appeal as a final option.
October 31, 2019
Question: Rodney filed his Schedule C for 2016 and 2017 using the cash method of accounting. When filing his 2018 Schedule C, can he change his method of accounting to accrual by amending his 2016 and 2017 returns or does he need to file Form 3115 to change his method of accounting for 2018?
Answer: Rodney needs to file Form 3115 to change his method of accounting for 2018. Two returns filed in consecutive years using an improper method establishes a method of accounting for which consent to change is required. A taxpayer may not file amended returns to change such method (Rev. Rul. 90-38).
October 24, 2019
Question: Jason is the owner of a self-directed IRA. The IRA holds a rental property with a FMV on Dec. 31, 2018, of $400,000 and a basis of $250,000. On Jan. 1, 2019, Jason decides to convert the rental property held by the IRA to a personal-use vacation home. How will the conversion from rental to personal use of the IRA asset be treated for income tax purposes?
Answer: The conversion of the rental to personal use is a prohibited transaction because Jason is a disqualified person. A disqualified person is the IRA owner and the IRA's beneficiaries for purposes of determining when a prohibited transaction has occurred [§4975(e)(2)].
The trustee of the IRA will issue Jason a Form 1099-R with a distribution of $400,000. The taxable amount of the distribution will be checked as not determined. Jason must determine if he has basis in the IRA to offset the ordinary income distribution. If he does not have basis in his IRA, the entire $400,000 is taxable as ordinary income. The amount may also be subject to a 10% early distribution penalty if Jason is under age 59½ on the date of the distribution.
October 17, 2019
Question: Your client owns a residential rental property that has accumulated suspended passive losses over the years. He stopped renting the home, tore the home down, and built a personal residence for himself. Can he claim the suspended losses since he demolished the building and won’t be renting a new home? Can he add the remaining basis in the demolished property and the costs to demolish it to the basis in the new home?
Answer: No, the suspended passive losses are only allowed to the extent of passive income, or when the client disposes of the property in a fully taxable transaction [§469]. According to §280B, the adjusted basis of the demolished home and the demolition costs must be added to the basis in the underlying land. The depreciation taken stays with the property and will generate unrecaptured §1250 gain when the client actually sells the property.
According to §280B, Demolition of structures, in the case of the demolition of any structure:
(1) no deduction otherwise allowable under this chapter shall be allowed to the owner or lessee of such structure for:
(A) any amount expended for such demolition, or
(B) any loss sustained on account of such demolition; and
(2) amounts described in paragraph (1) shall be treated as properly chargeable to capital account with respect to the land on which the demolished structure was located.
October 10, 2019
Question: Isabelle would like to form an LLC with two members. She will be a 95% member and her revocable living trust will be the other 5% member. The trust is a grantor trust, and Isabelle is treated as the owner of the trust. She would like the LLC to be taxed as a partnership. Is this a problem?
Answer: Yes. The LLC will be treated as having only one member since it is owned by Isabelle and another disregarded entity (living trust) that is owned by Isabelle. A one-member LLC cannot be taxed as a partnership. To be taxed as a partnership, there must be two separate partners. Thus, Isabelle’s LLC is either taxed as a disregarded entity, or she can elect to be taxed as a C corporation or an S corporation (Rev. Rul. 2004-77).
October 3, 2019
Question: The taxpayers’ daughter is age 21 and a full-time student in her junior year of college. She lived with her parents until August, and they provided all her support. In August she moved in with her boyfriend, but her parents continued to provide for her. In October, she and her boyfriend eloped, but by March the following year, they were divorcing. The daughter has $5,000 of wages and her husband has $6,000 of wages earned during the tax year. The couple plans on filing married filing separately (MFS). Can the parents claim their daughter on their tax return this year if she files MFS from her husband?
Answer: Yes, providing the daughter meets the requirements of a qualifying child or qualifying relative. In this case, she was a full-time student, under the age of 23, and did not provide more than 50% of her own support. Therefore, she meets the requirements for a qualifying child for the parents. To be eligible to claim her dependency, the daughter will need to file as MFS. If she and her husband choose to file a joint return, the parents may still claim her if she and her husband are not required to file a tax return, neither spouses would have had a tax liability if a separate return was filed, and the joint return is filed to merely get a refund of taxes paid in. Additionally, the parents may be able to claim an education credit for any tuition paid to the college if they can claim their daughter as a dependent.
September 25, 2019
Question: Linda placed her primary residence into an irrevocable trust with no powers to withdraw funds. The home was sold five years later. Does she get to use the §121 exclusion on this home?
Answer: No, Linda will not get to use the §121 exclusion on this home. Once the home is placed into an irrevocable trust and the individual does not retain any powers to withdraw funds, the trust has complete ownership and control of the property. Linda no longer owns the home and will not get the benefit of the §121 exclusion.
September 19, 2019
Question: Sara operates a sole proprietorship from an area in her home that she uses regularly and exclusively for her business. Sara itemizes her deductions on Schedule A and the aggregate of her state and local taxes exceeds the $10,000 SALT limitation. Can Sara claim the portion of property taxes related to the business use of her home on Form 8829,
Expenses for Business Use of Your Home?
Answer: She can, but the $10,000 limit extends to the business use portion as well. In years prior to 2018, otherwise deductible expenses, such as mortgage interest and real estate taxes (§280A(b) expenses) were not limited to the profit of the business. Beginning in 2018, the property taxes are now capped at $10,000 under the SALT limitation, but they are not lost. Any excess taxes disallowed by the SALT limit are recategorized as §280A(c) expenses which are limited to the gross income of business.
September 12, 2019
Question: Isaac is an independent insurance agent who sells various insurance products to his clients. He doesn’t provide consulting services. His taxable income for 2019 is $450,000. Does he qualify for the qualified business income deduction (QBID)?
Answer: Yes, Isaac qualifies for QBID. An insurance agent is specifically excluded from the definition of a specialized service trade or business (SSTB) and is not subject to the phase out [§1.199A-5(b)(2)(x)]. The IRS noted that, while the term “broker” is sometimes used in a broad sense to include anyone who facilitates the purchase and sale of goods for a fee or commission, the term "brokerage services" is most commonly associated with services, such as those provided by brokerage firms, involving the facilitation of purchases and sales of stock and other securities [TD 9847, 2/8/2019].
September 5, 2019
Question: Aiden and Sophia, both under age 59-1/2, are a married couple who are short on cash. They both have IRAs. They were wondering if Aiden could take $50,000 out of his IRA in September and replenish it within the 60-day window. The money to replenish Aiden’s IRA would come from Sophia’s IRA. Sophia would replenish her IRA within a new 60-day window with a large settlement the couple is expected to receive in December. Is each spouse allowed to do the one rollover per 12-month period?
Answer: Yes, the single rollover in any 365-day period applies per individual. IRAs (but not qualified plans) are limited to a single rollover in any 365-day period [§408(d)(3)(B)]. This one-year prohibition applies from the date the first IRA withdrawal is made, and applies to all IRAs owned by an individual. Rollovers from a traditional IRA to a Roth IRA (Roth conversion) are not subject to the single rollover limit. However, rollovers from a Roth IRA to another Roth IRA do count towards the one-rollover-per-year limit.
August 29, 2019
Question: Your client Alice is age 67. She has several IRAs, each with a large balance and no basis. Her granddaughter, Jasmine is going to purchase her first home and grandma Alice wants to help with the down payment. Alice wants gift one of her IRAs to her granddaughter. What are the tax consequences on both sides of the transaction?
Answer: Alice cannot gift an IRA but is able to take a distribution and then gift that money to her granddaughter. Alice will include the distribution in taxable income and then file a gift tax return for the amount in excess of the annual gift exclusion amount. Gifts of cash or property are not taxable to the recipient.
August 22, 2019
Question: Breanna received Form 1065, Schedule K-1, from her IRA reporting $30,000 of unrelated business taxable income (UBTI) on Line 20, Code V. Prior year Schedule K-1s had a UBTI loss. Can the losses be carried over to this year to offset the $30,000?
Answer: Yes, if the custodian of the IRA files/filed Form 990-T for the years they had a loss then they can carry it forward to offset UBTI in a later year.
Form 990-T is required when an organization has gross unrelated business income (UBI) of $1,000 or more. When the organization has a net operating loss, it has an additional reason to file the Form 990-T to establish the loss and help to ensure that the organization can carry it forward to a year in which a taxable profit or gain is generated. Although it may be possible to file all prior loss year Forms 990-T in the year a profit occurs to establish the loss, this has several risks (substantiation problems), plus the cost and difficulty of filing old returns.
August 15, 2019
Question: When executors create a fiduciary relationship between themselves and the decedent’s estate, when and where will the Form 56, Notice Concerning Fiduciary Relationship, be filed?
Answer: Form 56 should be mailed to the service center where the decedent’s final Form 1040 is required to be filed as soon as the relationship has been established [Reg. 301.6903-1]. However, the form can be attached to the first Form 1041 for the estate (or final Form 1040) filed by the fiduciary and signed by the fiduciary in the space provided.
August 8, 2019
Question: Harry and Sally divorced. Pursuant to a court order in connection with the divorce, Sally was required to provide health insurance coverage for Harry. Sally made the required election under her employer’s §125 cafeteria plan. Harry died on Feb. 13 in the current year. When is Sally allowed to change her health insurance coverage to drop Harry due to his death?
Answer: Sally must wait until her annual open enrollment period before the beginning of the next plan year to make any changes to coverage. She is not eligible to change plan benefits in the middle of the plan year. Under Reg. §1.125-4(c), an employee cannot change the election during the plan year unless a "change in status" occurs. A change in the number of an employee’s dependents is considered a change of status [Reg. §1.125-4(c)(2)(ii)]. However, an ex-spouse is not a dependent as defined under §152. That code section does not extend to the death of an ex-spouse for which the death effectively terminates the court ordered requirement to provide the ex-spouse health insurance coverage.
August 1, 2019
Question: On Sept. 1, 2018, Mary (filing as single and itemizing deductions) made a $500 contribution to a qualified charitable organization in exchange for a dollar-for-dollar state income tax credit. Mary’s state income tax liability before this credit was more than $500, and Mary applies the entire $500 credit to her state income tax liability for 2018. Does Mary have to reduce her charitable contribution deduction for federal income tax purposes? If so, can she deduct this payment any other way, assuming no business purpose for the payment?
Answer: Under final regulations issued on June 11, 2019, Mary must reduce her charitable contribution deduction on Schedule A (Form 1040),
Itemized Deductions, by the amount of the state income tax credit that she received ($500). Thus, her charitable contribution deduction is zero (assuming no other contributions). However, she may be able to treat the disallowed charitable contribution deduction as a payment of state or local tax under §164 using a safe harbor provided in Notice 2019-12. Under this safe harbor, payments that are disallowed as charitable contribution deductions under the final regulations may be deducted as state or local taxes on Schedule A, provided they don’t exceed the $10,000 ($5,000 if MFS) deduction limit for state and local taxes (SALT limit).
The final regulations and Notice 2019-12 apply to charitable contributions made after Aug. 27, 2018.
July 25, 2019
Question: The taxpayers’ daughter is starting college in September. As a cost savings incentive, the college is offering the option to pay all four years of college tuition up front in the first semester. This freezes tuition costs at the current rate with no increases in future years. The taxpayers would like to take advantage of this payment option. Can they take a distribution from their daughter’s §529 qualified tuition plan (QTP) covering the entire four years in her first semester and not incur tax or penalties on the earnings?
Answer: No. Distributions from QTPs can only be taken for qualified higher education expenses applicable to courses taken during the same year or billed through March 31 of the following year.
Therefore, if the parents prepay all four years in the first semester, any QTP distributions in excess of the qualified higher education expenses for the current year or billed through March 31 of the following year, will be nonqualified distributions, and a portion of the earnings will be taxable and subject to the 10% penalty.
Currently §529 is silent as to whether distributions from a QTP must be made in the same tax year as the qualified higher education expenses are paid or incurred. However, the IRS says it intends to issue proposed regs providing that, for the QTP earnings to be excluded from income, any distribution during the calendar year must be used to pay for qualified higher education expenses during the same calendar year or through March 31 of the following year. To determine the portion subject to tax and penalty, multiply the earnings by the ratio of nonqualified distributions to total distributions.
July 18, 2019
Question: Can my client, Wilma’s Auto Body Shop, offer a 401(k) and a SEP plan to its employees?
Answer: Yes, the 401(k) plan and SEP plan are both defined contribution plans and if the §415 limits are met per employee, then both plans can be offered. For 2019, the maximum employee elective deferral for the 401(k) plan is $19,000. The $19,000 is included in the §415 limit of $56,000 total per employee for 2019. The 401(k) employee deferral plus 401(k) employer matching contribution plus employer SEP contribution equals $56,000 or less per employee for tax year 2019.
July 11, 2019
Question: Harry and Sally are divorcing after many years of marriage. As part of the divorce settlement, Harry is required to transfer some of his stock to Sally. She wants to sell the stock, but Harry is being difficult. Since he won’t provide information about the stock, how does Sally determine her basis for gain or loss on the sale?
Answer: Because the stock was transferred incident to divorce, Sally’s basis in the stock under §1041(b) is Harry’s basis on the date of the transfer. Even though Harry is being difficult, he is required under Reg. §1.1041-1T(e) to provide Sally the records necessary to determine the adjusted basis and holding period of the stock. If Harry cannot establish basis in the stock, then Sally has no carryover basis and must use $0 basis for the stock sold.
July 3, 2019
Question: Ethan died in 2018. Although he did not have a taxable federal estate (Form 706), he had a taxable state estate. The executor is also filing Form 1041 reporting the estate’s income. Can the state estate taxes paid be deducted on the federal Form 1041?
Answer: No, state estate taxes are not deducted on the federal Form 1041. The following taxes cannot be deducted on the Form 1041 by an estate or trust:
- Federal income, duties, and excise taxes.
- Federal estate and gift taxes.
- Generation-skipping transfer taxes (unless imposed on income distributions).
- State estate, inheritance, legacy, succession, or gift taxes.
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