Tax Debt Help - IRS Collection Process

Notice and Demand

If the IRS examines a taxpayer’s return and finds an error which results in additional tax due, they will send a bill (including tax, interest, and penalties), which is a notice of tax due and demand for payment. This letter is called a CP2000 or L1058. In most cases, the IRS give the taxpayer 10 days from the date of the notice of tax due before they may take enforcedcollection actions. The taxpayer will receive Publication 1 with the initial notice and demand for payment.

Notice Of Federal Tax Lien

Once a notice and demand for payment is sent to a taxpayer and they neglect or refuse to fully pay the tax within 10 days, the IRS files a notice of federal tax lien. This is a public notice to the taxpayer’s creditors that the Government has a claim against the taxpayer’s property.
The IRS will issue a Release of the Notice of Federal Tax Lien for the following reasons:

· Within 30 days after the taxpayer pays the tax due in full (including interest and other additions) or by having it adjusted, or
· Within 30 days after the IRS accepts a bond that the taxpayer submits, guaranteeing payment of the debt.

Notice of Intent to Levy

Once this notice is sent to a taxpayer, they have 30 days to pay the tax, or face collection by levy. This notice may be given to the taxpayer in person, left at his/her residence or place of business, or sent by certified or registered mail to the taxpayer’s last known address.
Levy

A levy is the taking of property to satisfy a tax liability. Once served, a levy on salary or wages continues in effect until it is released, or the tax liability is satisfied or becomes unenforceable due to lapse of time. The IRS may levy up to 85% of salary or wages until the debt is satisfied.

Taxpayer’s should also know that they must be compliant in filing delinquent tax returns before a levy can be released.

There are certain properties that are exempt from being levied. The following are a list of those properties:

· School books and certain clothing
· Fuel, provisions, furniture, and personal effects for a household, totaling $7,720
· Books and tools used in trade, business or profession totaling $3,860
· Unemployment benefits and certain annuity and pension benefits
· Workmen’s compensation and certain public assistance payments
· Certain service-connected disability payments
· Salary, wages, or income included in a judgment for court-ordered child support
· Principal residence, unless prior written approval of the District Director or Assistant District Director is secured, or jeopardy exists
· A minimum weekly exemption for wages, salary, and other income based on the standard deduction plus the number of allowable personal exemptions divided by 52.

Statute of Limitations

Statute of limitations for assessing tax. Statutes of limitations generally limit the time the IRS has to make tax assessments to within three years after a return is due or filed, whichever is later.

Statute of limitations for collecting tax. Statute of limitations generally limit the time the IRS has to collect taxes to within 10 years after the taxes have been assessed.

Tax Help - Donations of Vehicles

If a taxpayer donates a car to a qualified organization, the deduction is limited to the gross proceeds from its sale by the organization.

This rule applies if the claimed value of the donated vehicle is more than $500. However, if the organization makes significant intervening use of or materially improves the car, the taxpayer may be able to deduct its fair market value.

In addition, the taxpayer may be able to deduct the car’s fair market value if the organization will give the car, or sell it for a price well below fair market value, to a needy individual to further the organization’s charitable purpose.

The organization must send the done Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes within 30 days of the sale of the vehicle, boat, or airplane, and the taxpayer must attach Form 1098-C to his or her tax return.

IRS Releases Updated Drafts of Corporate & Partnership Tax Forms

The IRS has released draft revisions to Form 1065, Form 1120, and certain related schedules. Included in the release are a new Schedule B for Form 1120 and Schedule C for Form 1065. These forms will be for use for tax years ending on or after December 31, 2008.

The major change to Form 1120 is to Schedule K and involves reporting direct and indirect ownership. When ownership meets certain percentage thresholds, it must be reported on Schedule K. Certain questions on Schedule K have been revised for this reporting.

The new Schedule B (Form 1120) is required of corporations that file Form 1120, Schedule M-3. Schedule B will provide the IRS information about allocations, transfers of interest, cost sharing arrangements, and changes in methods of accounting.

The major changes to the Form 1065 also involve ownership issues. When ownership meets certain percentage thresholds, it must be reported on Schedule B (Form 1065). The revised Schedule B will also be used to provide information about cancelled debt, and like-kind exchanges that the partnership may have participated in at any time during the tax year. For small partnerships, the asset threshold for filing Schedules L, M-1, and M-2 has been increased from $600,000 to $1,000,000.

The new Schedule C will be required of Form 1065 filers that file Schedule M-3. Schedule C will be used to report information about related party transactions, allocations, transfers of interest, cost sharing arrangements, and changes in methods of accounting.

New instructions for Item J of Schedule K-1 (Form 1065) clarify how partnerships determine partners’ percentage share in the profit, loss, and capital at the beginning and end of the partnership’s tax year. The redesigned forms are available at the IRS website.

Tax Help - Disaster Update

The Federal Emergency Management Agency (FEMA) has announced that the President, on July 15, 2008, determined that certain areas in Vermont are eligible for assistance from the federal government under the Disaster Relief and Emergency Assistance Act (42 USC 5121) as a result of severe storms and flooding beginning on June 14, 2008. Accordingly, taxpayers in the counties of Addison and Franklin who sustained losses attributable to the disaster may deduct the losses on their 2007 federal income tax returns.

FEMA also updated information for previously declared disasters in Iowa, Missouri, and Oklahoma. FEMA posts updated information on disasters on a regular basis on the FEMA website.

President Signs Housing bill

On Wednesday, July 30, President Bush signed the Housing Assistance Tax Act of 2008 into law. The legislation includes provisions for nonitemizers to claim an additional standard deduction for real property taxes, a refundable credit for first-time homebuyers, relaxed tax-exempt bond requirements, additional GO Zone provisions, eased AMT rules, and tax breaks for businesses that include an election to accelerate AMT, and research credits instead of bonus depreciation.

Check out a summary of the Housing Act at NATP website.

Housing Assistance Tax Act of 2008

To Strip or Not to Strip!

One of the most challenging clients that I have had to sit in front of me to prepare tax returns was a very attractive twenty-two year old young lady. Now that in itself is not strange, but when she started telling me about herself, that’s when the conversation took a turn.

This client was a “professional exotic dancer”, as she called herself. Her first question was, “do I have to report the money I receive while dancing?” In other words, the money that is “tucked” in her costume while dancing. She did not like the answer I gave which was obvious. She laughed and said that they were not paying her to dance, they were showing their appreciation for her talent. She felt that the money was more of a gift.

At that point, we began discussing deductions. She pulled out a list of items that she had purchased during the year. The list of items that she wanted to deduct read like catalog items from Victoria Secret and Fredrick’s of Hollywood. But the one that made me laugh was her $12,000 breast augmentation. Her exact words to me were, “this procedure has made me a more marketable employee”. She and I both had a laugh. And of course, all of the men in the office had their ears pointed our way.

After further discussion, I found out that she was working her way through college by dancing. Rather than being paid by W-2, she received a 1099-MISC for $75,000. I inquired about her “appreciation money” aka tips, and she estimated that she had received in approximately $500 per week.

We proceeded with the preparation of her return. She filed a Schedule C since she received the 1099-MISC and was hesitant but willing to include the tip monies. We claimed 75% of her costumes expenses (I figured that some of those purchases were personal). We also took a deduction for mileage driving to and from work since she was considered an independent contractor. But the breast augmentation could not be deducted as this was considered cosmetic surgery, she wasn’t happy with that.

Wonder if any of those onlookers claimed the “appreciation money” as tips or a business expense….huh!

Residential Energy Credit: A Difference of Opinion

There seems to be a difference of opinion regarding whether newly constructed homes qualify for the credits claimed on Form 5695, Residential Energy Credits.

Taxpayers who build a new residence in 2006 that included energy-efficient windows, doors, furnace, air conditioning, and water heater have all of the required manufacturer’s certifications and Energy Star ratings. They assume that the residential energy credit can be calculated on their tax return. Let’s see if they qualify for the credit.

While a manufacturer’s certification states that a particular product or component qualifies for the energy tax credit, the product must be installed as an improvement to an existing residence. For example, the taxpayer has to take out the old windows and install new energy-efficient windows, or tak out the old storm doors and install new energy-efficient storm doors. In other words, at the time of installation the house must already be owned and used as the taxpayer’s principal residence.

Taxpayers who have made qualified engery-efficient improvements to their existing personal residence must keep a copy of the manufacturer’s certification statement in their records and should not attach it to their tax return.

Additional reading:

Don't Overlook These Valuable Tax Credits

Keep Medicare Fair

Did you know that there was an 112% increase in Medicare Part B premiums since 2000?

AARP has a campaign urging Congress to “Keep Medicare Fair” generated more than 600,000 e-mails, phone calls and petitions as of mid-June. The effort aims to slow the growth in monthly

Part B premiums, which rose from $45.50 in 2000 to $96.40 in 2008.

Congress has grappled with how to prevent a scheduled 10 percent pay cut for doctors without hiking Medicare’s overall costs, to which Part B premiums are pegged. AARPP and many lawmakers say that reducing other program spending, including some payments to Medicare private plans, would pay for the fix, a proposal the White House threatens to veto.

Senate leaders hope to resoslve the issue this month. “The goal is to prevent yet another cut in physician payments,” says AARP’s Kirsten Sloan, “without the cost coming from beneficiaries’ pocketbooks.”

Babyboomers remember that Medicare Part B premiums are deductible on your Schedule A medical expenses when filing your tax returns.

Additional reading:

Older Americans' Tax Guide

1099-C Interest on Cancelled Debts

There seems to be confusion on the taxability of credit card interest reported on a 1099-C.

Most clients ask me the following, “A taxpayer received a 1099-C reporting cancelled debt from credit cards they used for personal purchases. The person is neither bankrupt nor insolvent. The 1099-C indicated that a portion of the cancelled debt included interest. Is the interest portion also included in the taxpayer’s income?

The answer is yes. Since the interest on the debt would not have been deductible had the taxpayer paid the credit cards, the interest is included in income as part of the cancelled debt income.

All taxpayers who may face the situation of 1099-C cancelled debt on credit cards should remember that you can negotiate with the credit card company for your settlement. During the settlement process you can inquire as to whether the “write-off” amount is going to be reported. You have the option of not accepting a payoff agreement when reporting is inevitable.

1099-C Cancelled Debt is reported on Line 21 of your 1040 and the amount reported is added directly to income. There are no deductions that will reduce this amount.

Retirees Reminded to File for Stimulus Rebate

The IRS is reminding qualifying retirees and veterans that it is not too late to file for an economic stimulus payment and announced it will send a second set of information packets to 5.2 million people who may be eligible but who have not yet filed for their stimulus payment. The information packets will be mailed over a three-week period beginning July 21, 2008.

Regulations Issued on Farm Income Averaging

For tax years beginning after 2003, the American Jobs Creation Act of 2004 extended the option of income averaging to individuals engaged in the trade or business of fishing. Previously, the option only applied to farmers. The IRS has just issued TD 9417 containing temporary, final, and proposed regulations under Sec. 1301 reflecting changes for fishing businesses. Taxpayers may apply these regulations in tax years beginning after 2003 and before publication in the Federal Register, but only if all provisions are applied consistently in each tax year.

Stimulus Update

This week marks the final week of mass disbursements of stimulus payments.

Payments will continue to be sent to households in small batches throughout the end of the year as returns are filed by the October 15 extension deadline.

Those taxpayers who do not file by October 15 and still qualify for a payment can obtain their stimulus payment by filing a 2008 tax return next year.

Those taxpayers who are not otherwise required to file a tax return, must do so by October 15, 2008 to qualify for the rebate.

Requirements for Non-Custodial Parent Claiming a Child as Dependent

To claim a child as a dependent, a non-custodial parent must attach Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents, to his or her tax return. Failing that, a substitute for the form must be attached. The IRS says the substitute can be a decree or agreement that states all three of the following:

· The non-custodial parent can claim the child as a dependent without regard to any condition, such as payment of support.
· The other parent will not claim the child as a dependent.
· The years for which the claim is released.

If the decree or agreement has a condition, it cannot be used as a substitute for Form 8332. In William N. Ward v. Commissioner, a separation agreement provided the father could claim the dependency exemptions for his two children “so long as [petitioner] is current in the payment of his child support obligations.” The father was current, but the mother claimed the children as dependents on her 2004 tax return. The taxpayer also claimed them as dependents on his 2004 return and attached a copy of the separation agreement to the return.

Because of the stipulation that the father be current on his child support obligation, and because there was no statement that the mother would not claim the children as dependents, the IRS claimed that the separation agreement does not meet the criteria to be a substitution for Form 8332. The court agreed. Tax Court Memo 2008-54

But that’s not the end of the story. What was the father’s solution? In this case, the father instituted legal proceedings in Juvenile and Domestic Relations District Court to enforce the terms of the separation agreement. The mother was required to pay the father $2,426, the resulting tax effect of claiming the children as dependents. This court noted any future problems the father may have with the mother in this regard would be more adequately and effectively remedied in the courts.

Remember, you can be first out of the gate by claiming the kids, but the finish line is determined by the IRS and you willingness to fight.

Is Mary Kay Cosmetics A Hobby, Trade or Business?

Ladies, this is one that you need to take great heed from. Before you invest in all those Pampered Chef, cosmetic sales and even “pleasure toy” shows, you might want to talk with Brenda Konchar, a Mary Kay Cosmetics representative who took her case before the Tax Court in Ralph D. Konchar, et ux. V. Commissioner, Tax Court Summary Opinion 2004-59.

Brenda Konchar reported net losses on Schedule C for her Mary Kay activity in 1996, 1997, and 1998. The IRS disallowed the business losses, since the activity was not a trade or business entered into for profit. It was a hobby. Furthermore, even if the activity had been conducted with a profit motive, most of her business expenses could not be substantiated.


Under §183(b), if an activity is not engaged in for profit, expenses are generally only deductible to the extent of the gross income from the activity. The deductions that exceed gross income cannot create a business loss.


An activity is conducted for profit if deductions are allowable under


1. §162 as ordinary and necessary trade or business expenses; or
2. §212 as expenses for the production or collection of income.


Under either section, the taxpayer must intend to make a profit. Whether an activity is conducted with a profit motive is based upon all relevant facts and circumstances.


Under §1.183-2(b), the Courts consider nine nonexclusive factors to determine whether an activity is engaged in for profit:


1. The manner in which the taxpayer carried on the activity.
2. The expertise of the taxpayer or his advisors.
3. The time and effort expended by the taxpayer in carrying on the activity.
4. The expectation that the assets used in the activity may appreciate in value.
5. The success of the taxpayer in carrying on other similar or dissimilar activities.
6. The taxpayer’s history of income or loss with respect to the activity.
7. The amount of occasional profits that are earned.
8. The financial status of the taxpayer.
9. Whether elements of personal pleasure or recreation are involved.


The Court determined that Brenda Konchar did not intend to make a profit in her Mary Kay activity based upon the following factors:


1. She did not conduct the activity as a business. She did not maintain a separate checking account or any business cards.
2. In general, her returns and allowances plus cost of goods sold exceeded her gross receipts, which indicate that she was selling her products at or near cost.
3. She had an element of personal pleasure in the activity, since most of her customers were family and friends. She took huge business mileage deductions for long distance travel to visit these customers for business and personal reasons.
4. She had no experience in operating her own business, and she did not seek any professional advice.
5. She had large losses each year and no possibility of ever recovering those losses. She never developed a plan to improve her profitability.


The Court concluded and ruled that Brenda did not have an honest objective to make a profit. She conducted her Mary Kay activity as a hobby. As a result, her business deductions were limited to the gross income from the activity. No business losses were allowed.

How to Report Dependent Care Benefits

According to the IRS, dependent care benefits are frequently reported incorrectly on tax returns. Let’s take an in-depth look at the proper way to report dependent care benefits.

Some employers offer employees a dependent care benefit plan to help cover the cost of child care for dependent children under the age of 13, or for an employee’s spouse or other dependent who is unable to care for himself or herself. An employer’s dependent care benefit plan may include:

1. Paying an amount directly to the employee or the daycare provider;
2. The fair market value of care provided in a daycare facility provided by or sponsored by the employer.

The employer must provide to the employee, an annual statement reporting the amount of dependent care benefits. Generally, amounts up to $5,000 contributed to a qualified plan are reported on the employee’s Form W-2 in Box 10, but are no include as wages in Box 1. However, if the amount of benefit exceeds $5,000, the excess is reported as additional wages in Box 1. Benefits received as a partner in a partnership are reported on Form 1065, Schedule K-1, Box 13, Code O.

An employee receiving dependent care benefits may be able to exclude from income all or a part of the benefit received. The exclusion for dependent care benefits is determined on one of two forms:

1. Form 2441, Child and Dependent Care Expenses, Part III;
2. Form 1040A, Schedule 2.

Taxpayers must meet the following basic tests to receive qualifying dependent care benefits:

1. Qualifying person test;
2. Earned income test;
3. Work-related expense test;
4. Joint return test; and
5. Provider identification test.

For more information on these tests, see Publication 503, Child and Dependent Care Expenses.

The limits for an employer-sponsored dependent care plan are generally $3,000 for one qualifying person and $6,000 for two or more. Dependent care benefit plans have a lower limit of up to $5,000 (or $2,000 if married filing separately). When adhering to these general rules, taxpayers can exclude or deduct amounts received.

When figuring the exclusion or deduction for dependent care benefit plans, the definition of earned income is not exactly the same as the definition used when figuring the credit for child and dependent care expenses. For dependent care benefits, only taxable compensation is included and it does not include any dependent care benefits received. However, a taxpayer can elect to include nontaxable combat pay in earned income. If filing a join return and both taxpayers received nontaxable combat pay, each can make their own election. Be sure to figure the exclusion or deduction both ways and elect the method that yields the greater tax benefit.

Are Your Children A Bargaining Tool for Tax Custody Issues?

Single parenting has become more prevalent in today’s society and with it comes more challenges in preparing taxes.

When a couple divorces, in most cases the divorce decree will contain very clear instructions as to how the finances will be handled including, but not limited to, who will claim the children on their taxes. When a couple has never been married, the lines are not as clear and sometimes it becomes a race between who files their taxes first. The following contains information that will help you in this situation prepare for the tax filing season.

When I was divorced in 1979, the divorce decree clearly stated that I retained fully and sole custody of my daughter. At that time, there was no stipulation on who would or would not claim our daughter. The second year of my divorce, my ex-husband jumped the gun and filed claiming my daughter and so did I. The IRS disallowed my dependency exemption and I had to fight tooth and nail to win my case with the IRS, which I did.

Over the last thirty years, the tax laws on dependency have changed drastically.
My scenario is not the case for members of my family, who I will call John and Jane for this writing. John and Jane were never married and they have two children. According to the official language of their custody agreement, Jane has primary physical custody of the children; however, according to the actual arrangement of time, they are basically equal. On a 14-night rotation, Jane has the children eight nights and John has the children six nights; however, John works from home and has been keeping the girls after school during times when Jane was supposed to be responsible for their care. Jane, feeling that being the primary physical custodian givers her permission to do whatever she wants, has been claiming both children even though John pays child support every month on time. There is no written agreement. John and Jane cannot talk rationally about this situation and agree on what should be fair to both parties. Jane basically claims the children without ever giving her actions a second thought.

John came to me and we examined the law and contacted the IRS for further clarification and input. According to Publication 17, pages 27-33 under “Personal Exemptions and Dependents” there are two main tests that must be considered, the relationship test and the residency test. John enrolled in his school district and has been for the past three years.

According to Publication 17, after one determines that a child can be claimed because of their relationship to the taxpayer and it is determined that the residency test has been passed, the next step is to determine the amount of time spent in each home. The IRS states that any time there is a child who spends equal amounts of time in both homes, the taxpayer with the highest adjustable gross income is the person who is legally eligible to claim the child. Additionally, upon speaking with a representative from the IRS, I found upon speaking with a representative from the IRS, I found out that they will actually compare the exact amount of hours – they will go down to the very minutes if necessary-to determine if there has been any false reporting or a misunderstanding of the current law in place. Jane was wrong to file her tax return without asking for permission from John. The best case scenario would be that each person would claim a child; however, that is not what happened in this instance and in probably 80% of these situations.

The outcome is that John will file and claim one of the children and he will allow the IRS to sort out whatever issues need to be sorted. There is one thing to be careful of when child support is concerned. Depending upon what state a person lives in, the amount of the tax refund may directly affect the amount of child support that will be paid.

Here are some tips that should be followed in order to educate and protect yourself and your ability to claim a child on your tax return:

1. Have a written agreement commitment as to how the income taxes will be handled. Having a written agreement makes it clear as to how things will be handled should the two parties not be able to agree on this issue at a later date.

2. Make an appointment with the office who handles your child support case. This should be a free service. The officer of the court will take all of your information and the other parent’s and let you know how much each party is responsible for and whether the tax refund has any bearing on the child support amount. Some states have a child support calculator on their state’s website that allows the taxpayer to figure out their support amount without going in to the state office.

Once the evaluation is completed, I would recommend a letter be sent to the other party by certified mail informing him or her of the intentions to file and claim the child(ren).
Once those steps have been taken, I believe you will be clear to move forward in claiming the children for tax purposes.

Should the other party choose to claim the children anyway, the IRS will step in and will want to see all available documentation concerning actual hours the children were with each parent. John if very fortunate in that he has kept very detailed records concerning the time he has spent with his children, including all extra time. Should the IRS come knocking on his door, we have him prepared.

These situations are never pleasant for anyone and the more prepared everyone is on the front end, the less hassle there will be on the back end. We cannot control the actions of anyone, yet you can make sure that you are aware of the law and your rights concerning this type of filing.

Age Discrimination Settlements Can Be Taxable

An example of such taxability can be found in the Tax Court Memo 2008-87. Michael Petit worked for Electronic Data Systems (EDS) until March 5, 2002, when he was terminated as a result of workforce reduction. The forty-seven-year-old was told that he was selected for the termination based on his age and salary. Subsequent to the workforce reduction, EDS hired a younger replacement. As a result, Mr. Petit sued EDS for age discrimination.

After the third day of trial, Mr. Petit and EDS decided to settle matters out of court. EDS agreed to pay its former employee $240,000. In 2003, EDS paid him half the settlement. The settlement provided that $44,250 was attributed to lost wages and was reported to Mr. Petit on Form W-2. The remainder of the payment was for “emotional distress, pain and suffering, and other non-wage damages.” EDS issued Mr. Petit Form 1099-Misc to report this payment.

On his timely filed Form 1040, Mr. Petit properly reported the W-2 as wages. On Line 21 (other income), he included the amount reported to him on Form 1099-Misc. However, he also entered the same amount as a negative “zero out” that portion of the legal settlement. He claimed that portion of the settlement was excludable under §104(a) specifically states that emotional distress is not to be treated as physical injury or sickness. The term “emotional distress” includes symptoms that result from emotional distress.

Even though Mr. Petit experienced headaches and irritable bowel syndrome as a result of the emotional distress stemming from his wrongful termination and the lawsuit, the amounts he received as compensation for this are not excludable. He was required to pay the tax on his tax deficiency. However, the court did not uphold the accuracy-related penalty because he acted with reasonable cause and in good faith.

The downsizing trend of companies seems to be devaluing the experience and knowledge of its older employees and relying on the inexperience of the younger generation to successfully run their businesses. How quickly these companies forget the hard work, loyalty and success its older employees have provided. This writer believes that older employees provide a greater value that seems to be lost in the employment marketplace.

Tax Help - Victims of Floods, Storms & Tornadoes

The Internal Revenue Service is postponing until Aug. 29 the time to file certain tax returns, to make certain tax payments and to perform time-sensitive acts for storm, flood, and tornado victims in presidential disaster areas in six states, mostly in the Midwest.
Previously, these deadlines varied by state, and the postponement provides people affected by the disasters with additional time.

"Our hearts go out to to the people hit by these disasters," IRS Commissioner Doug Shulman said. “We realize that as people put their lives back together, they need additional time to work on these tax issues."

This announcement will affect counties in Indiana, Iowa, Illinois, Nebraska, West Virginia and Wisconsin that qualify for individual assistance. Affected counties in Missouri previously have been granted relief until Aug. 29.

Related Items:

Disaster news release for Indiana,
Disaster news release for Iowa,
Disaster news release for Illinois,
Disaster news release for Nebraska,
Disaster news release for West Virginia,
Disaster news release for Wisconsin, and
Disaster news release for Missouri.

REDUCED EXCLUSION ALLOWED FOR THE SALE OF HOME

An individual purchased a residence on June 15, 2004, to be used as a principal residence for himself and his three children. He met a single mother with two children, and they were married in October of the same year. She and her two children moved into the taxpayer’s home.

The wife’s mother, for who she was caring, was left partially paralyzed because of an illness and could not live independently anymore, so the mother moved into their residence in May of 2005. In order to provide adequate space and care for his wife’s mother, the couple sold the residence in December 2005, and purchased a new home.

Code §121, provides that taxpayers can exclude the gain from the sale of residence if they own and occupy the residence tow out of the last five years. However, under special medical circumstances a reduced exclusion can be used if the sale of residence occurs prior to meeting the two-year test.

The regulations under this code provide a reduced exclusion if the sale is by reason of health of a qualified individual. A qualified individual includes the taxpayer, the taxpayer’s spouse, a co-owner of the residence, a person whose principal place of abode is in the same household as the taxpayer, and certain family members. In this PLR, the taxpayer’s disabled mother-in-law is a qualified individual for the reduced exclusion.

The IRS found that the reason for the sale of his residence prior to the two-year rule under §121(a) was to accommodate the special needs of his mother-in-law, a qualified individual. Thus, the IRS concluded that the taxpayer could exclude gain up to the reduced maximum exclusion amount under §121(c), even though he lived in the residence less than the two out of five years.

NO DEDUCTION FOR GIRLFRIEND’S CHILDREN

As a tax preparer, every year I have some tell me that they want to claim their girlfriend’s children since they lived with them all year and provided over 50% of their support. Well, here’s a real life example of why this theory will not fly with the IRS.

Dimitri Harris, his girlfriend, and her four children shared an apartment with another tenant. On his 2005 income tax return, Mr. Harris listed tow of the children as his niece and nephew, filed as head of the household, claimed a child care credit, the additonal child tax credit, and the earned income tax credit. The taxpayer later mailed two additional returns to the IRS for 2005 intending them to be amended returns. On the first amended return, Mr. Harris changed the identification of the two children from niece and nephew to adopted children, and then on the second amended return, he added the girlfriend as a dependent. The IRS rejected both amended returns and issued a NOTICE OF DELINQUENCY disallowing the filing status and deductions based on the children.

Mr. Harris was not married to the children’s mother, nor was he the father of her children. A taxpayer is allowed a dependency exemption deduction only if the claimed dependent is a qualifying child or qualifying relative under Tax Code §152 (c) or (d). None of the children met the relationship criteria to be the taxpayer’s qualifying child, a descendent of a qualifying child, or a brother, sister, stepbrother, or stepsister of the taxpayer or a descendent of any such relative. Nor did Mr. Harris provideany evidence to establish that he provided more than one-half of the total support for the two children. Also, it appeared from the record that the co-tenant paid at least half of the rent for the apartment. From Blanco v. commissioner 56 T.C. 512, 514-515 (1971), a taxpayer who cannot establish the total amount of support provided to a claimed dependent generally may not claim that individual as a dependent.

Without providing evidence that the children qualified as dependents for which an exemption could be claimed, Mr. Harris was denied dependent exemptions, head of household filing status, earned income tax credit, child care credit, and an additional child tax credit for his girlfriend’s children.

Dimitri Harris v. commissioner, TC Summary Opinion 2007-202

NEW RULES FOR SALE OF RESIDENCE WITH RENTAL USE

When a principal residence is sold, up to $250,000 ($500,000 MFJ) of the gain can be excluded from income under §121. There are special rules that aply to the sale of a principal residence when part of the residence is used to produce rental income. As of December 23, 2002, the rules changed regarding how taxpayers with rental use of their home report the sale of their residence.

GENERAL RULE

Generally, if the property is used as a principal residence in two out of five years preceding the sale, and the other §121 conditions are meet, the exclusion applies to all the gain except the part of the gain attributable to depreciation taken after May 6, 1997.

MIXED-USE PROPERTY

If property is mixed-use property (part residential and part rental), and it was not used entirely as a principal residence during the five years preceding the sale, the reporting depends on where the rental use takes place. If the rental use takes place within the dwelling unit – defined as a house, apartment, condominium, mobile hom, boat, or similar property, but does not include detached structures, all of the gain is eligible for the exclusion except the gain attributable to depreciation taken after May 6, 1997.

CONVERSION OF PRINCIPAL RESIDENCE TO RENTAL

The fact that the principal residence is rented at the time of sale does not necessarily prevent the gain from being excluded under the code. The gain exclusion depends on whether the taxpayer meets the ownership and use requirements and the one-sale-every-two years test at the time of sale. The depreciation allowed or allowable after May 6, 1997, is not eligible for the §121 exclusion.

Additional Resources:

Rental Property and the Tax Gap

Publication 527: Residental Rental Property

IRS Sets Offset Limits on Ordinary Income With Capital Losses

The following is a real life example of day trading activities and how the IRS and the Tax Court handle every day reporting mistakes.

In the case of Shahrooz Jamie who was a physician who was also a day trader of securities, buying and selling on his own account. He was looking for a profit on short-term fluctuations in the market by buying and selling the same stock within a few days. There were no other customers he traded for, he earned no commissions for the activity, and he did not maintain a place of business for this trading activity. He did not hold the securities to earn dividends. For Federal tax purposes, Shahrooz was not a dealer in the securities he traded.

During the tax years of 2000 to 2002, he reported his day trader activities on a Schedule C, claiming an ordinary loss on the sale of the securities. He used these losses to offset the income from his medical practice reported on a separate Schedule C, and also reported net operating losses for 2001 and 2002.

The stocks held by Shahrooz were determined to be a capital asset because he only purchased and sold securities on his own account and had no other customers. Losses from the sale of capital assets only allowed as capital losses.

The IRS determined that Shahrooz was trader holding capital assets and could only offset $3,000 of his ordinary income with his capital losses each year.

This case was held before the Tax Court in Shahrooz S. Jamie v. Commissioner, TC Memo 2007-22.

IRS EXPANDS PAYMENT OPTIONS FOR INDIVIDUALS AND BUSINESSES

The IRS has expanded its tax payment options for individuals and businesses. Using a credit card, taxpayers can now make the following payments by phone or over the Internet:

Individuals can pay Trust Fund Recovery Penalty (TFRP) liabilities, including installlment agreement liabilities, with their credit card. The accepted tax quarters include the first quarter of 1997 through the present.

Businesses can make balance due payments for their current and prior year Forms 941, Employer’s Quarterly Federal Tax Return, and Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. This includes installment agreement payments for any unpaid taxes for the prior ten years.

Businesses can also make a balance due payment for the new Form 941, Employer’s annual Federal Tax Return.

The following is a list of IRS e-pay Service Providers and Fees

LINK2GOV website http://www.incometaxpayment.com/ (the only cards accepted through this website are debit and credit cards and these cards must carry the NYCE, Star, or Pulse logos – this is a website only option). There is a $2.95 flat fee per transaction convenience fee. The Customer Service number is 866-967-3468.

LINK2GOV telephone payment can call 888-729-1040 and is available in English and Spanish. The websites for payments are http://www.pay1040.com/; http://www.pay941.com/ and http://www.pay940.com/. You will need to contact the service provider to receive up-to-date information regarding fees. The minimum convenience fee is $1. The Customer Service number is 888-658-5465

OFFICIAL PAYMENTS CORPORATION can be used by calling 800-272-9829 and is available in English and Spanish. Payments may also be made at their website http://www.officialpayments.com/. There is a 2.49% convenience fee. The Customer Service number is 877-754-4413.

Other websites for payments:
http://www.taxbrain.com/
http://www.fileyourtaxes.com/

Generally, taxpayers can make a payment ghrough the above-named service providers using an American Express Card, Discover Card, MasterCard, or Visa card.

To make a payment of $100,000 or greater through the LINK2GOV Corporation, taxpayers can call 888-729-1040. To make a payment of $100,000 or greater through the Official Payments Corporation (OPC), taxpayers can call OPC’s Special Services Unit at 877-754-4420.

BASIC vs. SPECIFIC RECORDKEEPING

There are two categories of records that all taxpayers should keep for tax reporting purposes. The following will describe both types.

BASIC RECORDS

These are documents that everyone should keep. The following lists the documents that should be ket as basic records for income, expenses, home and investments:

INCOME: Form W-2(s), Form 1099 (all types), bank statements, brokerage statements and Form(s) K-1.

EXPENSES: sales slips, invoices, records, cancelled checks or proof of payment.

HOME: closing statements, purchase and sale invoices, proof of payment and insurance records.

INVESTMENTS: brokerage statements, mutual fund statements, Form(s) 1099 and Form(s) 2439

SPECIFIC RECORDS

The following is a list of items that require specific records in addition to basic records.

ALIMONY. If receiving alimony, a taxpayer should keep a copy of his or her written separation agreement or the divorce, separate maintenance, or support decree. If paying alimony, the taxpayer will need to know the former spouse’s social security number for filing purposes.

BUSINESS USE OF THE HOME. A taxpayer should kee records that show the part of the home that is used for business and the expenses related to that use.

CASUALTY AND THEFT LOSS. To deduct a casualty or theft loss, a taxpayer must be able to prove that there was casualty or theft. The records also must be able to support the amount claimed.

CHILD CARE CREDIT. A taxpayer must give the name, address, and taxpayer identification number for all persons or organizations that provide care for a child or dependent.

CONTRIBUTIONS. The taxpayer must keep all records pertaining to the contribution.
If you find yourself in an audit situation, these are the types of records that the IRS will require you to produce to justify any deductions. Generally, without these records, the IRS will disallow any deduction that you may have taken on your return. It is always better to be proactive rather than reactive!.