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Disability income is taxable for a military veteran – despite not being taxable in earlier years.
The U.S. Tax Court ruled that disability retirement pay received by Kevin M. Campbell was taxable income despite the fact that, in previous years, the Internal Revenue Service had treated it as nontaxable (Kevin M. Campbell and Pamela J. Campbell v. Commissioner, U.S. Tax Court, T.C. Summary Opinion 2014-109, Dec. 22, 2014).
Campbell enlisted in the Coast Guard on July 12, 1987. He was forced into disability retirement in 1990 because he was diagnosed with insulin-dependent diabetes and determined to be unfit for duty.
At first, Campbell received temporary disability status. A letter from the Coast Guard dated Sept. 20, 1990, informed him that he would receive monthly retirement pay equal to his base pay multiplied by his disability rating. His disability rating was 40 percent.
The Coast Guard also informed Campbell that it would withhold federal income taxes on the gross amount of the retirement/disability pay. At the end of each year, the Coast Guard sent him a Form 1099-R for the gross amount of retirement/disability pay he had received.
Campbell’s accountant reviewed the 1099-R when preparing his client’s income tax return. The accountant never included any of the 1099-R amounts on the tax return because he and his client felt that these amounts were nontaxable income.
Through the years, the IRS sent Campbell letters threatening to increase his taxable income by the amount of the Coast Guard retirement pay. Campbell forwarded these letters to his accountant.
The accountant contacted the IRS to explain that this income was nontaxable. A short time later, Campbell would receive a “no change” letter from the IRS, accepting his tax return as filed.
On April 6, 1995, Campbell received a letter from the Coast Guard informing him that his diabetes qualified as a permanent physical disability. His disability rating was determined to be 60 percent, an increase from the 40 percent rating he had received back in September 1990 when he had temporary disability status.
The Coast Guard again informed Campbell that this retirement pay was taxable and that it would withhold federal income tax on the pay.
Fast forward to 2012 when Campbell timely filed his 2011 income tax return. Coast Guard retirement pay of $9,210 was omitted from the taxable portion of the return as it had been in prior years. The IRS sent a letter of deficiency for the 2011 tax year.
The IRS has a general rule for military retirement pay. The rule states that amounts received as a pension, an annuity or a similar allowance for personal injuries or sickness resulting from active service in the armed forces of any country are not included in gross income.
But the IRS has a limitation to this general rule. The limitation provides that the amount of military retirement pay considered nontaxable shall not be less than the maximum amount the individual would receive from the U.S. Department of Veterans Affairs as disability income.
Because the court had no evidence in the record that Campbell had applied to the VA for disability income, it considered the amount Campbell would receive from the VA as zero. Therefore, the court determined that all of the retirement pay from the Coast Guard for tax year 2011 was taxable and properly included in Campbell’s income.
If Campbell had documentation that he had applied for VA disability benefits and could show the court the amount of disability benefits the VA had determined that he was entitled to, this result might have been different. Unfortunately, Campbell had no such documentation.
©2015 CPAmericaInternational
A taxpayer was disallowed dependency exemptions for his son, daughter and grandchild in a January 2015 U.S. Tax Court case. The court also denied him head-of-household filing status.
This decision (Gregory McBride v. Commissioner, U.S. Tax Court, T.C. Memo. 2015-6, Jan. 8, 2015) cost the taxpayer $3,540 in additional federal income taxes and penalties of $708.
During 2010, Gregory McBride and his son, daughter and granddaughter all lived together in McBride’s home.
On Feb. 28, 2011, McBride’s son filed his Form 1040 income tax return, claiming himself as a personal exemption. Also on that date, McBride’s daughter filed her Form 1040. She claimed $11,892 in gross income.
McBride’s daughter claimed a personal exemption for herself and a dependency exemption for her daughter. She received a refund of $5,290, due mostly to a refundable credit of $4,450.
McBride had requested a filing extension for his 2010 return. He timely filed his return on May 23, 2011, claiming head-of-household filing status and dependency exemptions for his son, daughter and granddaughter.
A taxpayer can claim a dependency exemption for someone who is a qualifying child or a qualifying relative.
The IRS requires a taxpayer to meet a five-part test to claim an exemption for a qualifying child. The taxpayer must meet the requirements of all five parts to claim this exemption. One of the parts is an age test.
The dependent child must be under the age of 19 or a student and under the age of 24 as of the end of the tax year, which in this case was Dec. 31, 2010. The facts in this case stipulated that both the son and the daughter were over the age of 24, so the age test was not met and McBride would not be able to claim his children as dependents.
There is an exception – which did not apply in this case – for an individual who is permanently and totally disabled.
McBride could claim neither his daughter nor his son as qualifying relatives because he did not present any evidence that he provided more than 50 percent of their support during the year. A taxpayer must meet the support test to claim someone as a dependent relative. In the case of his daughter, McBride did not meet the support test.
McBride could not claim his granddaughter as a dependent because the mother had already claimed her. The Internal Revenue Code has a special “tie-breaker rule” when multiple taxpayers are claiming the same child as a qualifying child. In these cases, the child is treated as the qualifying child of the taxpayer who is the parent – in this case, the mother.
The court denied McBride’s claim for head-of-household status. To claim this status, a taxpayer must be unmarried at the end of the tax year and provide a home for a dependent for at least half of the year.
Because the son, daughter and granddaughter were not considered to be dependents by the court, McBride did not meet the criteria for head-of-household filing status. Therefore, the court disallowed all three dependency exemptions and the head-of-household filing status.
©2015 CPAmericaInternational
Be careful when filling out your W-4 form.
The Internal Revenue Service requires that employees fill out a Form W-4 on or before the first day of employment. The W-4 form determines how much federal income tax an employer will withhold from an employee’s wages. The information on the W-4 is used when calculating the employee’s first payroll check from the employer.
But use caution. There is a $500 civil penalty for employees claiming excess withholding allowances on Form W-4. Criminal penalties can apply when an individual willfully supplies false withholding information or fails to supply withholding information.
Employees are entitled to claim dependency exemptions for themselves and for each of their dependents, including their spouse. Employees who can be claimed as a dependent on someone else’s tax return may not claim a withholding exemption for themselves.
Employees with more than one job may not claim an exemption that is currently in effect with another employer. So, for example, if you are a single person with no dependents and you have two jobs, you would be allowed to claim one exemption on your W-4 form for one of the jobs. Then you would have to claim zero dependents on the W-4 form for the second job.
These rules do not apply if the wages from the second job are $1,500 or less.
If an employee does not fill out a W-4 form, the withholding must be computed as if the employee were single and claiming no other exemptions.
Employees who certify to their employer that they had no income tax liability for the preceding tax year, and don’t anticipate any tax liability for the current year, may claim to be exempt. No federal income tax will be withheld from their wages. They should fill out and file a W-4 form with the employer each year that they are in this situation.
©2015 CPAmerica International
When it comes to income taxes, it pays to be organized.
Begin gathering your tax information as early as it is available. You should receive most of your 2014 tax documents by early to mid-February 2015.
Probably the most important document you need to locate is a copy of last year’s tax return. The tax situation of most individuals does not change dramatically from year to year. The information shown on last year’s return is a good guide to what you need to look for this year.
On the other hand, if you experienced a life event during 2014, your tax situation could be in for a big adjustment. Life events include marriage, divorce, birth of a child, retirement, a business startup or a change in employment.
Everyone’s situation is different, but most people receive some common tax documents in the mail:
You may receive other income tax-related forms as well:
All of these forms will be needed to determine whether you qualify to itemize your deductions.
If you are self-employed, you will also need to gather receipts for all deductible business expenses. Check out IRS Publication 535 for more information about business expenses.
While you’re digging up all these records, look ahead to next year at this time. Sort everything and create files to hold:
Then keep items sorted as they come in during 2015. Using this method, next year’s income tax return should be easier.
©2015 CPAmerica International
The U.S. Tax Court recently determined that a cash method taxpayer is entitled to claim an American Opportunity Credit only in the tax year when the payment was actually made – not for the academic year when the tuition payment was paid.
John and Brenda Ferm paid their daughter’s tuition at the local community college for the 2011 winter semester, which ran January through April 2011. They made the tuition payments in three installments with the majority of the tuition paid on Dec. 28, 2010.
The taxpayers timely filed their 2011 income tax return, but they did not claim the American Opportunity Credit, a tuition credit available to parents of dependent children who are undergraduate students.
On April 1, 2013, the taxpayers filed an amended return. On the amended return, the taxpayers claimed an American Opportunity Credit of $2,107.
On June 13, 2013, the IRS sent the taxpayers a notice of deficiency disallowing the American Opportunity Credit for lack of payment verification.
The taxpayers filed a petition in court contesting the IRS in its disallowance of the credit.The taxpayers provided the court with the appropriate evidence that the tuition had been paid. The court disallowed all but $157 of the credit because $2,151 of the qualified educational expenses was paid in 2010, not in 2011.
The portion of the tuition paid in 2010 cannot be used to claim a credit in 2011. Only $157 of qualified tuition and related expense was actually paid in 2011.
The American Opportunity Credit is allowed only when payment is made in the same year that the academic period begins.
When a taxpayer prepays qualified tuition and related expense during one taxable year for an academic period that begins during the first three months of the following taxable year, the academic period is treated as beginning during the taxable year in which payment was made.
In this case (John Mark Ferm and Brenda Kay Ferm vs. Commissioner, T.C. Summary Opinion 2014-115, Dec. 30, 2014), the academic year and the majority of the tuition payments were considered 2010 transactions, not 2011, explaining the court’s disallowance of most of the credit.
The Tax Court’s opinion in this case may not be used as precedent for any other case.
©2015 CPAmerica International
Certain expiring tax provisions were extended on Dec. 19, 2014, when President Obama signed into law the Tax Increase Prevention Act of 2014.
Some interesting examples of tax law extended on the individual income tax side are:
These provisions of the Internal Revenue Code were set to expire in 2014. With passage of this new law, you are still able to take advantage of these provisions in 2014.
These are just a few examples of the various individual tax law provisions that were extended. A number of business income tax provisions were extended as well.
The law (P.L. 113-295) also included technical corrections to the Internal Revenue Code of 1986.
©2015 CPAmerica International
Now is the time to begin logging your business travel miles if you want to take a tax deduction for 2015.
The IRS requires strong substantiation – even if it is obvious that you use your vehicle for business purposes.
If you are audited, estimates are not acceptable. Each business trip should be documented with location, destination, purpose of trip, date and number of miles driven. Business driving must be separated from personal driving.
If you haven’t been taking a deduction for your business driving, 2015 is a good time to start because recently released standard mileage rates are attractive considering the decrease in gas prices.
Effective Jan. 1, 2015, the standard mileage rates for the use of a car, van, pickup truck or panel truck will be:
✦ 57.5 cents per mile, an increase from 56 cents per mile in 2014
✦ 23 cents per mile for medical or moving purposes, down from 23.5 cents per mile in 2014
✦ 14 cents per mile driven in service of charitable organizations (the same rate as last year – the longtime rate fixed by Congress)
Taxpayers also have the option of deducting vehicle expenses based on actual costs of using a vehicle rather than standard mileage rates.
For those filling out their 2014 tax returns, remember to use mileage rates that applied for 2014. Your mileage expenses must be documented in detail or they won’t be allowed.
If you don’t have strong enough substantiation and are audited, the IRS will in all likelihood deny your entire deduction. And to make matters worse, you’ll probably also be charged penalties and interest for overdue taxes.
If substantiation of auto expense records is lost or stolen, the IRS will generally also deny the deduction.
The standard mileage rate is based on an annual study of the costs of operating a vehicle, including gas, oil, maintenance, tires, repairs, insurance and depreciation.
©2015 CPAmerica International
Landlords who want to deduct 100 percent of their rental property expenses must be sure to watch the personal use of their rental property.
In the case of Mark A. Van Malssen and Patricia D. Kiley v. Commissioner, T.C. Memo 2014-236, T.C.M., the taxpayers were limited in the amount of rental expenses that they could claim because their personal use of the rental property exceeded 14 days.There is a section in the Internal Revenue Code that limits the amount of rental expenses that can be deducted when personal use of the rental property exceeds 14 days. When that is the case, instead of being able to deduct 100 percent of rental expenses, the owner must allocate those expenses.
The allocation percentage is derived by dividing the number of days the property was rented by the total number of days that the rental property was used. The number of days the rental property was used is determined by adding the rental days and the personal use days together.
Mark A. Van Malssen and Patricia D. Kiley had deducted 100 percent of their rental property expenses on their 2008 and 2010 jointly filed 1040 returns. In both of these years, it was determined by the facts and circumstances of the case that the personal use of the rental property had exceeded 14 days.
Therefore, instead of deducting 100 percent of their expenses, they should have allocated the expenses based on the above allocation percentage.
The issue in this case was how many personal days the taxpayers had used their rental property. The taxpayers said they used the rental property in both 2008 and 2010 for 14 days. Had this beenthe only personal use of the rental property, they would have been entitled to claim 100 percent of the rental expenses as a deduction.
An IRS regulation states that when the principal purpose of use of the dwelling unit is to make repairs and maintenance, those days do not count as personal days.
Whether the principal purpose is for repairs and maintenance or for personal use is determined under a facts-and-circumstances test.
A number of times over the course of 2008 and 2010 Mr. Van Malssen made the 350-mile trip from his home to the rental property in South Carolina. If the purpose of the trip is deemed to be primarily business, then the travel days are not considered to be personal days. If the primary purpose of the trip is personal, then those travel days are considered to be personal days.
The travel days were caused because it took the whole day for Mr. Van Malssen to drive from his personal residence to the rental property.
Mr. Van Malssen kept very detailed logbooks regarding his personal and business use of the rental property. The court used thoselogbooks when determining whether the different travel days counted as personal use days.
When traveling to the rental property, if more than 50 percent of the days spent at the rental property are related to making repairs and maintenance, then all of the days spent at the rental property and the one day of travel time are all deemed to be nonpersonal use.
But if less than 50 percent of the days spent at the rental property were related to repairs and maintenance, then the one day of travel time is deemed to be personal use time.
Because the court ruled that some of the travel time from the main residence to the rental property was properly counted as personal time, the taxpayers exceeded 14 personal use days in both tax years 2008 and 2010.
Because of this fact, the taxpayers were required to allocate the rental property expenses instead of deducting 100 percent of them. The court denied some of the rental expenses and a deficiency judgment was asserted against the taxpayers.
©2014 CPAmerica International
Discharge of debt is generally considered income for tax purposes – and it will be again in 2014 for principal residence indebtedness.
Many taxpayers took advantage of not being taxed on discharge of debt for principal residences from Jan. 1, 2007, through Dec. 31, 2013. Unfortunately, this exclusion has ended effective for the 2014 tax year. It applied to homeowner’s mortgages or equity loans secured by their residence.
For those who had their home reposed by the bank or had a short sale in which the fairmarket value of the home was less than the balance owed on the mortgage, the bank allowed them to walk away from the mortgage without paying the remaining balance still owed.
And because the IRS had a provision in one of their code sections in which this deficient balance was not considered to be taxable income, the taxpayer did not have a taxable event as a result of this transaction.
Starting in 2014 this loophole is no longer available. If the bank forgives debt related to a mortgage or home improvement loan secured by your primary residence, that debt forgiveness will now be considered taxable income.
The company that discharged the debt will send a 1099 form at tax time, and the taxpayer will be required to include the amount of debt discharged as income the tax return.
The IRS provides for five situations in which this discharge of debt is not taxable income. Those five situations are:
The general rule regarding gifts to employees is that they are taxable income to the employee.
There are some exceptions to this general rule. Two of the more common exceptions are:
1. Employee achievement awards
2. De minimis (small) fringe benefits
Employee achievement awards are nontaxable. These awards are tangible property that is given to the employees as a reward for length of service or for achieving some sort of a safety standard.
The IRS worries that employee achievement awards are actually a form of disguised compensation. That is why when the company is giving out these awards, they should be presented in some type of ceremonial format.
The amount of the gift that the employee is allowed to exclude from income is tied to the amount the company claims as a deduction. If the awards are given by a company that does not have a qualified plan, the maximum amount of the deduction for the company is $400. Therefore, the maximum amount the employee is able to exclude from income and treat as a nontaxable gift would be $400.
So, for example, if the employee received an award with a fair market value of $650, $400 of that would be considered a gift and $250 would be considered taxable compensation.
If the gift is given to an employee by a company that does have a qualified plan – an established written plan that does not discriminate in terms of eligibility or benefits to highly compensated employees – the maximum amount of the deduction for the company would be $1,600. The employee would then be able to exclude this same amount from income and treat it as a gift.
Other categories of gifts that are nontaxable are de minimis fringe benefits. De minimis fringe benefits are property or services that are so small as to make accounting for it unreasonable or administratively impracticable.
Not all de minimis fringe benefits are gifts. In fact, most are not. The IRS provides some guidance on what a de minimis fringe benefit is. The following three items are considered to be de minimis fringe benefits that impact the discussion of nontaxable gifts:
1. Birthday or holiday gifts of property with a low fair market value.
2. Occasional theater or sporting event tickets.
3. Flowers, fruit, books or similar property provided to employees under special circumstances.
These three items would be considered gifts and not added to the employees W-2 wages.
Employers that give gifts to employees for the holidays would be well advised to know what the rules are. Otherwise that gift might end up being taxable income to that employee.
