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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). ■
©2015 CPAmerica International
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). ■
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.
©2015 CPAmerica International
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.
©2015 CPAmerica International
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).
©2015 CPAmerica International
Donating an automobile with a fair market value of more than $500 has a few twists and turns when taxpayers claim a deduction.
Taxpayers donating to charity a qualified vehicle, car, truck, boat or aircraft valued at over $500 must obtain from the charity either a Form 1098-C or a similar contemporaneous written acknowledgment of the contribution. They should attach this documentation to their return.
The acknowledgment must provide the following information:
➜ Donor’s name
➜ Donor’s Social Security number
➜ Vehicle’s identification number
➜ Description of each donated item
➜ Good-faith estimate of any goods or services provided by the charity in exchange for the vehicle
The fair market value of any goods or services received by the donor reduces the amount of the charitable contribution deduction.
The acknowledgment also must contain the amount of sales proceeds if the vehicle was sold in an arm’s-length transaction. For a vehicle sold in an arm’s-length transaction with no material improvements, the amount of the donation is limited to the amount of the sales proceeds.
If the charity retains the vehicle for its own internal purposes, the acknowledgment must state that as well. Under those conditions, the taxpayer can deduct the fair market value of the vehicle.
If the charity sells the vehicle to a needy individual at a price below fair market value, the taxpayer is allowed to claim the fair market value as the deduction amount, provided the sale furthers the charity’s purpose. Most of these types of charities have as their purpose helping needy individuals by providing them with good-quality, low-cost automobiles.
When itemizing deductions, taxpayers should deduct charitable contributions on Schedule A and attach it to their Form 1040 tax return. In addition, they should remember to attach a copy of their 1098-C or similar acknowledgment.
©2015 CPAmerica International
You have a choice between deducting state and local sales taxes or state and local income taxes. A prudent tax planner would obviously choose the larger of the two deductions.
The option to deduct state and local sales taxes benefits the residents of Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. These states don’t impose a state income tax.
You may claim this deduction by electing to deduct state and local sales taxes instead of state and local income taxes on Schedule A of your 1040 return.
You can calculate this deduction in two different ways. You can choose to:
➤ Keep a copy of all of your sales receipts in which sales or use tax was charged, and total the amount of sales and use taxes paid during the year, or
➤ Use the optional sales tax tables provided by the IRS in the instruction booklet to Schedule A.
Using the optional sales tax tables reduces your record-keeping burden and is generally the easier way to go. The tables provide an amount of sales taxes paid based on a number of factors, including state of residence, adjusted gross income and number of exemptions.
A nice benefit of using the optional sales tax tables is getting to deduct the amount of sales taxes determined by the tables, plus any state sales and local taxes paid on the following:
➤ Motor vehicles
➤ Boats
➤ Aircraft
➤ Homes, including mobile and prefabricated homes
➤ Materials to build a home
The IRS provides taxpayers with an Internet tool to determine whether they might benefit by electing to deduct state and local sales taxes at www.irs.gov/Individuals/Sales-Tax-Deduction-Calculator. ■
©2015 CPAmericaInternational
The modern-day secession movement that has sprung up around the country in recent years is evidence that a number of states – as many as 20, stretching from New Jersey to Oregon to Texas – have citizens who would like to assert their independence from the federal government.
John Trowbridge Jr. found out the hard way that living in Texas means he is a U.S. citizen and is subject to U.S. tax laws.
In addition, district courts have the jurisdiction, and the Internal Revenue Code gives them the power, to hear tax cases and settle those disputes.
Trowbridge has been a longtime tax protester. He has on two prior occasions lost Tax Court cases regarding similar issues.
This particular case involved the district court, which had reduced Trowbridge’s tax liabilities for the years 1993 through 1997 to the amount of the associated tax liens on his property. The court foreclosed on the liens and then sold Trowbridge’s property for back taxes.
Trowbridge’s argument against the court is that he lives in Harris County, Texas, which he doesn’t consider a part of the United States, meaning that he is not, therefore, a U.S. citizen. He feels that he isn’t subject to the federal income tax laws and that the district court doesn’t have jurisdiction in his case.
The courts have already held in prior cases that citizens of Texas are also citizens of the United States, so Trowbridge lost that argument. There is also an Internal Revenue Code section authorizing the district courts to hear Tax Court cases and disputes, so he lost on that issue as well (United States of America v. John Parks Trowbridge, Jr., No. 14-20333, U.S. Court of Appeals, Fifth Circuit, Feb. 3, 2015).
©2015 CPAmerica International
don’t impose a state income tax.
Just in time for small business owners’ 2014 tax returns, a procedure for easier compliance with final tangible property repair regulations was announced by the IRS last week.
The simplified procedure is now available starting with the 2014 income tax return, which taxpayers or their tax professionals are currently preparing. In general, for the first taxable year beginning on or after Jan. 1, 2014, small businesses may change the method of accounting on a prospective basis.
The simplified procedure is available:
➤ To small businesses, including sole proprietors;
➤ With assets totaling less than $10 million; or
➤ With average annual gross receipts totaling $10 million or less.
Small businesses that intend to use this new procedure for 2014 taxes will not have to file a Form 3115, Application for Change in Accounting Method. Previously a requirement, the IRS decided to waive the filing of this form after receiving many requests from small business owners and tax professionals.
However, check with your accountant about certain circumstances that may still require a Form 3115.
The IRS is “pleased to be able to offer this relief to small business owners and their tax preparers in time for them to take advantage of it on their 2014 return,” IRS Commissioner John Koskinen said in making the announcement.
To read more details in Revenue Procedure 2015-20, click here. ■
©2015 CPAmerica International
You have a choice between using the business standard mileage rate or actual expenses when calculating the fixed and operating costs of an automobile. Once you select a method, you must use that method for the entire tax year.
There are some limitations on the eligibility to use the business standard mileage rate. A taxpayer cannot choose the standard mileage rate and:
Items 2 through 5 above relate to a situation in which the vehicle owner was claiming actual business auto expenses but then wanted to change to the business standard deduction method. Although you are allowed to change back and forth each year between the standard deduction method and the actual expense method, you cannot do so if items 2 through 5 pertain to you.
If that is the case, you must stay with the actual expense method.
The business standard mileage rate generally changes each year as the cost of operating a vehicle changes. The business standard mileage rate for 2014 was 56 cents per mile. That rate has been increased to 57.5 cents per mile for 2015.
The fluctuating cost of gasoline is one of the reasons for the rate change, as well as the increase in the cost of vehicles. The IRS sends out a notice toward the end of each year informing the general public of the new rate for the upcoming year. ■
