Dawn Connolly, Author at Barnard Vogler & Company

A Lockheed Martin employee who participated in the company’s retirement plan was ordered to pay tax on distributions because he couldn’t provide documentation that he had rolled over the account in time.

Balvin A. McKnight was required to include in income two early distributions from his qualified retirement plan because he could not prove to the Tax Court that he had actually rolled that money over into another account within 60 days of the distributions.

McKnight was a participant in the Lockheed Martin Salaried Savings Plan, a qualified retirement plan. State Street Retiree Services was the custodian of McKnight’s account.

During 2011, State Street Retiree Services issued to McKnight two Forms 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

The first Form 1099-R reported a gross distribution of $4,984, which was also the taxable amount. There was no federal withholding on this amount. The distribution was classified as an early distribution, with no known exception.

The second Form 1099-R reported a gross distribution of $206,515, which was also the taxable amount. Federal income tax of $48,303 was withheld. The distribution was classified as an early distribution, with no known exception.

When McKnight filed his 2011 Form 1040 return, he listed retirement distributions of $206,516 and $48,304 as the taxable amounts.

The IRS examined his return and determined that the first distribution amount of $4,984 was not picked up as income on his return. They also determined that the entire amount of both distributions, which equaled $211,499, was taxable.

Under IRS code, any amount distributed from an employee’s trust account is taxable to the person who receives the distribution. The facts establish that $211,499 was actually distributed to McKnight in 2011 by State Street Retiree Services, the custodian for Lockheed Martin’s employee retirement trust account. This amount is taxable unless an exclusion applies.

An IRS code section provides a “rollover” exception to the general rule. It excludes from gross income any portion of a distribution that is transferred to an eligible retirement plan made within 60 days of the distribution.

McKnight claims that he rolled over $95,000 of the distribution but was unable to provide the IRS or the court with any documentation of this rollover. Because McKnight didn’t offer the court any proof of the rollover, the entire distribution of $211,499 was determined to be taxable income (Balvin Anthony McKnight v. Commissioner, U.S. Tax Court, T.C. Memo 2015-47, 109 T.C.M. 1224, March 16, 2015). ■

A New York couple who had received an enterprise zone credit for property taxes were required to pay taxes on the amount because of the tax benefit rule.

Yigal and Bonnie Elbaz were required to include in income $54,507 received in 2008 from a refund of New York state income taxes as a result of the tax benefit rule. The entities receiving the benefits were actually flow-through entities.

The Elbazes owned three different companies organized as flow-through entities – in which income passes on to the owners or investors.

They had a 50 percent interest in all three of the entities. Superflex Management, LLC, was treated as a partnership for federal income tax purposes. Superflex Realty, LLC, was treated as an LLC for federal income tax purposes.

The state of New York provides tax benefits to businesses that invest in certain designated areas of the state. One of these benefits is the Qualified Empire Zone Enterprise credit for real property taxes.

In calculating this credit, the amount of property taxes paid or incurred by a business is a major factor. All three of the businesses owned by the Elbazes qualified for this credit.

The Elbazes’ three businesses deducted the share of property taxes that they had paid or incurred during 2007. These expenses decreased the amount of income allocated to them on their respective K-1 schedules. This is where the tax benefit comes in.

The taxpayers report less income on their 1040 return as a result of the businesses having deducted the property taxes paid or incurred.

The $54,507 refund received in 2008 by the taxpayers was a direct result of the Qualified Empire Zone Enterprise credit. The credit was calculated using the property taxes paid or incurred by the three flow-through entities owned by the taxpayers.

Therefore, the $54,507 was the receipt of a refund of a previously deducted tax and was fundamentally inconsistent with the previous treatment to the extent that the Elbazes benefited from the decreased pass-through income. Thus, the $54,507 is considered to be taxable income (Yigal Elbaz and Bonnie Elbaz v. Commissioner, U.S. Tax Court, T.C. Memo 2015-49, March 17, 2015). ■

To deduct your elderly parent as a dependent on your income tax return, you must first meet four tests.

The tests are:

1. “Not a qualifying child” test

2. Member-of-household or relationship test

3. Gross income test

4. Support test

The first test is the easiest to meet. By definition, a qualifying child is a son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, half brother, half sister or descendant of any one of them.

As you can see from this definition, your mother and father do not fit this defined terminology. So your parents cannot be your qualifying child.

To meet the member-of-household or relationship test, the person must have lived with you the entire year or be part of a group of persons not required to live with you.

The IRS publishes a list of persons who are not required to live with you. Your father and mother are on that list, so you can meet this test without having either one or both of your parents live with you at any time during the year. Your parents must be citizens, nationals or residents of the United States or residents of Canada or Mexico.

This rule is very helpful to you if you want to deduct your elderly parents as dependents on your tax return despite the fact that your parents are in a nursing home or some other type of care facility.

The gross income test is met if a person’s gross income for the year is less than the personal exemption amount – $3,950 in 2014 and $4,000 in 2015. Gross income is all income in the form of money, property and services that is not exempt from tax.

The gross income test works out well in a situation where the elderly parent has only Social Security income or minimal sources of other income in addition to Social Security. In this situation, all of the Social Security income is generally nontaxable income, allowing the elderly parent to meet the gross income test.

The support test is met if you provide more than half of your elderly parent’s support. Total support includes amount spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation and similar necessities. The IRS provides taxpayers with a worksheet to help in making this calculation.

If you make a lump-sum advance payment to a nursing home to take care of your elderly parent for life, and the payment amount is based on the parent’s life expectancy, the amount of support provided each year is the lump-sum payment divided by the parent’s life expectancy.

If you are making monthly payments to the nursing home facility, this monthly amount times 12 months would be considered part of the support you provided.

If you are helping to support an elderly parent who is in a nursing home or some other type of care facility, take the time to look into the gross income and support tests. You might discover you are entitled to a dependency exemption deduction that you have never before realized.

A Florida woman was denied a first-time homebuyer credit of $7,500 because the U.S. Tax Court determined that she had never actually purchased the home.

On Jan. 22, 2007, Ada Mae Pittman entered into a lease contract with an option to buy with James Piotrowski Jr. Pittman was required to meet certain conditions to exercise the option to purchase the house. She was required to:

➜ Close on the purchase of the home by Jan. 31, 2008

➜ Pay a $1,250 option fee

➜ Pay an additional $150 per month, which would be applied against the purchase price of the home if the option were exercised

Pittman paid the $1,250 option fee and made the $150 per month payments.

However, she did not exercise the right to purchase the house by Jan. 31, 2008, because she was unable to obtain the financing needed to close the purchase.

No sales documents were ever prepared.

When Pittman timely filed her 2008 federal income tax return, she claimed the $7,500 first-time homebuyer credit. The IRS subsequently sent her a letter of deficiency disallowing the credit.

Generally, under Internal Revenue Code Section 36, a transfer is complete upon the earlier of the transfer of title or the shift of the benefits and burdens of ownership.

An option to purchase a home in Florida does not give the person with the option an equitable interest in realty until the option is exercised.

IRC Section 36 is quite clear. A taxpayer must actually acquire a property to claim the first-time homebuyer credit.

Pittman did not provide any documentation substantiating her purchase of the residence.

In addition, she never exercised the option to purchase. Therefore, Pittman is not entitled to the claimed first-time homebuyer credit (Ada Mae Pittman v. Commissioner, T.C. Memo 2015-44, March 16, 2015).

An eye surgeon who had received a $2 million bonus in 2007 was told by the U.S. Tax Court that half of it was unreasonable compensation.

Dr. Afzal Ahmad was president and 100 percent shareholder of Midwest Eye Center, an ophthalmology surgery and care center practice with four locations. The center, organized as a C corporation for tax purposes, had paid him the bonus.

He held many positions for the business, including surgeon, chief executive officer, chief operating officer and chief financial officer. These various positions required him to perform different managerial tasks.

During 2007, Ahmad was paid total compensation of $2.78 million, of which $2 million was paid out in the form of a bonus. All of the bonus money was paid in November and December 2007 in four separate checks of $500,000 each.

Ahmad’s workload increased quite a bit in 2007 because one surgeon quit, and Ahmad had to take over that surgeon’s scheduled surgeries during the second half of the year. Because another surgeon had a reduced workload, Ahmad also had to take over some of that surgeon’s responsibilities.

On Ahmad’s corporate income tax return for 2007, $2.78 million was deducted as officer compensation.

The U.S. Tax Court agreed with the IRS, disallowing $1 million of the bonus as unreasonable compensation (Midwest Eye Center, S.C. v. Commissioner, T.C. Memo. 2015-53, March 23, 2015).

IRS Code Section 162 deals with this issue and “allows taxpayers to deduct ordinary and necessary expenses, including a reasonable allowance for salaries or other compensation for personal services actually rendered.” This means compensation is deductible only if it is:

➜ Reasonable in amount

➜ Paid or incurred for services actually rendered

Whether amounts paid as wages are reasonable compensation for services rendered is a question decided on the basis of the facts and circumstances of each case.

Some IRS published rules and some court cases conclude that, to determine reasonable compensation, taxpayers must look at factors other than return on equity. They have to look at what other similar professionals are earning in comparison to their overall compensation package.

Ahmad produced no evidence of comparable salaries. Instead, he said that there are no like enterprises or similar circumstances with which to compare.

Ahmad felt he was entitled to the large compensation amount because of the many different administrative hats he wore for his business.

The burden of proof was on Ahmad to show that the amount paid to him was not unreasonable. The doctor provided no such proof.

Employers should already be preparing to comply with next year’s Affordable Care Act reporting requirements regarding their employee healthcare benefits.

Self-insuring employers and employers with 50 or more full-time employees are required under the Affordable Care Act to file information with the IRS about health insurance coverage provided – or not provided – to their employees.

The required reporting with respect to calendar year 2015 begins with providing an information return to the IRS by Feb. 29, 2016, or March 31, 2016, if reporting electronically. (Normally, the deadline is Feb. 28 each year, but 2016 is a leap year.) But employers should have already begun pulling together the 2015 health coverage information for each month.

Self-insuring employers – Code Section 6055

Self-insuring employers must file an information return with the IRS using Form 1095-B, Health Coverage, and Form 1094-B, Transmittal of Health Coverage Information Returns, each year, providing information about minimum essential coverage for each individual receiving the coverage. The forms must be filed by Feb. 28, or March 31 if reporting electronically.

Minimum coverage is defined as a healthcare plan designed to pay at least 60 percent of the total cost of medical services for a standard population. Most employer-sponsored health coverage qualifies as “minimum essential coverage.”

However, specialized coverage, such as vision and dental care, workers’ compensation, disability policies and coverage for only specific health issues, does not qualify.

The required information return must contain the following:

➜ Name, address and taxpayer identification number of the primary insured, as well as the name and taxpayer identification number of any family members of the primary insured who are also covered under this policy.

➜ Dates during which individuals were covered under minimum essential coverage during the year.

➜ Whether the health insurance is a qualified health plan in the small group market offered through an exchange. In a situation where employers are providing minimum essential health insurance coverage during the year, they must provide information regarding whether the coverage is a qualified health plan offered through a healthcare exchange and how much the amount of the advance payment is, if any.

➜ Any additional information the IRS requires.

If the minimum essential coverage is provided by the employer through a traditional group health plan, a return is still required to be filed by the deadline.

The return must contain the following information:

➜ Name, address, and employer identification number of the employer maintaining the plan

➜ Portion of the premium, if any, required to be paid by the employer

➜ Any other information the IRS requires

Employers providing health insurance coverage are also required to furnish related information about the coverage to each individual. For calendar year 2015, the information is due to individuals by Jan. 31, 2016.

These statements must provide the following information:

➜ The name and address of the employer maintaining the plan, and a contact name and phone number that the employees can access if they have any questions

➜ The information required to be reported on the return with respect to such individual

Large employers – Code Section 6056

Large employers, those with 50 or more full-time or full-time equivalent employees, must file Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, and Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Return, with the IRS by Feb. 29, 2016, or March 31 if reporting electronically. This information return reports the terms and conditions of the healthcare coverage they provided to their employees for the calendar year.

The employers must also provide related information to their employees by Jan. 31, 2016.

The information return must include the following:

➜ Employer’s name and identification number

➜ Certification of whether the employer offers full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan

➜ Number of full-time employees for each month of the calendar year

➜ Name, address and taxpayer identification number of each full-time employee employed by the employer during the calendar year and any months during which the employee and any dependents were covered under the eligible employer-sponsored plan during the calendar year

➜ Any other information the IRS requires

Large employers that offer employees the opportunity to enroll in minimum essential coverage are required to report:

➜ Duration of any waiting period for the coverage

➜ Months during the calendar year when coverage was available

➜ Monthly premium for the option that cost the lowest amount in each enrollment category

➜ Employer’s share of the total allowed costs of benefits under the plan

Do you have a “junk drawer” as a catchall where you toss items that don’t seem to have a specific place?

The IRS provides Line 21, Other Income, of Form 1040 as a kind of catchall used to report any taxable income not reported elsewhere on your return or other schedules.

This line is where you list the type and amount of miscellaneous, or other, income. Some examples of income to report on Line 21 include the following:

1. Most prizes and awards

2. Jury duty pay

3. Gambling winnings, including lotteries and raffles

4. Recoveries of items deducted in earlier years, for example, various itemized deductions

5. Income from the rental of personal property if you were engaged in the rental for a profit but were not in the business of renting such property

6. Income from an activity not engaged in for profit

7. Taxable distributions from a Coverdell education savings account or a qualified tuition program

8. Taxable distributions from a health savings account or an Archer medical savings account

9. Canceled debts on something other than your personal residence, for which canceled debt is not taxable

10. Net operating loss (NOL) deduction

11. Alaska Permanent Fund dividends

Jury duty pay, recoveries, gambling winnings and NOL are some of the more common items to include on Line 21. All are income items except for NOL, which reduces the amount of income on this line.

NOL is a net operating loss from a prior year carried forward. It means you had more losses than income in a particular year. You are allowed to carry forward a loss for 20 years or until it is used up.

For more detailed information, refer to the 1040 instructions for Line 21.

The term “personal property tax” means an ad valorem tax imposed on an annual basis on personal property.

To qualify as a personal property tax, a tax must meet a three-part test:

Part 1: The tax must be ad valorem. A tax based on criteria other than value is not considered an ad valorem tax. For example, some states base a motor vehicle tax on the vehicle’s value, weight, model year or horsepower. If the motor vehicle tax is based on value, it is considered ad valorem and qualifies as a deductible personal property tax.

If part of the motor vehicle tax is based on value and part based on weight, the portion of the tax related to the value is deductible, and the portion of the tax related to the weight is not.

Part 2: The tax must be imposed on an annual basis, even if collected more or less frequently.

Part 3: The tax must be imposed on personal property. A tax may be considered to be imposed on personal property even if, in form, it is imposed on the exercise of a privilege.

These three rules are why taxpayers are able to deduct registration fees for cars, boats, mobile homes and trailers as a personal property tax provided that they are ad valorem or at least partially ad valorem.

To deduct any personal property tax, taxpayers must file Schedule A and itemize their deductions.

Taxpayers should look at a car, boat, mobile home or trailer registration to determine whether the registration fees are ad valorem. This document usually shows the amount of the fees as well. The registration form itself can serve as documentation or backup for the deduction.

Taxpayers should keep up with the U.S. bonds they purchase and cash in – and their tax liability on the interest.

Mr. and Mrs. Lobs purchased ten $1,000 Series EE U.S. savings bonds for their son in mid-November 1992. The bonds were registered to both Mr. and Mrs. Lobs even though they purchased the bonds to provide for their son Joseph’s college education.

In 1995, the Lobses divorced. Mrs. Lobs received the 10 bonds in the divorce settlement.

During September 2010, Mrs. Lobs’s son needed some money. Mrs. Lobs cashed in the bonds, which were registered in both her and her ex-husband’s names.

The proceeds from the bonds were deposited in her checking account. A cashier’s check for $12,640 was immediately made payable to her son Joseph. Joseph cashed the check.

Mrs. Lobs timely filed a Form 1040 return for 2010 but did not include any interest income from the bond transaction on the return.

The IRS sent Mrs. Lobs a notice of deficiency in April 2013 determining that she had failed to report $7,640 of interest income. Mrs. Lobs timely filed a petition with the IRS claiming that the bonds belonged to her son, not to her, and that the interest on the bonds was not properly taxable to her.

The Internal Revenue Code states that interest income received by the taxpayer constitutes taxable gross income. In particular, interest on U.S. obligations, such as U.S. savings bonds, is fully taxable.

Registration of Series EE U.S. savings bonds is generally conclusive of actual ownership of, and interest in, such bonds. Savings bonds are usually not transferable and are payable only to the owner named on the bonds.

Mrs. Lobs cashed in the bonds and had the proceeds transferred to her checking account. The difference between the original purchase price and the amount of proceeds received became taxable income to her.

It doesn’t matter that Mrs. Lobs had meant to have her son’s name put on the bonds when they were originally purchased. The court can rule only on what happened.

The reality of the situation is that Mrs. Lobs was a registered co-owner of the bonds who was entitled to receive, and did in fact receive, the proceeds of the bonds upon their endorsement and surrender. Therefore the $7,640 is taxable to her as interest income (Ruth A. Lobs v. Commissioner, U.S. Tax Court, T.C. Summary Opinion 2015-17, March 3, 2015).

James A. Ericson really missed the mark as a federal income tax preparer.

In February 2015, the U.S. District Court for the District of Hawaii permanently barred Ericson from preparing federal income tax returns.

Ericson had prepared a large number of income tax returns in which he took unrealistic and unsustainable positions on clients’ tax returns. He willfully understated taxes due and had a reckless and intentional disregard for tax rules and regulations.

The 9th U.S. Circuit Court of Appeals does not have a clear standard or test for the district court to apply in determining whether a lifetime or permanent ban against all tax return preparation is proper. However, the courts have considered a variety of factors in analyzing this issue.

The following are some of the factors considered by the courts through the years in determining whether a lifetime ban is appropriate:

1. A defendant’s willingness or refusal to acknowledge wrongdoing

2. Compliance with the law following a warning or notification by the IRS that the conduct is unlawful

3. Percentage of tax returns filed that are fraudulent

4. Severity of the harm, i.e., the amount of money fraudulently requested and the amount actually and erroneously released

5. Number of discrete fraudulent practices

6. Longevity of the fraudulent scheme

7. Defendant’s degree of “scienter,” or knowledge

The facts and circumstances of the case indicate that Ericson performed negatively under all seven factors.

Regarding the first factor, Ericson has always maintained his innocence under cross-examination. He was warned by the IRS back in 2009 that his practices were improper, and he was fined.

Ericson continued preparing improper returns for the next three years, violating the second factor.

Ericson severely violated the third through fifth factors. The IRS examined 611 federal income tax returns of his clients from 2007 through 2012 and found a total tax shortfall of more than $2.4 million. This amounts to an average of almost $4,000 per return, and when projected over all of the returns that Ericson prepared, a loss to the U.S. Treasury of over $30 million in revenue. Between 86 and 92 percent of Ericson’s clients received a refund.

The sixth factor was violated because this fraudulent activity had been carried out for over five years. The court also found Ericson guilty of the seventh factor because it felt that he knowingly and repeatedly violated the U.S. Tax Code.

Because the court found all of the seven factors against Ericson, it felt it was appropriate to impose a lifetime ban on his ability to prepare individual income tax returns (United States of America v. James A. Ericson, U.S. District Court, District of Hawaii, 2015-1 U.S.T.C. Paragraph 50,222, Feb. 20, 2014).