Exempt Groups: The Skinny

EXEMPT GROUPS

Mixed news for state chartered credit unions that sell products to members:

Income from sales of financial services is tax-exempt, a district court says. It rejects IRS’ position that such income is hit with unrelated business income tax. Selling financial products such as mutual funds and annuities to members is related to the group’s exempt purpose.

But income from insurance sales to members may be taxable. The court reserves judgment on whether income from selling credit life and disability insurance and car loan protection coverage to members is taxed as unrelated business income. This does not affect federal credit unions. They do not pay unrelated business tax.

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IRAs: Losses from Ponzi Schemes

IRA’S

There’s little relief for IRAs victimized by Ponzi schemes, IRS privately says.The deductible loss is limited to your tax basis in the IRA…that is, the sum of your nondeductible contributions. You can claim the loss only after the balance in all your IRAs is paid out. And any deductible loss is a miscellaneous itemization, deductible only to the extent the total exceeds 2% of your adjusted gross income. IRA owners can’t pledge funds in other accounts to cover IRA shortfalls, the Labor Dept. says. Before an investor could open a self-directed IRA allowing himto buy and sell securities using his IRA funds, his brokerage firm said that it needed to have a security interest in his other accounts with the firm. That way,
liabilities incurred by the IRA would be covered. But Labor said the arrangement amounted to an extension of credit to the IRA by its owner, which is a prohibited transaction.

Also prohibited: Pledging one’s IRA funds to cover the debts of non-IRA accounts.

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Real Estate: Home Buyer Credit

REAL ESTATE

Note how divorce affects qualifying for the first time home buyer credit:

The marital home is your principal residence until the divorce is finalized, IRS privately says. So even if a divorce court ordered you to vacate the marital home more than three years before the divorce was finalized, you must wait three years after the divorce is final to be eligible for the $8,000 credit for buying a residence. But you may qualify for the new $6,500 credit for prior homeowners immediately, if you’ve maintained the same home for five consecutive years out of the last eight before buying another house. Time spent out of the home due to the court’s order would still count toward the necessary five years, under the Service’s rationale.

A reminder for unmarried co-purchasers on taking the home buyer credit:

The buyers can apportion the credit any way they want, IRS privately rules. So if two brothers buy an $80,000 home before May 1, 2010, but one is not eligible for the credit, the $8,000 break can be fully allocated to and claimed by the other.

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Fighting The IRS - In Court

FIGHTING THE IRS

You can beat IRS in court, but you can’t make the agency apologize to you. Although a taxpayer won a case that fully allowed his alimony deduction, the Service audited him two years later and nixed the deduction again. In Tax Court, IRS quickly conceded he owed no tax (Caldwell, TC Summ. Op. 2009-169). However, the Court said it had no power to grant his demand for a written apology from IRS.

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Benefit Plans: Continuing Coverage

BENEFIT PLANS

The COBRA health coverage subsidy will affect health care plans in 2010:

Firms must let subsidy recipients take part in open enrollment for next year if their subsidy period continues into 2010. Since terminated workers are eligible for a nine month subsidy period,
this can affect former employees who were let go after March 2009. IRS says if premiums for these ex-workers go up due to a change in their benefit plan, they don’t lose the subsidy. That’s
good news for individuals who choose to add dental or vision care or switch from an HMO to pricier coverage. Cash balance plans get a reprieve on a new rule for calculating benefits, IRS says.

They now get an extra year, until the end of 2010, to ensure that the rate used to figure earnings on participants’ accounts does not exceed a market rate of return. The Service needs more time to determine how to compute the rate. IRS won’t grant further delays on reporting stock transfers involving ISOs... incentive stock options. Under newly issued regulations, firms needn’t report to
IRS about ISOs exercised during 2009. But reports must be filed for options exercised in 2010. Ditto for employee stock purchase plans. Firms already must report data on ISOs, such as their grant date, exercise price and the like, to their employees.

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Business Taxes: What’s New

BUSINESS TAXES

Firms get guidance from IRS on the expanded loss carry back rules. A new law allows businesses of all sizes to carry back a 2008 or 2009 NOL for up to five years. Those that have average gross receipts of $15 million or less can elect to do so for losses in both years. The election for either year must be filed by the due date of the firm’s 2009 return, plus extensions. Any loss carried back to the fifth year can offset only 50% of that year’s income. The election can be made on Form 1139 by corporations and on Form 1045 by self-employed individuals.

Information return filers can now enter truncated Social Security numbers on forms sent to taxpayers, the Revenue Service says. Payers of interest, dividends and the like can mask all but the last four digits of taxpayer ID numbers on 1098s, 1099s and 5498s to help thwart identity theft. The IRS already blocks out portions of Social Security numbers on documents that publicly record or release tax liens. Of course, the payee’s full tax ID number must still be listed on the copy that’s filed with IRS. Otherwise, the IRS couldn’t match the income with the taxpayer’s 1040.

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My Crystal Ball

IRS will soon have to take on a big new job:

Managing major parts of health care reform once the landmark legislation is finally enacted. The Service will grow by leaps and bounds as it puts a slew of tax changes related to health care into effect and sets up systems to enforce the rules. How well the IRS can handle this increased workload hinges on whether lawmakers are willing to give the OK to billions more in agency funding for years to come.

Take a look at what IRS will take charge of: Enforcing a mandate on individuals. By 2013 or so, most will be required to show they have health care coverage or pay a penalty when filing their returns. IRS will have to match reports from insurers with taxpayers’ returns to make sure that those filers who don’t have coverage pay the penalty when they file their taxes.

Remitting affordability credits to help low incomers pay for coverage that they will purchase through state-run exchanges, beginning around 2013. IRS is expected to be the middleman here…taking information from the exchanges about the amount of credit that individuals qualify for and sending those amounts directly to insurance companies. The exchanges, in turn, will get income information from IRS to verify that those who apply for credits fall below the income thresholds. Policing requirements for employers.

IRS will be tasked with collecting fees from large and mid size companies that don’t provide affordable coverage to workers. The fees are designed to offset the cost of the tax credits being given to low incomers. Implementing a new excise tax on high cost health plans, which lawmakers are expected to retain in the final health care bill to help defray the cost of reform. Checking tax credits claimed by small firms.

Those offering a health planto employees will qualify for a new income tax credit that will help offset the cost. Many in Congress worry IRS won’t be up to the task, even with extra funds. The concern: The Service is being asked to manage a huge social welfare program… something that agency staff have no experience with and have not been trained for.

Critics also point to IRS’ spotty management record on similar programs. Among them: An existing credit for health coverage for displaced workers. A sampling of 2006 return filers who got the credit found that nearly three quarters failed to attach documentation and may not have qualified, but IRS didn’t nab them. The earned income credit. Despite increased document matching, the IRS still misses most of the more than $10 million in bogus claims a year, Treasury says.

But the IRS isn’t the only problem here:

Congress shares the blame. For example, the Service is taking heat for allowing a slew of bogus refund claims for the first time home buyer credit. But that snafu would likely have been avoided if Congress had written the law to require taxpayers to attach settlement statements to their tax returns. The recently enacted credit extension contains the requirement.

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Payroll Taxes: Withholding Tables

PAYROLL TAXES

Some wage earners will see more tax withheld from their paychecks, now that the Service has released the revised withholding tables for 2010.

Last year’s tables were updated in the spring to reflect the Making Work Pay Credit...a 6.2%credit on earned income, capped at $400 for singles and $800 for couples. Those tables crammed the benefit of the credit into the last nine months of the year, about $45 a month for singles and $67 a month for couples. Since this year’s tables spread the credit over a full 12-month period, the savings each month from the credit will be lower. Thus, on the same pay, the amount of tax withheld will be a bit larger.

And IRS has revised the optional table for pension withholding. It allows for extra withholding to offset the benefit of the Making Work Pay Credit that is built into the regular tables. Pensioners without earned income don’t qualify for the credit and may wind up being under withheld at year-end if the regular tables are used.

Schools must withhold FICA tax on grant payments to postdoctoral fellows, the Service privately rules. The fellows are treated as employees of the university. They are hired after the school secures funding for a project, and they are directed to particular areas of research. Their work is supervised by faculty members.
And they are eligible to receive retirement plan benefits while the position lasts.

All in all, the IRS concluded that the payments made to the fellows were for services. The rule is different for National Research Service grants. No FICA is due on those, IRS says, because the school doesn’t have direct control over that research.
Smalls get more flexibility in choosing how often to file payroll tax returns. Beginning next year, businesses that now file Form 944 annually will be permitted to switch to filing Form 941 quarterly for any reason. For 2009, firms filing annually could make the switch only if they expected their payroll tax deposits to top $1,000 for the year or they planned to e-file quarterly return. To make the changeover to quarterly filing, firms will have to notify IRS in writing, and keep filing annually until they receive written permission from the Service that they can file the 941.

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Enforcement: IRS on the War Path

ENFORCEMENT

IRS will crack down on firms owning foreign vessels that dodge U.S. taxes. In a memo to field agents, IRS says the problem involves foreign contractors that work for U.S. oil and gas companies in the Outer Continental Shelf.

Typically, they perform drilling or salvage work, or transport supplies between U.S. ports and oil rigs. Since those waters are U.S. territory, vessel owners are liable for tax on income derived there. A foreign vessel owner claiming a treaty-based exemption from U.S. tax still is required to file a U.S. income tax return and attach Form 8833, disclosing its claim of exemption. Since foreign businesses have to register to work in the Outer Continental Shelf, the Service will review that list for audit targets.

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Year-End Reminders: Cash Gifts

YEAR END REMINDERS

If you plan to make cash gifts to relatives during the holiday season...

Remember to use the benefits of the $13,000 annual exclusion for gifts. This is a very easy way for individuals to reduce their future estate tax liability. Each year you can give up to $13,000 free of gift tax to a child, a grandchild, or anyone else. The cap is $26,000 per recipient if you are married and your spouse concurs in the gift, even if the entire amount of it comes from one spouse’s assets.

Larger size gifts can pay off as well. No gift tax is due on amounts in excess of $13,000 unless you have used up your $1-million lifetime exemption. Also, any future increase in the value of assets you give is excluded from your estate. There’s an unlimited break for tuition that donors pay directly to schools. It doesn’t count toward either the $13,000 annual exclusion or $1-million exemption. The same goes for medical expenses that donors pay on behalf of donees. If you give securities, endorse them over to the recipient. On yearend gifts, companies may not be able to re-title the certificates in the donee’s name by Dec. 31.

If you are giving a check, be sure that the donee deposits the check in 2009 if you want the money to count as a 2009 gift for gift tax purposes. Alternatively, deliver a certified check to the recipient this year. That will count as a 2009 gift, even if the donee does not deposit the check into his or her account until next year.

Did your child or grandchild work this year? A Roth payin is a great gift. You can give $5,000 or what the child earned, whichever is less. But keep in mind that the gift does count toward the $13,000 or $26,000 annual gift tax exclusions.

A Roth can grow into a nice nest egg, especially if you keep making payins each year.

One more thing....start bookkeeping now...

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