Reno tax accountants Archives - Page 5 of 22

The U.S. Tax Court settled a case in July between a landlord and a tenant who wasn’t paying rent – and the court came down on the side of the tenant.

John E. Burgess owned a piece of land that he rented to Dennis Mineni. The land was used as an overflow parking lot for Mineni’s business, Atwater Flea Market. The two men had a handshake agreement that required Mineni to pay Burgess $2,000 (later reduced to $1,500) a month for the use of the land.

Burgess failed to file income tax returns for the years 1999 through 2007. The IRS assessed taxes for each unfiled year, and the total amount was almost $5 million.

Because of the assessment, Burgess was considered a delinquent taxpayer. This designation allows the IRS to place a levy upon a taxpayer’s property or rights to property.

Burgess brought up tax-protestor-type arguments, claiming that he is not a federal citizen and therefore is not subject to the jurisdiction of any federal institution or law, including but not limited to Congress, the IRS and the Social Security Administration.

Burgess felt that he did not owe any federal income tax and that the levy placed against him was invalid.

Mineni’s business was required by law to report the rent payments made to Burgess on IRS Form 1099. A copy of the Form 1099 was sent to Burgess and another copy was submitted to the IRS as required. The IRS became aware of Burgess’s income through the Form 1099.

The IRS sent a notice of levy to Atwater Flea Market, which was now incorporated and renamed Franklynn Properties, Inc. Through payments made by his business, Mineni honored the notice of levy by paying his monthly rent payment directly to the IRS instead of Burgess.

Over a 21-month period, Franklynn Properties, Inc., paid $31,500 to the IRS.

Under Internal Revenue Code Section 6332, anyone in possession of property, or rights to property, that belongs to a delinquent taxpayer upon whom a levy has been made must surrender to the IRS the property or rights to the property. Failure to honor the levy may result in personal liability.

The person who surrenders the property or rights to the property to the IRS will be discharged from any obligation or liability to the delinquent taxpayer. Immunity under IRC Section 6332 has been interpreted generously to protect people who honor levies.

The U.S. government requested and received summary judgment on the grounds that Mineni is immune from suit for his surrender of rental payments, owed to Burgess, to the IRS under an IRS levy.

So Mineni was not required to reimburse Burgess for the rent payments that were sent to the IRS. In fact, he is to continue making the rent payments directly to the IRS until such time as the levy is found invalid or stopped (John E. Burgess, Plaintiff, v. Dennis Mineni, Defendant/Dennis Mineni, Counterclaim-Plaintiff, v. John E. Burgess, United States of America, Counterclaim-Defendants, U.S. District Court, Eastern District of California, 2015-2 U.S.T.C., July 20, 2015).

The U.S. Tax Court recently upheld the IRS’s frivolous return position, costing a taxpayer $10,000 in fines.

Mark A. Lovely failed to file tax returns for 2005, even though he admitted that he had received compensation from Tradewinds Airline, Inc., and Triad International Maintenance Corp. He claimed the compensation did not constitute “wages” and therefore it was not taxable income.

Each of Lovely’s employers issued to him a Form W-2 Wage and Tax Statement. Because the IRS receives a copy of every W-2, the agency knew that Lovely had earned income and a requirement to file a tax return.

Using this information, the IRS prepared a substitute return for Lovely and assessed income tax, penalties and additions to tax.

In July 2009, Lovely prepared a Form 1040X, Amended U.S. Individual Income Tax Return. He claimed that he had no income for the tax year at issue, which was 2005. He in fact had $29,500 worth of taxable compensation for that year. He requested that the federal income tax amount of $1,475.37, which had been withheld from his wages, be refunded to him.

In September 2012, Lovely followed a similar procedure. This time he filed a 1040X requesting a refund of $781.51.

The IRS determined that both Forms 1040X submitted by Lovely had constituted frivolous returns and assessed a $5,000 fine for each one submitted.

In a collection due process hearing with the IRS, Lovely contested the $10,000 in fines assessed by the IRS for his having submitted frivolous returns. He claimed he did not receive a statutory notice of deficiency and did not have a proper opportunity to dispute the fines.

Both of the issues raised by Lovely are defenses to the existence of the amount of the tax liability according to the Internal Revenue Code. The tax liability in this case was the $10,000 in fines.

The IRS brought up some prior court cases that supported the position that issuing a statutory notice of deficiency and allowing the taxpayer an opportunity to dispute the tax are not required when the taxpayer’s original position on the 1040X is frivolous.

Lovely agreed that he had received compensation for his services but contended that it was not taxable income because he didn’t work for the federal government. The court ruled that his tax-protestor-type arguments in support of his position were frivolous.

Taking all of the facts and circumstances of the case into account, the Tax Court ruled in favor of the IRS and upheld the $10,000 in fines (Mark A. Lovely v. Commissioner, T.C. Memo 2015-135, July 27, 2015). ■

Qualified education expenses under the American Opportunity Tax Credit are basically tuition, fees and course materials.

The tuition must be paid to an eligible educational institution. An “eligible educational institution” is generally any accredited public, nonprofit or proprietary (private) college, university, vocational school or other postsecondary institution.

Student activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. Student health fees are not included as part of this expense. They are considered a medical expense.

Course materials include books, equipment and supplies. You do not have to purchase these items directly from the school to include them. Books included in the credit are the textbooks needed for the course. Supplies include highlighters, pens, pencils, etc. An example of equipment is a laptop computer.

If you do not purchase your course materials from the university bookstore, those qualified education expense items will not be included on the Form 1098-T that you receive from the university. You will need to enter these expenses – in addition to the expenses listed on the Form 1098-T – when preparing your income tax returns.

Qualified education expenses never include personal expenses. Room and board, insurance, medical expenses, transportation and similar personal, living or family expenses are examples of personal expenses.

The amount of qualified education expenses is reduced by the amount of a qualified scholarship, which is excluded from gross income, as well as tax-free fellowship grants, the tax-free part of employer education assistance and veterans’ educational assistance. The amount of the scholarship will be provided to you on Form 1098-T. ■

from the IRS

If you have something called qualified dividend income, it receives special tax treatment.

Qualified dividend income is defined as dividends received during the tax year from a domestic corporation or a qualified foreign corporation. It is taxed at the lower preferential capital gains tax rates.

A domestic corporation is a corporation incorporated within the United States. A qualified foreign corporation is a corporation incorporated in a possession of the United States or a corporation eligible for benefits of a comprehensive income tax treaty with the United States that the secretary of the Internal Revenue Service determines is satisfactory.

In contrast, ordinary dividends are fully includable in gross income. An ordinary dividend is any distribution made by a corporation to its shareholders whether in money or property. The amount of the dividend is the amount of cash received plus the fair market value of any property received, if applicable.

You pay tax on ordinary dividends at your ordinary income tax rates. Your tax bracket determines the rate of income tax that you pay. There are currently seven ordinary income tax rates or brackets.

However, if the corporation’s dividends meet the criteria for qualified dividend income treatment, the lower preferential tax rates apply, as shown in the table below:

Ordinary Income Tax Rate Qualified Dividend Rate

10% 0%

15% 0%

25% 15%

28% 15%

33% 15%

35% 15%

39.6% 20%

These rates are applicable for individuals, estates and trusts.

Investments in tax-deferred retirement vehicles such as a regular IRAs, 401(k)s and deferred annuities do not receive any benefit from the preferential rate reduction.

Distributions from these accounts are taxed at ordinary income tax rates even if the funds represent dividends paid on the stocks held in these accounts.

There is a 60-day holding period requirement to qualify for the preferential qualified dividends rate. You have to hold a stock at least 60 days within a 121-day period, which begins 60 days before the ex-dividend date and ends 60 days after.

The ex-dividend date is the day after the date of record, which is the date on which all shareholders who own a particular stock will receive a dividend for that period of time.

Obviously, following the rules and qualifying for the preferential qualified dividends rate can result in a substantial tax savings. ■

Courts

Ordinary and necessary business expenses are not deductible when a trade or business consists of trafficking in controlled substances prohibited by federal law, under a recent decision by the 9th U.S. Circuit Court of Appeals.

Martin Olive owns a business called the Vapor Room, located in San Francisco, Calif.

He appealed the Tax Court’s decision to disallow the deduction of all of his business expenses for 2004 and 2005. The Vapor Room had $236,502 of business expenses in 2004 and $417,569 of business expenses in 2005.

The Internal Revenue Code (IRC) defines “gross income” and allows a business to deduct from its gross income all of the ordinary and necessary expenses paid or incurred during the taxable year in carrying on the business. The difference between the two items is the business’s net income.

The IRC also has some exceptions to what is deductible as an ordinary and necessary business expense. One exception is IRC Section 280E, which disallows the amount paid or incurred during the taxable year for the purpose of carrying on any trade or business consisting of trafficking in controlled substances.

The test for determining whether an activity constitutes a trade of business is whether the activity was entered into with the dominant hope and intent of realizing a profit.

The Tax Court in applying the profit test determined that the only business activity that was engaged in by the Vapor Room was the sale of medical marijuana. Medical marijuana, while legal to sell in the state of California, is still considered to be a controlled substance for federal government purposes.

The Tax Court found that the only income-generating activity in which the Vapor Room engaged was its sale of medical marijuana. Marijuana was the only item for which the Vapor Room charged a fee.

It offered other services and amenities for which it did not charge a fee. For example, it provided vaporizers, food, drink, yoga, games, movies and counseling. The business offered the free items hoping to lure in customers to its dispensary to buy its medical marijuana.

Because marijuana is a controlled substance, IRC Section 280E disallows the deduction of any expenses related to this activity.

Thus, the appeals court affirmed the Tax Court’s decision to deny the Vapor Room a deduction for what it had considered the ordinary and necessary business expense associated with its operation (Martin Olive v. Commissioner, U.S. Court of Appeals, Ninth Circuit, No. 13-70510, July 9, 2015). ■

The IRS recently lost a lawsuit to Public.Resource.Org, Inc., but its loss may result in greater protection of sensitive taxpayer information.

The U.S. Court of Appeals for the Ninth Circuit in California found that, under the Freedom of Information Act, the IRS was required to provide Public.Resource.Org, a nonprofit corporation that provides public access to information, with a small set of Forms 990. The IRS raised objections to doing this based on cost concerns, but the court ordered the agency to comply anyway.

The problem is that certain information contained on Form 990 (Return of Organization Exempt from Income Tax) is considered to be sensitive and of a personable nature. For this reason, it must be protected from public distribution.

In complying with the court’s decision, the IRS had to manually copy certain portions of the Forms 990, which are available to the public. They then had to assemble this information and send it out to the interested party. This procedure is time-consuming and expensive.

As it stands right now, if the IRS were to send an electronic file to an interested party to comply with the law, that electronic file would contain all of the information on the Forms 990, including the sensitive and personal information that is not to be released to the public.

In response to the court’s requirement to provide the Forms 990, the IRS announced that it was considering using new technology to produce electronic versions of the publicly available portions of exempt organization returns in machine-readable form. Machine-readable is not a format that the IRS has historically used to make Forms 990 available.

With the new technology, the IRS will be able to send the whole electronic file to the interested party, which will be able to print out only the information on the return that is approved for public disclosure. The sensitive personal information will be kept confidential. The interested party will not be able to access this information or print it out.

Using the new technology will allow the IRS to meet the reporting requirement in a timely and cost-effective manner. ■

The tax treatment for renting out your vacation home depends on the number of days it’s rented.

If you don’t use your vacation home all the time and are considering renting it out for a portion of the year, you have three possible situations – all with different tax ramifications:

Not rented at all
Rented for fewer than 15 days
Rented for more than 15 days

The first situation is the easiest and most straightforward. You own a second home as a vacation property. You do not rent out that property at all during the year. You would be able to deduct the mortgage interest and real estate taxes that you paid during the year as Schedule A itemized deductions.

If you use your vacation home for personal use at least 15 days and rent it out for fewer than 15 days, the IRS considers the primary function of the property to be personal and not a rental. Therefore no rental income or rental expenses should be claimed on Schedule E, Supplemental Income or Loss, of Form 1040.

You are not required to report the rental income and rental expenses from this activity. The expenses that you are able to deduct include mortgage interest and real estate taxes, which would be deducted on Schedule A as itemized deductions.

The third situation is a little more complicated. If you used the vacation home as a home and rented it out 15 days or more during the year, you would be required to include all of your rental income as income on Schedule E. Because you used the home for personal purposes, you must allocate your expenses between business and personal use.

When allocating your expenses, you should follow these two rules:

Any day that the unit is rented at a fair rental price is a day of rental use even if you used the unit for personal purposes that day.
Any day that the unit is available for rent but not actually rented is not a day of rental use.

The numerator for allocation purposes would be the number of days that the vacation home was rented out at a fair market rental price during the year. The denominator would be 365 days.

Crunching these numbers will give you the business-use percentage. You would then multiply all of your various business/rental expenses by this percentage to arrive at the deductible amount of your expenses.

The deductible amount of your expenses is then entered on Schedule E. The IRS provides a worksheet to help you calculate the amount of your deductible business/rental expenses. Unallocated mortgage interest and taxes (the personal part) still goes on Schedule A.

If you follow these simple rules when renting out your vacation home, you can avoid unintended consequences.

The IRS allows taxpayers to use an optional safe harbor method when claiming a home office deduction.

The safe harbor method saves the taxpayer from having to substantiate, calculate and allocate deductible home office expenses, a procedure that is part of the nightmare taxpayers have to go through if they want to use the old actual expense method.

With the optional method, the taxpayer simply calculates the number of square feet used for the office and multiplies that number times $5. The maximum square footage that can be used is 300, so the maximum home office deduction at the present moment is $1,500.

The IRS can adjust the $5 rate as warranted.

The safe harbor deduction may not exceed the gross income from the business. If it does, the excess may not be carried forward.

Taxpayers using the safe harbor method will not be able to depreciate the portion of their home used in the trade or business. But the advantage is the taxpayer may deduct mortgage interest, real estate taxes and any casualty loss as itemized deductions on Schedule A of Form 1040.

The taxpayer would still be allowed to deduct, to the extent allowed by the Internal Revenue Code and regulations, any trade or business expenses unrelated to the qualified business use of the home for that taxable year. Some examples would be advertising and office supplies.

If reimbursed by an employer for the home office expenses, a taxpayer cannot use the safe harbor method.

The taxpayer may elect from taxable year to taxable year whether to use the safe harbor method or to calculate and substantiate actual expenses for the purpose of the home office deduction. A method is elected simply by using the particular method for that tax year. A method once selected for that tax year cannot be changed. ■

Nonemployee compensation received in exchange for services rendered is taxable income, despite tax protester arguments to the contrary.

Stephan Foryan, a resident of the state of Washington and an apparent tax protester, did not file a tax return for 2009. He also did not make any estimated tax payments for the 2009 tax year.

Foryan admits to having received nonemployee compensation for services rendered, but he told the U.S. Tax Court that the compensation was not taxable. He mistakenly relied on a court case from 1920 to support this argument. Unfortunately for him, a 1955 Supreme Court case superseded the 1920 case, making it not applicable to the present matter.

Internal Revenue Code Section 61(a) provides that “gross income means all income from whatever source derived,” including compensation for services.

Using information obtained from third parties, the IRS had calculated Foryan’s income for 2009 to be $137,282. Against this income, Foryan was allowed a self-employment income tax deduction of $8,460, a standard deduction of $5,700 and a personal exemption of $3,650.

Foryan had been involved in a prior court case a few years earlier regarding a tax matter. He lost that case, and the court put him on notice regarding raising tax protester arguments.

The same situation arose in this case. The court rejected Foryan’s arguments as frivolous tax protester arguments. In addition, the court fined him $1,000 because it felt that his position in this case was frivolous or groundless.

Therefore, the court agreed with the IRS in this case, finding that Foryan had received $137,282 in compensation for services performed at various farms during the year and including that amount in his gross income for 2009. He was allowed the deductions calculated by the IRS (Stephan Foryan v. Commissioner, U.S. Tax Court, T.C. Memo 2015-114, June 22, 2015). ■

The IRS has announced that it will issue estate tax closing letters only on request for estate tax returns filed on or after June 1, 2015.

Prior to this change, CPAs and clients anxiously awaited the closing letter for filed estate tax returns. A very large portion of returns are audited. Receiving the closing letter meant that the IRS had accepted the return (Form 706, United States Estate Tax Return) as filed and it would not be audited.

The IRS recommends waiting at least four months after filing your Form 706 return before requesting a closing letter.

If you filed your estate tax return before June 1, 2015, the IRS will continue its policy of issuing closing letters provided the return is accepted as filed and has no other errors or special circumstances. Expect to wait four to six months to receive the letter.

Not all returns filed before June 1, 2015, will receive a closing letter. The IRS will not issue a closing letter for any return that was filed after Jan. 1, 2015, but before June 1, 2015, that did not meet the filing threshold for an estate tax return and whose taxpayer portability election was rejected by the IRS.

The filing threshold simply means the gross value of the estate. Those numbers are indexed for inflation and are as follows:

2015 – $5,430,000

2014 – $5,340,000

2013 – $5,250,000

A portability election allows a deceased spouse to transfer the estate’s unused exclusion amount to the surviving spouse.

The IRS gives a great deal of attention to the estate tax return when a portability election is made, so the election must be made properly.

For returns filed after Jan.1, 2015, and before June 1, 2015, the IRS will still issue a closing letter if the estate met the filing threshold. In addition, if the filing threshold was not met, but no portability election was made, you will still receive a closing letter.

If you have any questions about estate tax closing letters, please contact your CPA. ■