Another circuit holds that tax debt on late-filed return rarely dischargeable in bankruptcy

Experienced Tax Accountant –The Court of Appeals for the First Circuit has held that, except with respect to returns prepared with the assistance of IRS under Code Sec. 6020(a), debts for unpaid taxes from late-filed tax returns are not dischargeable in bankruptcy. In so doing, it came to the same conclusion as the Fifth and Tenth Circuits.

Background. 11 USC 727(b) provides for the discharge of all debts that arose before the date of a bankruptcy discharge order, except as provided in 11 USC 523. 11 USC 523(a)(1) excludes from discharge any debt for a tax “... (B) with respect to which a return..., if required (i) was not filed or given; or (ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition...”

11 USC 523(a)(1) also provides in flush language to that section (in what the First Circuit called “the hanging paragraph”) that, “for purposes of this subsection, the term 'return' means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to Code Sec. 6020(a)..., but does not include a return made pursuant to Code Sec. 6020(b).” The hanging paragraph was added to the Code in 2005, well after the rest of 11 USC 523(a)(1).

Code Sec. 6020(a) refers to a return prepared by IRS with the assistance of the taxpayer, and Code Sec. 6020(b) refers to a return prepared by IRS without the assistance of the taxpayer. Code Sec. 6020(a) returns are allowed only at IRS's request; returns filed under Code Sec. 6020(b) may involve willful fraud.

To qualify as a return under the Beard four-pronged test: (1) a document must purport to be a return; (2) it must be executed under penalty of perjury; (3) it must contain sufficient data to calculate tax liability; and (4) there must be an honest and reasonable attempt to satisfy the requirements of the tax law. (Beard, (1984) 82 TC 766)

Facts. The taxpayers all failed to timely file their Massachusetts income tax returns for multiple years in a row. They also failed to pay (either timely or otherwise) their taxes to the Massachusetts Department of Revenue. Eventually, each debtor filed his late tax returns, but still failed to pay all taxes, interest, and penalties that were due. More than two years later, they filed for Chapter 7 bankruptcy.

First Circuit says “no discharge.” The Court ruled that the plain meaning of the hanging paragraph, when read together with the language of the applicable Massachusetts law, which itself was very similar to the applicable Code section, meant that a Massachusetts tax return filed after the due date for that return is not a “return” for purposes of 11 USC 523(a)(1) and thus debt with regard to such a return is not dischargeable.

The Court said that, looking solely at the non-hanging paragraph part of 11 USC 523(a)(1), and using a common notion of what a “return” is, one could easily conclude that any return filed after the due date but more than two years before a bankruptcy filing would place the tax due under that return outside the 11 USC 523(a)(1) exception, and thus within the broad category of dischargeable debts. Prior to 2005, courts nevertheless attempted to fashion a definition of “return” that prevented debtors from relying on “bad faith” returns, or returns filed only after the taxing authority actually issued an assessment for taxes due in the absence of a tax return. (In re Moroney, (CA 4 2003) 92 AFTR 2d 2003-7381)

In 2005, Congress decided to define “return” on its own when it passed the Bankruptcy Abuse Prevention and Consumer Protection Act, which included the hanging paragraph. It provided that, to be a return, a document must satisfy the “applicable filing requirements.”

Like Code Sec. 6072, the relevant Massachusetts statute provided that income tax returns “shall be filed on or before” a given date. And, the Court said, like the Tenth Circuit in Mallo, (CA 10 2014) 114 AFTR 2d 2014-7022, and like the Fifth Circuit in McCoy v. Mississippi State Tax Commission, (CA 5 2012), 666 F3d 924: a) where the language of the statute is plain, it must be interpreted in accordance with the usual and natural meaning of the words, b) here the language of the statute is plain, and c) the phrase “shall be filed on or before” a particular date is a classic example of something that must be done with respect to filing a tax return and therefore is an “applicable filing requirement.”

The taxpayers and a dissenting judge had made a series of arguments to the effect that the 11 USC 523(a)(1) language was not “plain,” all of which the Court rejected.

First, the Court said that the dissent relied on the accurate premise that, when a statute states that the universe of X “includes” Y, one normally presumes that Y is merely an example of what is in X, and that X includes more than Y. The Court said that the dissent erred, though, in claiming that the Court's interpretation fails to satisfy this premise. The dissent made this error by presuming that the universe defined by the statute is “late-filed returns that count as returns,” and that Code Sec. 6020(a) returns (and “similar” state or local law returns) are therefore simply examples of a wider array of permitted late filed returns. The statute neither says nor implies any such thing. Rather, the statute provides that a “return” includes a “return prepared pursuant to Code Sec. 6020(a). . . or similar State or local law.” So one presumes only that a “return” includes more than these few types of returns. And it plainly does: it includes all sorts of returns that satisfy their respectively applicable filing requirements.

Second, the Court said, the dissent erred in claiming that the Court's reading of the statute “means that, conversely, a Code Sec. 6020(b) return would be the only type of return that is not a return.” This is plainly not so—any type of return not filed in accord with applicable filing requirements is not a "return" under the Court's reading of the statute. The returns at issue in this case were a notable demonstration that Code Sec. 6020(b) returns are not the only ones that are not returns under the statute.

Third, the taxpayers pointed to the language of 11 USC 523(a)(1)(B)(ii) (“the two-year provision”), which they said clearly implies that there can be a “return” that is filed within two years “after the date on which such return . . . was last due.” They said that this means that the hanging paragraph cannot be read as entirely excluding the possibility that a late return can also be a “return.” The taxpayers contended that the Court's interpretation would “vitiate in its entirety” the two-year provision, rendering it “superfluous,” thus violating a standard rule of statutory interpretation.

The Court said that the defect in this argument is that the hanging paragraph itself carves out an exception from its general rule, deeming one type of late return to be a return. It specifies that “a return prepared pursuant to Code Sec. 6020(a). . . or similar State or local law” qualifies as a “return,” while those prepared pursuant to Code Sec. 6020(b) do not. Code Sec. 6020(a) and Code Sec. 6020(b) can both be invoked when a taxpayer "fails to make" a proper return, including situations where the taxpayer is late in filing a return to IRS Therefore, a late tax return, if prepared in compliance with Code Sec. 6020(a) and filed within two years of the bankruptcy petition, is still a return (and the tax due thus dischargeable), notwithstanding its failure to meet the otherwise "applicable filing requirement" of a mandatory deadline. The fact that a late-filed Code Sec. 6020(a) return can still qualify as a "return" for 11 USC 523(a) purposes means that the two-year provision still has a role to play if the hanging paragraph's plain meaning controls.

Fourth, the dissent deemed it "absurd" to think that Congress would allow a discharge of taxes due with respect to a Code Sec. 6020(a) return prepared years after the due date, but not with respect to any other return that is one day late. The Court said that it saw no absurdity. Code Sec. 6020(a) is a tool for IRS, invoked solely at its discretion, when it decides obtaining help from the late filing taxpayer is to IRS's advantage. That Congress left IRS a carrot to offer a taxpayer in such infrequent cases does not mean that it was absurd for Congress not to extend this carrot categorically to large numbers of other late filers.

Finally, the taxpayers argued that the Court's reading of the hanging paragraph still renders unnecessary its last clause, i.e., the clause that states that the term "return" does not include "a return made pursuant to Code Sec. 6020(b)." The Court said that the taxpayers were correct on this point. Nevertheless, the Court said that it did not see this as the type of redundancy that invokes any effective application of the doctrine that a court try to read statutes so that no section is superfluous. Here, in context, it simply appears that in creating an exception for Code Sec. 6020(a), the drafters made clear (desiring a belt and suspenders) that they were not including its companion Code Sec. 6020(b). Whatever one thinks of this redundancy, it offers too little to parry the force of the observation that a requirement to file on time is a filing requirement.

References: For denial of discharge of taxes in bankruptcy where no return was filed or the return was filed late, see FTC 2d/FIN ¶  V-7364  ; United States Tax Reporter ¶  68,734.01  ; TG ¶  72009  .

If you would like more details about these or any other aspect of the law, please do not hesitate to call. I look forward to hearing from you. Click this link to view our YouTube video http://youtu.be/EYJdQtbPZAI

Amare Berhie

AB Tax Accounting

info@abataxaccounting.com

(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

Social Security Benefits and Your Taxes

Experienced Tax Accountant –If you receive Social Security benefits, you may have to pay federal income tax on part of your benefits. These IRS tips will help you determine whether or not you need to pay taxes on your benefits. They also explain the best way to file your tax return.

• Form SSA-1099.  If you received Social Security in 2014, you should receive a Form SSA-1099, Social Security Benefit Statement, showing the amount of your benefits.
• Only Social Security.  If Social Security was your only income in 2014, your benefits may not be taxable. You also may not need to file a federal income tax return. If you get income from other sources you may have to pay taxes on some of your benefits.
• Interactive Tax Assistant.  The IRS has a helpful tool that you can use to see if any of your benefits are taxable. Visit IRS.gov and use the Interactive Tax Assistant.
• Tax Formula.  Here’s a quick way to find out if you must pay taxes on your Social Security benefits: Add one-half of your Social Security to all your other income, including tax-exempt interest. Then compare the total to the base amount for your filing status. If your total is more than the base amount, some of your benefits may be taxable.
• Base Amounts.  The three base amounts are:

1. $25,000 – if you are single, head of household, qualifying widow or widower with a dependent child or married filing separately and lived apart from your spouse for all of 2014
2. $32,000 – if you are married filing jointly
3. $0 – if you are married filing separately and lived with your spouse at any time during the year

For more information on this topic, please do not hesitate to call. I look forward to hearing from you. Click this link to view our YouTube video http://youtu.be/EYJdQtbPZAI

Amare Berhie

AB Tax Accounting

info@abataxaccounting.com

(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

Caution is advised when outsourcing payroll payments

Experienced Tax Accountant –Outsourcing of payroll and related tax duties to payroll service providers can allow employers to streamline their business operations and painlessly meet filing deadlines and deposit requirements. However, employers who outsource their payroll responsibilities remain liable for all taxes, penalties and interest due. Recently, a business learned this lesson the hard way when it was victimized by its third party provider. However, IRS said it would help the business set up a payment plan to repay the amount owed. And IRS's website offers practical tips on avoiding problems when using payroll service providers.

Background. In general, to be excused for failure to timely pay taxes owed, a taxpayer must show that the failure (1) did not result from willful neglect, and (2) was due to reasonable cause. (Code Sec. 6651) Under the case law, including the Supreme Court's decision in Boyle, (S Ct 1985) 469 US 241, 55 AFTR 2d 85-1535, reliance on an agent is not a reasonable cause and does not excuse a taxpayer's failure to timely file a tax return. Applying this principle in a payroll tax context, the Third Circuit, affirming the district court, has held that an employer remained liable for payroll taxes and interest, even though it relied on a payroll firm to fulfill its employment tax obligations and the payroll firm had embezzled the money. The employer's reliance on the payroll firm and the payroll firm's failure to perform its task properly did not amount to reasonable cause for failure to pay the taxes. (Pediatric Affiliates P.A., (CA 3 4/16/2007) 99 AFTR 2d ¶2007-845.

Recent case in point. Accent Payroll Services (APS) was hired to provide payroll processing services for Tytan International L.L.C. from 2008 to 2010. APS was responsible for paying the wages of Tytan's employees, withholding employment taxes, filing Tytan's employment tax returns, and paying withheld employment taxes to IRS. The owner of APS, John M. Moore, transferred more than $2 million in employment tax withholdings from Tytan's bank account to his company's bank account. However, he only paid IRS approximately $1.3 million. To keep Tytan from receiving notices from IRS that taxes were not paid, Moore gave IRS an address for Tytan at a post office box he controlled. Moore was sentenced to 78 months in federal prison for filing false tax returns. Now, Tytan owes more than $744,000 to IRS. (U.S. District Attorney's Office, Kansas City Division News Release, Johnson County Tax Preparer Sentenced For Filing False Tax Return, Wire Fraud, can be accessed at http://www.justice.gov/usao-ks/pr/johnson-county-tax-preparer-pleads-guilty-filing-false-tax-return-wire-fraud).

To mitigate the damage, IRS said it was willing to help the Kansas employer set up a payment plan to repay the amount owed. “Businesses who utilize a third party for paying their payroll taxes must realize that if the taxes aren't paid, they are ultimately responsible for the tax liability,” said Sybil Smith, Special Agent in Charge of IRS Criminal Investigation. “The IRS will work with victims to set up payment plans or possibly reduce penalties.”

Practice suggestions from IRS. IRS's recently updated web page called “Outsourcing Payroll Duties” has guidance for employers on how to avoid the situation that Tytan found itself in. Two useful suggestions:

If there are any issues with an account, IRS will send correspondence to the employer at the address of record. Thus, IRS strongly suggests that the employer not change its address of record to that of the payroll service provider as it may significantly limit the employer's ability to be informed of tax matters involving their business.

Employers should ensure their payroll service providers are using the Electronic Federal Tax Payment System (EFTPS) so that employers can confirm that payments are being made on their behalf. Everyone should use EFTPS, and IRS regs require electronic payment for payroll taxes over $200,000 in a calendar year. Employers should register on the EFTPS system to get their own PIN and use this PIN to periodically verify payments. A red flag should go up the first time a service provider misses or makes a late payment. When an employer registers on EFTPS they will have on-line access to their payment history for 16 months. In addition, EFTPS allows employers to make any additional tax payments that their third-party provider is not making on their behalf such as estimated tax payments.

If you would like more details about these, please do not hesitate to call. I look forward to hearing from you. Click this link to view our YouTube video http://youtu.be/EYJdQtbPZAI

Amare Berhie

AB Tax Accounting

info@abataxaccounting.com

(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

Can an owner of rental real estate qualify as a real estate professional?

Experienced Tax Accountant –In addition to your regular business (which has nothing to do with real estate), you have a number of rental real estate properties that are throwing off losses that you'd like to deduct against your other income for tax purposes. As you may be aware, the passive activity loss (PAL) rules would normally make this impossible. Under those rules, losses from passive activities—that is, activities in which you do not “materially participate” (see below)—cannot be deducted against nonpassive activity income (such as salary, professional fees, income from a business in which you do materially participate, interest, or dividends); and credits from passive activities cannot be used to reduce taxes on nonpassive activity income. For purposes of the PAL rules, rental real estate activities are automatically treated as passive activities, even if the owner “materially participates” in their management, operations, etc. As a result, tax losses from rental realty can't be deducted against nonpassive income.

One important exception to this rule allows taxpayers to deduct up to $25,000 of losses and credits from passive rental real estate activities against nonpassive income, if they “actively participate” in those activities. (Active participation requires a lesser degree of participation than “material participation”). This exception phases out for taxpayers with adjusted gross income over $100,000.

There's another exception to the above rule that's even more potentially beneficial than the $25,000 active participation rule I just mentioned. If you qualify as a “real estate professional,” your rental real estate interests are not automatically treated as passive activities. As a result, if you materially participate in the rental real estate activity, the activity will not be treated as passive, and you will be entitled to deduct losses from that activity against nonpassive income. In addition, the amount of losses and credits allowed under the $25,000 active participation rule is determined after any recharacterization of rental real estate activities as nonpassive under the rules discussed above. As a result, if you're a real estate professional, you can deduct against nonpassive income not only losses and credits from rental real estate that are nonpassive under the above rules, but up to $25,000 of losses and credits from “active participation” rental real estate activities that remain passive after application of those rules.

How do you qualify as a real estate professional? First, you must materially participate (see below) in a real estate business. The business of renting and leasing realty is a real estate business. Second, more than 50% of the personal services you perform in all businesses during the year must be performed in real estate businesses in which you materially participate. Third, your personal services in material participation real property businesses during the year must amount to more than 750 hours. For these purposes, you can't count any work you perform in your capacity as an investor.

In determining whether you qualify as a real estate professional, each of your rental real estate interests is treated as a separate activity—that is, as a separate business—unless you make an election to treat all those interests as a single activity. Because of this rule, if you have multiple rental properties and you don't make the election, you must establish material participation for each property separately, and must satisfy the more-than-50% test and the 750-hours test for each property separately in order to qualify as a real estate professional with respect to that property—and qualifying for one property wouldn't mean you qualify for any other property. Thus, if you don't make the election, qualifying as a real estate professional for all your properties becomes more difficult (and may become impossible) as the number of properties increases. But if you do make the election, you only have to establish material participation, and satisfy the more-than-50% test and the 750-hours test, for the combined properties as a whole.

You don't have to work full-time in real estate to qualify as a real estate professional. Even if you have another occupation, you can qualify if you materially participate in a real estate business, and spend more time, and more than 750 hours, on that business. (But remember, in this case, if you have multiple properties, it may be difficult or impossible to qualify unless you make the “single interest” election mentioned above.)

These tests are applied annually. This means that you may qualify as a real estate professional in some years but not in other years. As a result, the same real estate activity may generate passive losses in some years and nonpassive losses in other years.

If you're a real estate professional, what more do you have to do to treat losses from rental real estate as nonpassive? If you qualify as a real estate professional, your rental real estate properties are not automatically treated as passive. This doesn't mean that they are automatically treated as nonpassive—it means that, if you materially participate (as explained below) in the operation of a rental real estate property, then it will be treated as nonpassive, and you may deduct losses from that property against other nonpassive income.

But if the real estate business that qualifies you as a real estate professional is the renting or leasing of real property, as discussed above, you will already have established that you materially participate in that business—because if you don't, you can't qualify as a real estate professional on the basis of that business (see above).

As I mentioned above, if you have multiple properties, you may not be able to qualify as a real estate professional unless you elect to treat all your rental real estate interests as a single activity. If you make the election, it applies both for purposes of qualifying you as a real estate professional, and for all other purposes of the PAL rules. And, generally speaking, the election is irrevocable. This means that you can't make the election in order to qualify as a real estate professional, and then revoke it with respect to a particular property later, when, for example, that property produces income, and you'd like to use that income to absorb losses from another non-real-estate-related passive activity. Making the election will also disqualify you from utilizing the $25,000 active participation rule mentioned above, because that rule applies only with respect to losses from rental real estate activities that are passive, and the election will—presumably—work to make your rental real estate properties nonpassive. (If making the election is the right course for you, I can make sure that it is made in a timely and proper fashion.)

What's material participation in an activity? Material participation in an activity means involvement in the operations of the activity on a regular, continuous, and substantial basis. If a taxpayer passes one of the following seven tests, IRS accepts that as establishing material participation in an activity:

• participating in the activity for more than 500 hours in the tax year (the most frequently utilized test);
• participating in the activity if the taxpayer's participation is substantially all of the participation in that activity by any individuals (including non-owners);
• participating in the activity for more than 100 hours in the tax year, if nobody else (including nonowners) participated more;
• participating significantly in the activity, if participation in all “significant participation” activities for the tax year exceeds 500 hours (but this test isn't accepted for showing material participation in rental activities);
• having materially participated in the activity during any five of the ten tax years before the year at issue;
• with respect to personal service activities, having materially participated in the activity for any three years (not necessarily consecutive) before the year at issue;
• showing regular, continuous and substantial participation on the basis of all the relevant facts and circumstances, but only if more than 100 hours of participation during the tax year can be shown (and management services aren't taken into account for purposes of this test unless certain stringent requirements are satisfied).

The extent of an individual's material participation in an activity may be established by any reasonable means. But the most reliable means of showing material participation consists of contemporaneously kept appointment books, calendars, daily time reports, logs, or similar documents that provide a detailed account of what the taxpayer did with respect to an activity, when he or she did it, and how much time it took. Failure to substantiate material participation is one of the most common ways of losing the right to treat rental real estate activities as nonpassive.

Please call me to schedule an in-depth review to determine whether you can qualify as a real estate professional, and how you might use the above rules to your advantage—or to discuss any other aspect of your business. I look forward to hearing from you. Click this link to view our YouTube video http://youtu.be/EYJdQtbPZAI

Amare Berhie

AB Tax Accounting

info@abataxaccounting.com

(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

Reporting requirement for recipients of foreign gifts

If the value of aggregate foreign gifts that you receive during any tax year exceeds a threshold amount, you must report each foreign gift to the IRS. A foreign gift is any amount you receive from a non-U.S. person which you treat as a gift or bequest. A non-U.S. person is any person other than a citizen or resident of the U.S. or a U.S. partnership or corporation. The term non-U.S. person also includes a foreign estate. Foreign gifts don't include qualified tuition or medical payments made on behalf of the recipient, or gifts which are otherwise properly disclosed on a return under the separate requirements applicable to amounts received from foreign trusts.

For purposes of determining whether the receipt of a gift from a foreign person is reportable, different reporting thresholds are applied for gifts received from nonresident alien individuals, and foreign estates, and for gifts from foreign partnerships, and foreign corporations. So, a U.S. person is required to report the receipt of gifts from a nonresident alien or foreign estate only if the total amount of gifts from that nonresident alien or foreign estate is more than $100,000 during the tax year. Once the $100,000 threshold has been met, the one who receives the gift must separately identify each gift which is more than $5,000, but doesn't have to identify the donor.

A U.S. person must report the receipt of purported gifts from foreign corporations and foreign partnerships if the total amount of purported gifts from all such entities during the tax year is more than $10,000, subject to cost-of-living adjustments. (If the total amount of gifts is more than $15,601 for tax years beginning in 2015; $15,358 for tax years beginning in 2014.) Once the threshold has been met, the gift recipient must separately identify all purported gifts from a foreign corporation or foreign partnership, and provide the name of the donor.

If you fall within these reporting rules, you have to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. The form is due on the date that your income tax return is due, including extensions. The form must be sent to the IRS at the address shown on the IRS website (irs.gov).

Where appropriate, I may be able to recommend planning approaches which may allow you to avoid the reporting requirements. For example, if you are expecting a gift of $120,000 from a nonresident alien individual or foreign estate, it may be possible to arrange for the gift to be paid over two years, so that in neither year does the gift exceed $100,000. If the split gift is the only foreign gift you receive each year, you will avoid the reporting requirement. Alternatively, if we can arrange for part of the gift to be made in the form of qualified tuition or medical payments, the rest of the gift may be reduced enough to avoid the reporting requirement.

The penalty for not reporting a foreign gift that must be reported is 5% of the amount of the gift for each month the failure to report continues, up to a maximum of 25%. The penalty will be excused if reasonable cause for the failure to report can be established.

Please call if you would like me to assist you regarding the requirements outlined above. Click this link to view our YouTube video http://youtu.be/EYJdQtbPZAI

Amare Berhie

AB Tax Accounting

info@abataxaccounting.com

(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

What You Should Know if You Changed Your Name

Experienced Tax Accountant – Did you change your name last year? If you did, it can affect your taxes. All the names on your tax return must match Social Security Administration records. A name mismatch can delay your refund. Here’s what you should know if you changed your name:

• Report Name Changes.  Did you get married and are now using your new spouse’s last name or hyphenated your last name? Did you divorce and go back to using your former last name? In either case, you should notify the SSA of your name change. That way, your new name on your IRS records will match up with your SSA records.
• Dependent Name Change.  Notify the SSA if your dependent had a name change. For example, this could apply if you adopted a child and the child’s last name changed.  
• If you adopted a child who does not have a SSN, you may use an Adoption Taxpayer Identification Number on your tax return. An ATIN is a temporary number. You can apply for an ATIN by filing Form W-7A, Application for Taxpayer Identification Number for Pending U.S. Adoptions, with the IRS.
• Get a New Card.  File Form SS-5, Application for a Social Security Card, to notify SSA of your name change. Your new card will show your new name with the same SSN you had before.
• Report Changes in Circumstances in 2015.  If you purchase health insurance coverage through the Health Insurance Marketplace you may get advance payments of the premium tax credit in 2015. If you do, be sure to report changes in circumstances, such as a name change, a new address and a change in your income or family size to your Marketplace throughout the year. Reporting changes will help make sure that you get the proper type and amount of financial assistance and will help you avoid getting too much or too little in advance. 

If you found this Tax Tip helpful, please share it through your social media platforms. Feel free to call me if you have specific questions or need additional information.

YouTube video http://youtu.be/KfO0_kmz7qc

Amare Berhie

AB Tax Accounting

info@abataxaccounting.com

Deducting travel expenses of teachers or professors for job-related education

Experienced Tax Accountant –As a teacher or professor, you've probably seen advertisements for job-related courses in exotic locales. You may have wondered whether such courses are tax-deductible. The answer depends on the specifics of the course and of your job situation.

If the education comes from the travel itself, the expenses aren't deductible. For example, a French teacher can't deduct the cost of a trip to France to maintain familiarity with the French language and culture.

Education in the form of a course that is related to your job as a teacher or professor may be deductible, but only if the course either maintains or improves skills that you need for your job, or meets your employer's requirements or the requirements of applicable law or regulations to maintain your job or salary.

But a course won't be deductible if it is needed to meet the minimum requirements to be a teacher. “Minimum requirements” refers to the college degree or minimum number of college hours required of a person hired as a teacher. For example, if state law requires beginning high school teachers to have a bachelor's degree and to complete a fifth year of training within 10 years of hire, the costs of the getting the bachelor's degree won't be deductible, but the costs of the fifth year will.

Once you have met the minimum requirements in your own state, you are considered to have met them in all states. Any additional courses you need to be certified in another state will qualify for deduction.

Education that qualifies you for a new trade or business is not deductible. But a change from elementary school teacher to secondary school teacher, from teacher of one subject to teacher of another, or from classroom teacher to guidance counselor or school administrator isn't considered a change to a new business.

If a course you've taken qualifies under the above rules, you can deduct your course expenses, such as tuition, fees, books, and supplies. Whether you can also deduct your travel, meal, and lodging expenses while away from home to take the course depends on the main purpose of the trip.

If the trip was mainly job-related, you can deduct the costs of travel, meals, and lodging, except for the part that is allocable to personal activities, such as sightseeing, recreation, or social visiting. If the trip was mainly personal, travel expenses aren't deductible, and meals and lodging are deductible only for the time that you attend the qualifying courses. Determining the purpose of the trip is largely a matter of comparing the time spent on job-related activities with time spent on personal activities.

To illustrate how these rules work, let's examine two cases that produced opposite results. In the first case, a teacher named Gloria went to Hawaii to attend a course on Hawaiian culture. In the second case, another teacher named Ann travelled to Thailand, Cambodia, and Indonesia to take a course on Southeast Asian religious traditions.

At first glance, the two courses appear similar. Yet only Ann got to deduct her travel expenses. What caused the difference?

Gloria, who was a science teacher, couldn't show a connection between her teaching and the course on Hawaiian culture. The most she could say was that the course gave her “better understanding of people.” That wasn't enough to justify the deduction.

Ann, who was an English teacher and chaired her high school's English department, was able to show how she applied what she learned to work more effectively with her Asian students and introduce new literary works into the curriculum.

In addition, the court was impressed by the fact that the course featured lectures by university professors and a substantial reading list. While the course did include visits to tourist sites, each visit served an educational purpose.

Ann was also able to prove that she spent most of her travel time on course activity. Because her trip was mainly job-related, Ann could deduct all of her expenses, including tuition, airfare, meals, and lodging.

Ann's successful experience suggests guidelines that you can follow to help you nail down the deduction for job-related education:

• Choose either a course that you must take in order to keep your job or salary or one that enhances your job skills in specific ways. Be sure that you can identify the ways in which your job skills were enhanced.
•  Make sure that the course you choose has a structured academic component and isn't just a glorified vacation. For example, there should be regular lectures, a syllabus, and reading assignments.
• If the course work occupied the majority of your time on the trip, keep records to prove that fact. If the trip was primarily personal, you should still keep a record of your meals and lodging expenses for the time that you attended the course, since those expenses are deductible.

I hope this overview of the deductibility of teachers' travel expenses for job-related education is helpful. Feel free to call me if you have specific questions or need additional information.

YouTube video http://youtu.be/EYJdQtbPZAI

Amare Berhie

AB Tax Accounting

info@abataxaccounting.com

(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

Self-employed deduction for health insurance costs

Experienced Tax Accountant –Self-employed taxpayers can deduct 100% of their health insurance costs in computing their income taxes. This tax savings can reduce your after-tax cost of health coverage.

A brief review of the tax rules on health insurance premiums may be useful. Health insurance premiums are deductible as itemized medical costs, but only to the extent your total medical expenses exceed 10% of your adjusted gross income (AGI). A more favorable 7.5%-of-AGI threshold applies if you or your spouse has reached age 65 by the end of the tax year.

If total medical expenses don't exceed 10%/7.5% of AGI, no itemized deduction is available. However, self-employed taxpayers can nevertheless deduct—as an “above the line” deduction, reducing AGI—100% of the health insurance costs for him or herself, his or her spouse, dependents, and for any child of the self-employed who is under age 27 as of the end of the tax year.

Example. Max, who is self-employed, pays $3,000 in health insurance premiums and has no other medical expenses. His AGI is $50,000. Since 10% of $50,000 equals $5,000, Max can't claim an itemized medical expense deduction for the health insurance premiums. However, since Max is self-employed, he can deduct the entire $3,000 above the line.These rules only apply for any calendar month in which you aren't otherwise eligible to participate in any subsidized health plan maintained by any employer of yours or of your spouse, or any plan maintained by any employer of your dependent or your under-age-27 child.

Also, the deduction can't exceed your earned income from the trade or business for which the health insurance plan was established.

These rules also apply to partners in partnerships and more-than-2% shareholders of S corporations where the partnership or corporation pays for health insurance coverage for its partners or shareholders.

The tax benefits of a self-employed individual's health insurance costs effectively can reduce your cost of health insurance. You may wish to consider stepping up your coverage in light of these savings. Please call if you wish to discuss how these rules apply to your particular situation or if you have any questions.

If you found this Tax Tip helpful, please share it through your social media platforms.

Amare Berhie,  AB Tax Accounting

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info@abataxaccounting.com

(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

How to take a loan from your controlled corporation and avoid dividend treatment

Controller Services – If you need to withdraw funds from your controlled corporation, you can structure the withdrawal so that it is not subject to tax as a dividend. While dividends are generally taxed to non-corporate shareholders at capital gains rates, a loan from a corporation to its shareholder is not subject to tax. However, even though no dividend has been declared, IRS can treat shareholder withdrawals of cash from a corporation as dividends, if they aren't structured properly.

A Tax Court case demonstrates what can happen when a shareholder isn't careful and treats a controlled corporation as though it were a personal bank account. In that case, a husband and wife wholly owned the corporation. The husband, Michael, ran the corporation, and dealt with it very informally. He took money out as needed for personal expenses, and received a $100 check along with each weekly paycheck. Michael and the corporation accounted for these withdrawals as “shareholder advances,” and both Michael and the corporation showed these advances as loans on financial statements that were given to third parties. At the end of every year, part of the outstanding balance of the shareholder advances account was repaid by crediting Michael's year-end bonuses against it. On audit, IRS determined that the shareholder advances weren't true loans, and treated them as dividends. The Tax Court agreed that the withdrawals were dividends and that the year-end repayments didn't establish existence of a true loans because there was no written agreements obligating Michael to repay the advances, the loans had no maturity date, no ceiling and no security, and the corporation had earnings and profits, but never made dividend distributions.

There are about a dozen factors that the courts look at to decide if a shareholder withdrawal is a loan or a dividend. Most of these are within your control. One important factor, for example, is whether there is a written promissory note. It isn't necessary that each of the factors point to a loan, but taken together they must be sufficient to establish that the withdrawal is not a dividend.

I would be happy to examine your dealings with your corporation. Where appropriate, I can help you structure withdrawals and other transactions with your corporation to alleviate the risk that your withdrawals will be subject to tax as dividends. If you found this Tax Tip helpful, please share it through your social media platforms.

Amare Berhie,  AB Tax Accounting

Click this link to view our YouTube video http://youtu.be/EYJdQtbPZAI

info@abataxaccounting.com

(651) 621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396

Bitcoin-tax planning in the uncertain world of virtual currency

Federal, State, Local and International Taxes - The use of bitcoin and other virtual currency has increased in recent years. It is estimated that over 80,000 businesses now accept bitcoin, including mainstream companies such as Overstock.com, 1-800 Flowers, and Dish Network.

 

Background. Bitcoin is an online digital currency that was created in 2009 by an unknown computer programmer using the alias Satoshi Nakamoto. Bitcoins are created by mining, a process whereby computers are used to solve complex mathematical problems. Miners who successfully solve these problems are rewarded with bitcoins. A finite number of bitcoins will be produced, so the recoverable pool of bitcoins is decreasing gradually. The number of bitcoins available to be mined is capped at 21 million and all bitcoins are expected to be mined by 2140. Once created, bitcoins can be sold, traded on an exchange, or used to buy goods and services. Bitcoin operates as virtual currency and has no physical form. Instead, bitcoins transfer from computer to computer using cryptographics. Each bitcoin consists of a coded Internet address that the owner stores in a digital wallet. Bitcoins are not backed by any government or bank and no one can be forced to accept them. Unlike credit cards, bitcoins have no processing fees. They are being accepted by an increasing number of businesses.

 

Taxation of virtual currency. IRS provided guidance on the U.S. tax consequences of transactions in, or transactions that use, convertible virtual currency (including bitcoin) in Notice 2014-21, 2014-6 IRB 938. This guidance, in Q&A format, applies well-established tax principles to virtual currency. Notice 2014-21 defines virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” It says although virtual currency operates like “real” currency and is customarily accepted as a medium of exchange, it does not have legal tender status. The Notice is the starting point for analyzing the tax consequences of bitcoin, but it does not address all of the issues. IRS recognized this and has requested public comments regarding other aspects of virtual currency transactions that should be addressed in future guidance.

 

Virtual currency is property. Virtual currency is treated as property for tax purposes, and the general tax principles that apply to property transactions apply to virtual currency. Notice 2014-21 says that taxpayers recognize gain or loss on the exchange of virtual currency for other property. As a result, gain or loss is recognized every time that bitcoin is used to purchase goods or services.

 

Treating bitcoin as property creates an accounting nightmare for taxpayers who use it for everyday purchases because a taxable transaction occurs every time that a bitcoin is exchanged for goods or services. There is currently no de minimis exception to this gain or loss recognition. Taxpayers must track their bitcoin's basis continuously to report the gain or loss recognized on each transaction properly. It is easy to see how this treatment can discourage the use of bitcoin for everyday transactions. The loss recognition on bitcoin transactions is particularly problematic. A deduction is allowed only for losses incurred in a trade or business or on a transaction entered into for profit. Whether bitcoin is held for investment or personal purposes may be difficult to determine, and further guidance is needed.

 

Basis and recordkeeping. It is important for bitcoin owners to properly track basis. Bitcoin's value has been extremely volatile since its inception. The default rule for tracking basis in securities is FIFO. Taxpayers can also determine basis in securities by using the last-in, first out (LIFO), average cost, or specific identification methods. The general opinion is that these methods should be available for property that does not qualify as a security, and that taxpayers investing in bitcoin should use the method that is most beneficial to them. However, no direct authority supports this position.

 

It may be difficult to use specific identification for bitcoin because it has no physical existence and is a divisible virtual currency. Taxpayers must track their bitcoin lots carefully to minimize gain. Each bitcoin purchase should be kept in a separate online wallet and appropriate records should be maintained to document when the wallet was established. If a taxpayer uses an account with several different wallet addresses and that account is later combined into a single wallet, it may not be possible to determine the original basis of bitcoin that is used in a subsequent transaction.

 

Character of gain or loss. The character of gain or loss on bitcoin transactions depends on whether the bitcoin is a capital asset in the taxpayer's hands. Gain on the sale of bitcoin that qualifies as a capital asset is netted with other capital gains and losses. A net long-term capital gain that includes gain on bitcoin transactions is eligible for the preferential tax rates on long-term capital gains.

 

Bitcoin gain constitutes unearned income for purposes of the unearned income Medicare contributions tax introduced as part of the Affordable Care Act. As a result, taxpayers with modified adjusted gross income over $200,000 ($250,000 for married taxpayers filing jointly) are subject to an additional 3.8% tax on bitcoin gain.

 

Code Sec. 475 says that any security that is inventory in the hands of a dealer is included in inventory at FMV. Also, unless specifically identified as held for investment, securities that are not inventory are marked to market and treated as sold on the last business day of the year. IRS has not provided guidance on whether bitcoin is a security, and it is unclear whether the rules of Code Sec. 475 apply to bitcoin dealers. Whether bitcoin is classified as a security also determines its treatment under the wash sale and like-kind exchange rules.

 

Virtual currency is not currency. Virtual currency is not treated as currency that can generate foreign currency gain or loss. Treating bitcoin as property rather than currency is favorable to investors because of the preferential tax rate on long-term capital gain. Foreign currency gain or loss is treated as ordinary income under Code Sec. 988. Because bitcoin is not currency for foreign currency gain or loss purposes, individuals are not eligible for the $200 per incident exception for foreign currency gain or loss recognition.

 

Mining bitcoin. A taxpayer who successfully mines bitcoin recognizes gross income equal to the FMV of the bitcoin on the date of receipt. The FMV of bitcoin received must be reported in U.S. currency as of the date of receipt. Notice 2014-21 says that if virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the FMV is determined by converting the virtual currency into U.S. dollars at the exchange rate “in a reasonable manner that is consistently applied.” The exact manner to be used (e.g., highest daily value, average daily value, lowest daily value) is not described. Taxpayers should be able to use a method that minimizes income recognition as long as the method is applied consistently.

 

Information reporting. A payment made with bitcoin is subject to information reporting to the same extent as any payment made in property. Any person who, in the course of a trade or business, pays $600 or more to a U.S. nonexempt recipient is subject to information reporting. The value of bitcoin is aggregated with other currency when determining whether the $600 threshold is met. A person in a trade or business who pays $600 or more to an independent contractor for the performance of services is required to report the income on Form 1099-MISC. Payments using bitcoin should be reported using the FMV as of the date of payment. Payments made using bitcoin are subject to backup withholding to the same extent as other payments. Payors using bitcoin must solicit a taxpayer identification number (TIN) from the payee and backup withhold if a TIN is not obtained prior to payment.

 

FBAR and FATCA disclosure. Whether bitcoin must be disclosed under the Bank Secrecy Act or the Foreign Account Tax Compliance Act (FATCA) is unresolved. IRS informally stated that U.S. taxpayers are not required to report bitcoin on FBAR for 2013 but acknowledged that it is continuing to analyze virtual currency and this policy could change in the future. It has not indicated whether bitcoin will be subject to FBAR reporting in 2014. Most bitcoin brokers and exchanges accept deposits in the ordinary course of business and meet the definition of a financial institution for FATCA purposes. For both FBAR and FATCA reporting, tax practitioners should consider a conservative course of action and recommend disclosure in appropriate situations.

 

Conclusion. Bitcoin is treated as property for tax purposes, but that treatment is the beginning of the analysis, rather than the end and several issues remain unsettled. IRS will likely address the unsettled tax aspects of bitcoin and other virtual currency in future guidance.

 

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AB Tax Accounting

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The Affordable Care Act’s Employer Shared Responsibility Provisions

Experienced Tax Accountant – Employers that are considered “applicable large employers” are subject to the employer shared responsibility provisions of the Affordable Care Act. In general, an applicable large employer is an employer with at least 50 full-time employees or an employer with both full-time and part-time employees whose hours add up to the equivalent of at least 50 full-time employees.

In general, an applicable large employer either must offer affordable health insurance coverage that provides a minimum level of coverage to its full-time employees and their dependents or make a payment to the IRS, if at least one of its full-time employees receives a premium tax credit in connection with purchasing health care coverage through the Health Insurance Marketplace.

The employer shared responsibility provisions apply as of January 1, 2015. Employers should get prepared and make decisions regarding health insurance coverage offered to their employees. No employer shared responsibility payments will be due for 2014.

Full-time employees and full-time-equivalent employees

Under the employer shared responsibility provisions, a full-time employee is an individual employed on average at least 30 hours of service per week, per month, or 130 hours of service per month. The final regulations under the employer shared responsibility provisions include much more information on the determination of full-time employees.

A full-time equivalent employee is two or more employees who are not full-time employees whose hours combined are the equivalent to a full-time employee. An employer’s number of full-time equivalent employees is only relevant to whether the employer is an applicable large employer, and an employer need not offer coverage to part-time employees who combine to result in full-time equivalent employees in order not to be subject to an employer shared responsibility payment. For purposes of determining whether an employer is an applicable large employer, two or more part-time employees could equal one full-time equivalent employee. For instance, two part-time employees each with 15 hours of service per week would equal one full-time-equivalent employee.

Employers use information about the number of employees they employ and their hours of service during 2014 to figure if they have enough employees to be considered an applicable large employer for 2015.

Special rules

Because an employer will be calculating its number of full-time employees and full-time equivalent employees for the first time for 2015, there is a transition rule intended to make this first calculation easier.

Rather than being required to use the full twelve months of 2014 to figure out if an employer has at least 50 full-time employees and full-time-equivalent employees, an employer may measure during any consecutive six-month period as chosen by the employer during 2014. This is most helpful to those employers who are near the 50-employee mark.

Additionally, employers with 50 to 99 full-time and full-time-equivalent employees in 2014 will not be subject to an employer shared responsibility payment for 2015, if the employer meets certain conditions described in the preamble to the final regulations under the employer shared responsibility provisions. However, such an employer is still required to complete information reporting for 2015.

There are various other kinds of transition relief available for employers for 2015, described in the preamble to the final regulations under the employer shared responsibility provisions. If you found this Tax Tip helpful, please share it through your social media platforms.

Amare Berhie

AB Tax Accounting

Click this link to view our YouTube video http://youtu.be/EYJdQtbPZAI