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The IRS has issued final and proposed regulations on the calculation of the new 3.8 percent tax on net investment income that took effect Jan. 1, 2013.
The new tax, also known as the “3.8 percent Medicare surtax,” or “net investment income tax,” can affect joint filers and surviving spouses with modified adjusted gross income (MAGI) over $250,000, married couples filing separately with MAGI of more than $125,000 and others with MAGI above $200,000. Trusts and estates will also be subject to the new tax if they have income taxed in the highest marginal tax bracket – $11,950 for 2013.
Consider the following example: For 2013, a married couple has net investment income (NII) of $100,000 and MAGI of $270,000. They pay the surtax only on the $20,000 amount by which their MAGI exceeds their threshold amount of $250,000 because that is less than their NII of $100,000. Thus, the surtax is $760 ($20,000 × 3.8%).
Because the $250,000 and $200,000 thresholds are not adjusted for inflation, it is likely that more people will become subject to the surtax in future years as their income rises because of inflation and other factors.
For purposes of the surtax, NII is investment income less properly allocable deductions. Investment income is:
The surtax applies to a trade or business only if it is a passive activity or a trade or business of trading in financial instruments or commodities.
Investment income does not include amounts subject to selfemployment tax, distributions from tax-favored retirement plans (for example, qualified employer plans and IRAs), or tax-exempt income (for example, interest earned on state or local obligations).
The surtax does not apply to trades or businesses conducted by a sole proprietor, partnership or S corporation. But income, gain or loss attributable to an investment of working capital is not treated as derived from a trade or business and thus is subject to the tax.
Gain or loss from a disposition of an interest in a partnership or S corporation may be taken into account by the partner or shareholder as NII. This gain or loss is considered a part of the owner’s NII only to the extent the gain or loss from the deemed sale of the entity’s assets would have been NII if the partner or shareholder had owned and sold those assets himself/herself. For smaller taxpayers, a simplified calculation of the gain subject to the surtax is available.
The fact that self-employment income is not subject to the surtax does not result in a benefit to the self-employed. Beginning Jan. 1, 2013, the Medicare tax rate on earned income, including self-employment income, was also raised by 0.9 percent.
As a result, most people with MAGI above the $250,000/$200,000 thresholds will see an increase in their taxes for 2013.
The IRS released Notice 2013-80 containing the standard mileage rates for 2014.
Beginning Jan. 1, 2014, the standard mileage rates for the use of a car (also vans, pickups and panel trucks) will be:
➤ 56 cents per mile for business miles driven (down a half cent from 2013)
➤ 23.5 cents per mile for medical or moving purposes (down a half cent)
➤ 14 cents per mile for charitable mileage driven (unchanged from 2013)
©2013 CPAmerica International
With only a few days remaining in 2013, it is time to complete your year-end tax planning and make your New Year’s resolutions.
Here are planning points you might want to consider:
Gather your tax information and get it to your tax preparer early in the filing season. With all the tax changes that took place for 2013, you do not want to be unpleasantly surprised just before the due date by a higher amount of tax due.
©2013 CPAmerica International
If you’ve been making energy improvements around your house, be sure to consider the available residential energy tax credits.
To claim a credit for 2013, the improvements must be installed by the end of this year. Some residential energy tax credits are scheduled to expire at the end of 2013, while others will remain in effect for a few more years.
The credits, which are aimed at homeowners installing energy-efficient improvements such as insulation, new windows (including skylights), certain roofs, furnaces and hot water boilers, ranged from $50 to $1,500 in years past and now are limited to a lifetime maximum of $500, depending on the type of property placed in service.
In Notice 2013-70, the IRS provides additional guidance on the types of property that qualify for the credits.
Code Sec. 25C allows a credit in an amount equal to the sum of:
The credit is allowed for qualifying property placed in service through Dec. 31, 2013. For property placed in service in tax years beginning in 2009 and 2010, Code Sec. 25C allowed a maximum aggregate credit of $1,500. For other years, the credit is limited to the excess of $500 over the aggregate credits allowed for all prior tax years ending after Dec. 31, 2005 (including credits claimed in 2009 and 2010).
The credit under Code Sec. 25C may be limited depending on the type of property placed in service. For example, the maximum credit allowed for any tax year is $50 for any advanced main air-circulating fan; $150 for any qualified natural gas, propane or oil furnace or hot water boiler; and $300 for any item of energy-efficient building property. In the case of amounts paid for exterior windows, including skylights, the credit is limited to the excess of $200 over the aggregate maximum amount of the credits allowed for exterior windows for all prior tax years ending after Dec. 31, 2005.
Code Sec. 25D allows a credit for qualified expenditures made for residential energy-efficient property placed in service before Jan. 1, 2017. The IRS defines qualified expenditures for residential energy-efficient property to include:
You may rely on a manufacturer’s certification that property is eligible for either credit – so long as the IRS has not withdrawn the manufacturer’s right to make the certification. ■
©2013 CPAmerica International
The Tax Court determined in a recent case that a mortgage broker was not in the trade or business of trading securities because she didn’t execute enough trades.
The court upheld the IRS’s disallowance of over $800,000 in expenses claimed in connection with these activities over two tax years. It also determined that Sharon Nelson, the sole stockholder of a corporation engaged in the mortgage broker business, was liable for accuracy-related penalties.
John Zabasky, who lived with Nelson, was the chief executive officer and sole stockholder of a different corporation. Zabasky had been involved in the trading of stocks, bonds and currencies for approximately 25 years. Nelson executed securities trades through an online investment account. Zabasky also executed securities trades through the same account.
During 2005, there were 250 available trading days. On a total of 121 days (48.4 percent of the total available trading days), 535 trades were executed through Nelson’s account. The purchases for 95 of those trades occurred in the one-week period from Sept. 27 to Oct. 3. The holding period for the securities traded on the account during 2005 ranged from one to 48 days.
Over the course of the year, there were eight periods of at least seven days when no purchases or sales occurred through the account. The 2005 trades generated $470,472.90 of net short-term capital gain for that tax year.
During 2006, there were 250 available trading days. On a total of 66 days (26.4 percent of the total available trading days), 235 trades were executed through the account. The holding period for the securities traded on the account during 2006 ranged from one to 101 days.
During 2006, there were only two trading days on which trades were executed through the account during the period from Jan. 27 to May 4, and there were seven periods of at least seven days when no purchases or sales occurred. The 2006 trades generated $36,852.28 of net short-term capital gain for that tax year.
Nelson reported her trading activities on Schedule C, Profit or Loss From Business. The IRS disallowed all of the expenses that Nelson claimed on the Schedules C – $504,217 and $303,910 for 2005 and 2006, respectively – and imposed accuracy-related penalties.
The Tax Court initially noted that it was unclear what portion of the trades for each year was in fact executed by Nelson. However, it found that, even if it were to assume that she executed all of them, she still would not carry her burden of establishing that she was a trader for both years. Specifically, the number of trades was not sufficient to constitute a “substantial” amount for either year.
The court noted that, while the amount of money involved each year (with purchases and sales ranging from $24.2 million to $32.9 million) was “considerable,” it was not determinative of whether the activity was substantial. Finally, the court found that the total number of days spent trading – and extended periods of inactivity – belied Nelson’s claim that she was a trader.
Accordingly, the court found that Nelson was not entitled to deduct under any of the expenses claimed as Schedule C expenses. The court also upheld the IRS’s imposition of accuracy-related penalties (Sharon Nelson v. Commissioner, TC Memo 2013-259, Nov. 13, 2013).
©2013 CPAmerica International
The IRS is working to better train its small business auditors and do a better job of selecting small business returns for audit, according to Faris Fink, who represents the Small Business/Self-Employed Division of the IRS.
CFO Magazine reported on Fink’s presentation at the American Institute of Certified Public Accountants tax conference in early November. Fink referred to the fuel-tax reporting compliance project, which began in July 2012. The IRS is looking at more than 1,000 tax returns, with 600 of those returns in the field right now for examination, the report said.
Next on the agenda is an effort to better train examiners to audit partnership returns, Fink said. Understanding how to audit partnerships “will be a point of emphasis for the next 12 months and, I guarantee you, beyond that.”
©2013 CPAmerica International
You have until April 15, 2014, to make your 2013 IRA contributions, but there are five important points to consider prior to year-end:
Paid directly from your IRA (not an ongoing SEP or SIMPLE IRA);
You can use a qualified charitable distribution to satisfy the required minimum distribution for your IRA for the year. However, you cannot deduct this amount as a charitable contribution on your tax return. ■
The Fast Track Settlement program is now available nationwide.
Fast Track Settlement (FTS) is designed to help small businesses and self-employed individuals who are under examination by the IRS’s Small Business/Self Employed (SB/SE) Division to more quickly settle their differences with the IRS. The IRS announced the program’s nationwide availability in Information Release 2013-88.
Originally launched as a pilot program for small businesses and self-employed individuals in September 2006, FTS was expanded in January 2011 to specified cities and areas: Chicago, Ill.; Houston, Texas; St. Paul, Minn.; Philadelphia, Pa.; central New Jersey; and San Diego, Laguna Niguel and Riverside, Calif.
While not all disputes with the IRS are eligible for consideration, the FTS program is designed to expedite case resolution.
It uses alternative dispute resolution techniques to save time and avoid a formal administrative appeal or lengthy litigation. As a result, audit issues can usually be resolved within 60 days rather than months or years.
The IRS emphasizes that taxpayers choosing this option lose none of their rights because they still have the right to appeal if the FTS process is unsuccessful.
Either the taxpayer or the IRS examination representative may initiate Fast Track for eligible cases. The goal is to complete cases within 60 days of acceptance of the application.
©2013 CPAmerica International
The Tax Court determined in a recent case that, because an individual’s IRA owned the shares of his limited liability company, the payment of compensation to the individual for his services to the company was a prohibited transaction.
The prohibited transaction resulted in disqualification of the IRA and a deemed distribution of its assets.
In 2005, Terry Ellis organized a limited liability company (LLC), signing the operating agreement on behalf of the Terry Ellis IRA, an entity that did not yet exist. The IRA owned 98 percent of the membership units.
The LLC was formed to engage in the business of used car sales, with Ellis as the general manager. A month later, Ellis created the Terry Ellis IRA. He then transferred cash from his 401(k) account with a former employer to the IRA. The IRA transferred the funds to the LLC and received its membership units. The LLC elected to be treated as an association taxable as a corporation.
During 2005, the LLC paid Ellis $9,754 as compensation for his role as general manager and deducted that amount on its corporation tax return. Ellis’s 2005 return reported the $9,754 as taxable compensation. It also reported the distribution from the 401(k) account but did not report any portion of the distribution as taxable.
The IRS concluded that Ellis engaged in a prohibited transaction with his IRA either:
The Tax Court concluded that the formation of the LLC did not involve any prohibited transaction. However, the compensation that the LLC paid to Ellis was a prohibited transaction.
The court agreed with Ellis that, at the time of its formation, the LLC was not a disqualified person with respect to the IRA because, at that point in time, the LLC had no owners or ownership interests. However, the court said that, by paying the compensation, Ellis engaged in a prohibited transaction.
Ellis argued that the payment of compensation was not a prohibited transaction because the amounts paid to him by the LLC did not consist of plan income or assets of his IRA. He saw the compensation as merely the income or assets of a company in which his IRA had invested.
Given the facts in this case, the court concluded that the LLC and the IRA were substantially the same entity.
As a result of the prohibited transaction, the full amount that Ellis transferred to the IRA from his old 401(k) account was deemed distributed to him on Jan. 1, 2005. That amount was therefore includible in his gross income.
The court also found that Ellis was subject to the 10 percent additional tax that applies to early distributions from qualified retirement accounts. Finally, the court found that Ellis was liable for the 20 percent accuracy-related penalty (Terry L. Ellis v. Commissioner, TC Memo 2013-245, Oct. 29, 2013).
©2013 CPAmerica International
The IRS has modified the “use-it-or-lose-it” rule for health flexible spending arrangements.
At the plan sponsor’s option, employees participating in a health flexible spending arrangement (health FSA) may be allowed to carry over to the next plan year up to $500 of unused amounts remaining at year-end, according to Notice 2013-71 and an accompanying fact sheet. Prior to this announcement, any amounts that were not used by year-end were forfeited.
Health FSAs are benefit plans established by employers to reimburse employees for healthcare expenses, such as deductibles and co-payments. These plans are usually funded by employees through salary reduction agreements, although employers may contribute as well. Qualifying contributions to, and withdrawals from, health FSAs are not subject to tax.
Unused health FSA contributions left over at the end of a plan year have historically been forfeited to the employer. A plan can, but is not required to, provide an optional grace period immediately following the end of each plan year. The grace period would extend the period for incurring expenses for qualified benefits to the 15th day of the third month after the end of the plan year (March 15 for a calendar-year plan).
For a health FSA to be a qualified benefit under a cafeteria plan, the maximum amount available for reimbursement of incurred medical expenses of an employee, the employee’s dependents and any other eligible beneficiaries with respect to the employee cannot exceed $2,500 per year. This maximum is effective for tax years beginning after Dec. 31, 2012.
The new notice provides that an employer, at its option, can amend its cafeteria plan document to provide for the carryover to the immediately following plan year of up to $500 of any amount in a health FSA remaining unused as of the end of the plan year. The notice also clarifies that the carryover does not count against or otherwise affect the next year’s salary reduction limit. Any unused amount in excess of $500 will be forfeited.
The notice provides that the plan sponsor can specify a lower amount as the permissible maximum carryover amount or can decide not to allow any carryover at all.
For a cafeteria plan offering a health FSA to adopt this new carryover provision, the plan must be amended on or before the last day of the plan year from which amounts may be carried over. The new provision may be effective retroactively to the first day of that plan year.
However, a plan may be amended to adopt the carryover provision for a plan year that begins in 2013 at any time on or before the last day of the plan year that begins in 2014. As a result, some plans may be able to put the carryover option into effect for 2013.
©2013 CPAmerica International
The Tax Court has once again ruled that regular commuting expenses are nondeductible personal expenses, no matter what the mitigating circumstances might be.
William Cor was an engineer living in Las Vegas. He worked at a remote test site in the desert. There was no direct public transportation to the job site.
Cor commuted by car and calculated that he drove approximately 160 miles round-trip, four days a week. Although he kept no records of his commuting expenses, he claimed $50 an hour, or $150 per day, for a daily commute of three hours. The amount works out to almost $1 per mile, which is about double the standard mileage allowance the IRS generally allows for travel deduction purposes – but not for commuting expenses.
Although the court agreed that Cor endured a more costly and much longer commute than average in both mileage and time, the drive to the job was still a personal commute between home and work. The expenses of the commute were not deductible, regardless of the distance traveled or the lack of housing near the job site (William Cor v. Commissioner, TC Memo 2013-240, Oct. 22, 2013).
Since the commuting expenses were personal, any reimbursement by an employer to defray those expenses would be subject to income and employment taxes, as would any increase in salary to induce employment. Cor was also liable for a 20 percent negligence penalty.
©2013 CPAmerica International
