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Court saw rollover limit from taxpayer’s viewpoint

 

Appalled by what it called the IRS’s unfair argument, the Court of Appeals for the Eighth Circuit has reversed a Tax Court decision that a taxpayer did not make a timely rollover to his IRA from which he previously had made IRA withdrawals at different times.

The Tax Court had held that the rollover, which was in the same amount as one of the withdrawals, was not timely because it was not made within 60 days of that withdrawal. However, the Eighth Circuit found that the rollover occurred within 60 days of a withdrawal in a larger amount and thus

qualified as a valid partial rollover.

During 2007, Harry Haury made four withdrawals from his IRA:

➤ Feb. 15 – $120,000

➤ April 9 – $168,000

➤ May 14 – $100,000

➤ July 6 – $46,933

On April 30, 2007, Haury deposited $120,000 into his IRA. The IRS matched the $120,000 contribution with the $120,000 distribution and concluded more than 60 days had elapsed, precluding rollover treatment. The Tax Court agreed with the IRS.

On appeal, Haury argued that the $120,000 contribution occurred within 60 days of the April 9 distribution and rollover treatment should be allowed. The appellate court agreed with Haury (Haury v. Commissioner, CA-8, wMay 12, 2014).

During the appeal, the IRS acknowledged that the 60-day limit was satisfied. However, the IRS argued that the partial rollover defense was forfeited because Haury had failed to argue it to the Tax Court. The appellate court rejected this contention.

Then the IRS tried to argue that Haury failed to prove that he had not already exercised his one-rollover-per-year opportunity within the 12 months preceding this transaction.

The appellate court characterized this argument as silly and factually without merit since the IRS agreed that it had access to the transactions in Haury’s IRA account during the year leading up to April 30, 2007. There were no prior rollovers in the records.

Important Reminder: The IRS has historically applied the one-rollover-per-year rule separately to each IRA. However, starting with distributions made after 2014, it intends to apply the rule on a more restrictive aggregate basis.

©2014 CPAmerica International

 

A recent Tax Court decision serves to re-emphasize that, when the owner of a hobby-like activity meets the requisite profit motive in one year, the courts may not necessarily apply that profit motivation to other years. Each year will be tested on its own.

Merrill Roberts is a former nightclub owner who became a horse breeder. Despite his rudimentary recordkeeping system and history of large losses, his profit objective was shown by the following facts:

➤ He liquidated his old, unsuitable facility and moved his activity to new property on which he built a premier training facility.

➤ He hired an assistant trainer.

➤ His accounting methods allowed him to make informed business decisions.

➤ He consulted with bloodstock agents and respected trainers on various business aspects.

Further, Roberts was asked by peers to run for leadership roles in professional horse racing organizations and lobbied for horse racing interests. He spent substantial time on business and was successful in his prior business ventures.

However, the court found that Roberts did not engage in the activity with the required profit motive during the earliest two years involved in the case. The court determined that his primary motivation in those years was as an investor in real estate.

The court said that Roberts’ participation in horse-related activities during those two years was equally divided between the social aspects and the business aspects of horse racing (Merrill C. Roberts v. Commissioner, TC Memo 2014-74, April 29, 2014).

Roberts avoided accuracy-related penalties during the earlier years by demonstrating reasonable cause/good faith for his tax positions. ■

©2014 CPAmerica International

 

The IRS has introduced a new one-year pilot program providing administrative relief to plan administrators and plan sponsors of certain retirement plans that must file with the IRS – but not the Department of Labor.

The one-year pilot program, established by Revenue Procedure 2014-32, provides relief to plan administrators who fail to timely file Form 5500-EZ. The relief is available to the plan administrator or plan sponsor of certain one-participant plans and certain foreign plans. No penalty will be assessed for late filing.

The applicant’s submission must include a complete Form 5500 Series Annual Return/Report, including all required schedules and attachments, for each plan year for which the applicant is seeking penalty relief. All returns must be sent to the IRS and cannot be filed through the Department of Labor (DOL) EFAST2 filing system. The relief is effective on June 2, 2014, and will remain in effect until June 2, 2015.

In addition, the IRS recently issued Notice 2014-35 to provide relief for late filers that satisfy certain requirements as well as the Delinquent Filer Voluntary Compliance (DFVC) Program administered by the DOL Employee Benefits Security Administration.

The IRS will not impose penalties for late filing of Form 5500, Form 5500-SF and Form 8955-SSA if the filer:

➤ Is eligible for, and satisfies the requirements of, the DFVC Program with respect to a delinquent Form 5500 series return; and

➤ Separately files with the IRS, within the prescribed time, a Form 8955-SSA with any information required to be filed for the year to which the DFVC filing relates.

Any Form 8955-SSA required to be filed with the IRS must be filed on paper by the later of 30 calendar days after the filer completes the DFVC filing or Dec. 1, 2014.

©2014 CPAmerica International

 

Parents and grandparents often lend money to their children or grandchildren to help with major expenditures like education, a wedding or the purchase of a new home.

Similarly, closely held businesses may lend money to shareholder-employees. And business owners sometimes lend money to the business to assist with expansion plans.

All of these transactions are examples of related-party loans.

Not surprisingly, the IRS requires that loans be structured in a business-like manner with terms that reflect current market conditions. If the loan terms are deemed too favorable, the IRS has the ability to recharacterize the loan – perhaps as a gift, additional compensation, or a corporate dividend or distribution – with all the tax implications that a recharacterization implies.

For no-interest or below-market interest loans, the IRS also has the right to reflect the current “market” interest rate for tax purposes by requiring that the lender take into income more interest than was actually received under the terms of the loan. The interest for tax purposes is calculated based on the Applicable Federal Rate (AFR).

The IRS publishes AFRs each month. They represent the minimum acceptable interest rates for most loans. If the interest rate on your loan at its inception is equal to or exceeds the relevant AFR, the IRS cannot challenge the appropriateness of the rate during the term of the loan.

AFRs include annual, semiannual, quarterly and monthly rates for short-term loans (terms of three years or less), mid-term loans (terms over three years but not exceeding nine years) and long-term loans (terms longer than nine years).

The recently published AFRs for May 2014 are as follows:

AFR                                                               Interest Compounding Period

                                        Annual              Semiannual               Quarterly                Monthly

Short-term                   0.33%                     0.33%                      0.33%                       0.33%
Mid-term                       1.93%                      1.92%                      1.92%                         1.91%
Long-term                     3.27%                      3.24%                     3.23%                         3.22%

To ensure that the IRS recognizes your transaction as a loan for tax purposes and does not recharacterize it as something else – a gift, additional compensation, or a corporate dividend or distribution, for example – you should have a written loan document or promissory note with an interest rate at least equal to the applicable AFR.

The borrower should sign and date the document, which should describe the terms of the loan, including loan amount, interest rate, payment schedule and any other terms. If your borrower is providing collateral, include a detailed description.

If the IRS determines that the interest rate for your loan is below the prescribed minimum established by the AFR, the loan is subject to the below-market loan rules. These rules generally require the lender and the borrower to recognize interest income and interest expense for federal tax purposes based on the relevant AFR rather than the loan’s actual interest rate.

For a demand loan, without a fixed loan term and end date, the Applicable Federal Rate used to calculate interest for tax purposes varies each month, based on fluctuations in the AFR. For a term loan, with a documented loan term and end date, the interest calculation is based on the relevant AFR as of the loan’s start date.

There is an exception to the below-market loan rules for a loan with a total amount outstanding between lender and borrower that does not exceed $10,000, if the loan is not for tax avoidance purposes.

If you create a new term loan now, when the AFR is near its all-time low, you can lock in a very favorable interest rate.

The tax rules governing below-market and related-party loans are complex with a number of exceptions. To understand all of the tax implications, consult your taxadviser before you enter into or renegotiate any loan.

©2014 CPAmerica International

 

It’s a little scary to contemplate that Social Security trust funds are projected to be exhausted in the not-too-distant future. But that is the subject recently studied in a 2013 report from the Congressional Research Services (CRS).

If the trust funds cannot pay current expenses out of current income or accumulated assets, they are considered to be exhausted or insolvent, and that means the Social Security trusts funds cannot pay full current benefits on time. The report projects that without change, the trust funds will be insolvent by 2033. And that same year the program is projected to have enough income to pay only about 77% of scheduled benefits. The law provides that any individual who meets the eligibility requirement is entitled to benefits, which means the government is legally obligated to pay benefits to such individuals. If the government fails to pay the benefits provided by law, beneficiaries could take legal action. Insolvency does not relieve the government of its obligation to provide benefits.

The CRS study puts forth various scenarios that might take place in the future regarding Social Security benefit payments. If Congress has the will to act sooner rather than later, the less draconian the required changes necessary to maintain full benefit payments will be. The affect of earlier changes would be spread over a large number of workers and beneficiaries over a longer period of time. And prompt action would also allow Congress to more gradually phase in the necessary changes, rather than waiting until 2033 and abruptly cutting benefits and/or raising taxes. Early action would also make it easier for workers to plan for their retirements.

If Congress waits until 2033 the trust funds’ annual deficit could be eliminated with a cut in benefits of about 23%, rising to 27% by 2087. If Congress acts today, the necessary changes would be about half as large as those needed if Congress waits until the trust funds become insolvent.

Scary, yes. But we should hope for the changes to be made sooner than later.

 

 

A recent case demonstrates the difficulties involved in securing a tax deduction from transactions between related parties.

Bad debt deduction

In 1990, Robert Alpert established two irrevocable trusts to fund his two sons’ educations. In 1996, he established a third trust for the benefit of his sons.

Between 1990 and 1996, Alpert transferred $1.1 million to the trusts. In January 1996, the trustee of each of the trusts signed a promissory note to Alpert. No funds were actually transferred in connection with the promissory notes.

Rather, the amounts stated as owed approximated the net funds Alpert had previously advanced to each trust. Subsequently, Alpert continued to transfer moneys to the trusts, but no additional promissory notes were executed.

In 2006, Alpert reported a $1.9 million nonbusiness bad debt deduction on account of worthless debts owed him by the 1990 trusts.

The IRS argued that Alpert was not entitled to the bad debt deduction because he did not establish that:

➜ The transfers to the trusts were bona fide debts;

➜ He was the debt holder in 2006; and

➜ The debts became worthless in 2006.

In concluding that the transfers were not bona fide debts, the court noted that:

➜ The beneficiaries of the trusts were Alpert’s sons.

➜ There was no written agreement with respect to the majority of the transfers.

➜ There was no evident plan of repayment.

The court then said that, even if the transfers represented bona fide indebtedness, Alpert failed to establish that he was the creditor in 2006. Finally, the court found that Alpert failed to show that the debts became wholly worthless in 2006, particularly since the trusts were not insolvent.

Indemnification loss

Alpert was the founder of Aviation Sales Co. (AVS), a publicly traded company. He also had trading authority over his mother’s brokerage accounts.

Acting without his mother’s knowledge, Alpert purchased AVS shares for her at a cost of $2 million. The share price of AVS declined precipitously, and when Mrs. Alpert learned of the purchases, she threatened to sue.

Alpert orally promised his mother that he would cover any losses she incurred if she sold the AVS shares at a loss. In exchange, she agreed that he would share in half of any profits if the shares were sold at a gain. Those promises were later memorialized in a letter.

In 2006, Alpert reported a loss, which he identified as “Indemnification Payment to G. Alpert.” Alpert contended that he was entitled to a loss for his indemnification payments because:

➜ His trade or business involved acquiring majority ownership positions in distressed companies, improving their operations and profitability, and taking them public;

➜ In so doing, he sought out and enlisted other investors for the purpose of acquiring these companies; and

➜ The indemnification agreement with his mother was part of that business process.

In rejecting Alpert’s argument, the court said that the indemnification agreement and the losses stemming from it were not incurred in his business activities. The court said that it was clear from the letter agreement between Alpert and his mother that he was trying to protect himself from liability for mismanagement of his mother’s assets, not from his business activities. (Robert Alpert v. Commissioner, TC Memo 2014-70, April 17, 2014) .

©2014 CPAmerica International

The Tax Court recently concluded that, when the taxpayers in the case asserted that they had reasonable cause and acted in good faith as a defense to penalties assessed by the IRS, they forfeited their privilege protecting attorney-client
communications.

In this case (Ad Investment 2000 Fund, LLC, et.al. v. Commissioner, 142 TC No. 13, April 16, 2014), the IRS asserted that the taxpayers engaged in transactions designed to create artificial tax losses. The IRS also assessed penalties attributable to:

A substantial understatement of income tax;
A gross valuation misstatement; and/or
Negligence or disregard of rules and regulations.

Anticipating the taxpayers’ argument that the penalties should not apply because they acted with reasonable cause and in good faith, the IRS asked the court to compel production of six tax opinion letters the taxpayers had obtained from their law firm.

The taxpayers objected to the disclosure on the grounds that the letters were privileged attorney-client communications. The IRS argued that the taxpayers waived any privilege under the common-law doctrine of implied waiver by relying on affirmative defenses to the penalties that turn on the taxpayers’ beliefs or state of mind. The taxpayers contended that they had developed their reasonable belief by analyzing the pertinent facts and authorities and not by any reliance on advice from their attorneys.

The court concluded that, by putting the taxpayers’ legal knowledge and understanding into contention to establish good-faith and state-of-mind defenses, the taxpayers forfeited the privilege protecting attorney-client communications relevant to the content and formation of their legal knowledge, understanding and beliefs.

The court reasoned that the taxpayers must show that they analyzed the pertinent facts and legal authorities and, in reliance upon that analysis, reasonably concluded in good faith that there was a greater than 50 percent likelihood that the tax treatment would be upheld if challenged. This put into contention their knowledge of the pertinent legal authorities, their understanding of those legal authorities and their application of the legal authorities to the facts.

The court noted that the taxpayers received the opinions well before their tax returns were due and they did not claim that they ignored the opinions. If the opinions formed the basis for the taxpayers’ beliefs, the court concluded that it is only fair to allow the IRS to review those opinions.

©2014 CPAmerica International

The IRS has released a draft of a shorter, less burdensome version of the regular Form 1023 – Form 1023-EZ – for organizations that plan to apply for tax-exempt status. It is not currently available for use.

When finalized, the two-page Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, may be used if an organization meets specific criteria. Organizations that would normally file Form 1023 will be able to file Form 1023-EZ if they meet all of the following requirements:

Some organizations may be considered tax-exempt under Section 501(c)(3) even if they do not file Form 1023 or 1023-EZ. These include churches, synagogues, temples and mosques, integrated auxiliaries of churches and conventions or associations of churches, and any organization that has gross receipts in each tax year of normally not more than $5,000. However, the IRS cautions that, even though these organizations are not required to file Form 1023 or 1023-EZ to be tax-exempt, they may be liable for annual filing requirements.

If an organization files Form 1023-EZ within 27 months after the end of the month in which it was legally formed, and the IRS approves the application, the legal date of formation will be the effective date of its exempt status. If it did not file Form 1023-EZ within 27 months of formation, the effective date of its exempt status will be the postmark date when it filed Form 1023-EZ.

If an organization did not file Form 1023-EZ within 27 months of formation, and it believes it qualifies for an earlier effective date than the postmark date, it must file Form 8940 after it receives exemption to request the earlier date. Alternatively, it could complete Form 1023 in its entirety instead of completing Form 1023-EZ.

©2014 CPAmerica International

 

With April 15 behind us, most taxpayers have filed their income tax returns. If for some reason, people have yet to file their 2013 return, they may owe interest and penalties when the return is ultimately filed.

It is important to note that interest and penalties are charged only if taxes are owed. If the return shows a refund, no interest or penalties apply, even if the return is filed late.

Here are eight points you should know about interest and late penalties:

  1. The IRS checks all returns for mathematical accuracy. If the IRS finds you owe more money,it will send you a bill.
  2.  Interest is generally charged on any unpaid tax from the due date of the return until the date of payment. The interest rate is determined quarterly and is the federal short-term rate plus 3 percent. Interest is compounded daily. Currently, the interest rate is 3 percent because the federal short-term interest rate is 0 percent.
  3. In addition to interest, if you file a return but do not pay the entire amount due on time, you will generally have to pay a late payment penalty of one-half of one percent for each month, or part of a month, up to a maximum of 25 percent, on the amount of tax that remains unpaid.
  4. If you owe tax and do not file your return on time, a separate failure-to-file penalty is usually 5 percent of the tax owed for each month, or part of a month, that your return is late, up to five months. If your return is over 60 days late, the minimum penalty for late filing is the lesser of $135 or 100 percent of the tax owed.
  5.  The failure-to-file penalty is usually much more than the failure-to-pay penalty. In most cases, it is 10 times more, so those who cannot pay what they owe by the due date should still file their tax return on time, or file for an extension, and pay as much as they can.
  6. The maximum penalty for failure to file and for failure to pay is 25 percent of the amount of tax owed, so the combined maximum is 50 percent of the tax owed.
  7. The penalties for filing and paying late may be abated if you have reasonable cause and the failure was not due to willful neglect. Generally, interest charges are not abated. They continue to accrue until all assessed tax, penalties and interest are paid in full.
  8. If you requested an extension of time to file your income tax return by the tax due date and paid at least 90 percent of the taxes you owe, you may not face a failure-to-pay penalty. However, you must pay the remaining balance by the extended due date. You will owe interest on any taxes you pay after the April 15 due date.

©2014 CPAmerica International

 

Are you 65 or older, have Medicare, and other insurance coverage such as a group health plan from an employer? Who is the “primary payer” responsible for paying your medical bills first?

When there’s more than one payer, “coordination of benefits” rules decide who pays first. The “primary payer” pays what it owes on your bills first, and then your provider send the rest to the “secondary payer” to pay. There may be a “third payer” in some cases.

Who the “primary payer” is depends on a number of things including the number of employees in the company that is providing the group health care coverage. Generally, your group health plan pay first if you’re 65 or older, covered by a group health plan through a current employer and the employer has 20 or more employees. Your health care provider should bill Medicare if the group health plan did not pay all of your bill. Medicare generally will pay first if your employer has less than 20 employees.

Medicare becomes your “primary payer” after you retire at 65 or older.

There are various situations and type(s) of coverage that determines who the “primary payer” will be. Situations and coverage include disability, COBRA coverage, medical expenses from an accident, workers’ compensation coverage or Veterans’ coverage.

Medicare has a 32 page booklet entitled “Medicare and Other Health Benefits: Your Guide to who Pays First” that’s available at www.medicare.gov/publications or by calling 1-800-MEDICARE (1-800-633-4227) to get the most current information. TTY users should call 1-877-486-2048.

 





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