2014 Tax Reminders

Washington, Dec. 5, 2014

Dear Client:
  2014’s tax rules still haven’t been finalized. But help is on the way as year-end nears. Congress had all year to revive a series of tax breaks that lapsed after 2013, but taxwriters procrastinated. 

 All major tax provisions will be reinstated: For individuals, the deductions for state sales taxes in lieu of income taxes, college tuition and up to $250 of teachers’ classroom supplies, plus direct payouts of $100,000 or less from IRAs to charity for folks 70½ and older. Also, letting debtors exclude up to $2 million of forgiven debt on primary homes. For businesses, 50% bonus depreciation, the R&D credit and higher ceilings on expensing assets.

  President Obama nixed a tentative deal by House and Senate negotiators that would have made a number of breaks permanent, including many key ones for businesses. Obama wanted more-permanent relief for lower- and middle-incomers. That, plus opposition from some Senate Democrats, put the kibosh on the proposal. But the House has OK’d a fallback plan…reviving all key breaks just for 2014. We expect the Senate to reluctantly accept the House bill. As a result, the extensions will expire a couple of weeks after the measure is signed into law. This means businesses and individuals will face the same uncertainty next year about the tax rules as they try to make their business and investment decisions.

  The final bill will contain a significant new break for disabled individuals: Tax-free ABLE savings accounts, similar to 529 college savings plans. Starting in 2015, states can set up ABLE programs so families can set aside funds to help the long-term disabled maintain their health, independence and quality of life. Nondeductible contributions to ABLEs of up to $14,000 a year will be allowed for those who became blind or disabled before age 26. Lifetime payins would be capped at the same level as the state’s 529 plan. Account owners would remain eligible for Medicaid. And account balances of $100,000 or less wouldn’t affect SSI benefits.

  Withdrawals will be tax-free if the funds are used for housing, education, transportation, job training and the like. This includes payouts of account earnings. Earnings used for nonqualified purposes are taxed and hit with a 10% penalty. Rollovers will be limited to another ABLE account for that individual or a disabled sibling. When an account beneficiary dies, amounts left in the ABLE after a state recovers some of its Medicaid costs would go to a designated beneficiary. The recipient owes tax on any remaining account earnings, but not the penalty.

  One revenue offset for ABLEs will help employers that use payroll agents. Currently, employers who use agents are on the hook for undeposited payroll taxes, even if the agent skips town. But IRS will set up a program next year to certify agents that post a bond, submit audited financial statements and pay a $1,000 annual fee. After 2015, a firm that uses a certified agent won’t be liable for the agent’s malfeasance.

HEALTH CARE:  More firms that reimburse workers for health insurance can owe a stiff tax, according to new IRS guidance. Many small companies have set up plans to reimburse premiums paid by employees for individual policies or for coverage bought on an exchange. Earlier this year, the IRS said that if these arrangements are done on a pretax basis, they violate the health reform law and likely trigger a $100-a-day tax per worker. But the Service also suggested after-tax arrangements were exempted. Now, IRS says they are not exempt. See www.kiplinger.com/letterlinks/healthfaq for details.

BENEFIT PLANS:  Plans get help on advising payees of their rollover options for distributions. If a plan makes a lump sum payout or other payment that can be rolled over to an IRA or another plan, the payee must be given an explanation of the tax rules. The Revenue Service has updated its model summary that plans can use. It reflects tax law changes over the past few years, including in-plan Roth rollovers and the tax aspects of allocating pretax and after-tax payins when doing a rollover. For full details, including the rules for designated Roth accounts, see Notice 2014-74. And IRS has a helpful rollover table for owners of retirement plans and IRAs. See www.kiplinger.com/letterlinks/chart for permissible and impermissible rollovers.

IRAs:  An IRA owner gets off the hook after an ill-advised rollover to a SIMPLE IRA. Acting upon a financial pro’s advice to consolidate her retirement accounts, she had the custodian of her IRA transfer the funds to the trustee of her SIMPLE IRA. After she became aware that a SIMPLE cannot accept a tax-free transfer or rollover from a regular IRA, she asked for additional time to recharacterize the transfer into a second traditional IRA that she owned. In a private ruling, IRS OK’d her request.

  IRAs can invest in trusts holding gold, the Service says in a private ruling. The rules that prohibit direct investments by IRAs in bullion do not apply if the gold is held by an independent trustee. Shares in the trust are marketed to the public, including IRAs and individually directed plans, and are traded on a stock exchange. But redeeming trust shares for gold bullion will trigger a tax bill. The trust lets holders convert their shares into physical gold. An IRA that does such an exchange will be treated as acquiring a collectible, so the full value of the shares exchanged for gold by the IRA will be treated as a taxable distribution to the IRA owner.

EXEMPT GROUPS:  A break for an exempt organization that is changing its state of domicile: It needn’t reapply for tax exemption, according to this private ruling from IRS. Both the state the group left and the one it’s moving to treat the move as a continuation of its existence and not as the creation of a new legal entity. Also, the domicile change won’t affect its charitable purposes or operations. But while the group needn’t reapply for a tax exemption, it must report the change when it files its annual Form 990. Groups that change their domicile via a merger do have to apply again for exemption.

  A preparer’s error excuses a private foundation from a 10% excise tax on excess business holdings, IRS privately rules. While analyzing the group’s assets, the preparer miscalculated its stock holdings and didn’t realize that the foundation was deemed to own over 20% of a corporation. When the mistake was discovered, the group rid itself of the excess stock. That was enough for IRS to abate the tax.

  IRS is approving the bulk of exempt applications filed on Form 1023-EZ… the two-page form that can be used by groups with annual gross receipts of $50,000 or less and total assets of not more than $250,000. The agency has rubber-stamped over 95% of the forms filed since the program began in July, and many of the rejects are because of mismatches between the organization’s name and identifying number. The agency has vowed to do back-end audits of some of these applicants, but many tax pros feel that the Service lacks the resources to do an adequate job.

REAL ESTATE:  Letting family members use a rental unit can bar a rental loss deduction. A couple owned a rental home and personally used it one year for 14 days, which was more than 10% of the time that the house was rented to vacationers. The husband’s brother also paid rent to stay at the property for a week’s vacation. Use by a relative is treated as personal use by the owners, the Tax Court says. The only exception is if the relative pays a fair market rent and uses the property as a principal residence. So the brother’s short stay is added to the couple’s 14 days of personal use. This triggers the ban on deducting rental losses when personal use tops the greater of 14 days or 10% of days rented (Van Malssen, TC Memo. 2014-236). As a result of the excess personal use, the couple’s deductions on the property other than for mortgage interest and real estate taxes are limited to the rental income.

  A sale of an interest in a lawsuit nets capital gain treatment on the proceeds. A developer had an option to buy land on which he planned to build condominiums but the landowner reneged on the deal. The developer sued to force a sale and won. While the case was on appeal, he needed to raise cash, so he assigned his interest in the lawsuit for $5.75 million. The Tax Court said that amount is ordinary income because he eventually planned to sell the land to customers as part of his business, but an appeals court disagreed. Since he never owned the land, what he actually sold was his right to purchase the land, which qualifies as a capital asset (Long, 11th Cir.).

TAX DEBTS:  IRS gets its wrist slapped for being too inflexible about collecting a tax bill. A sculptor offered to pay back a tax debt of over $200,000 in installments. But when the collection appeals officer insisted upon filing a lien against him as a condition of OK’ing the payment plan because the balance due was so large, he rejected the deal. He claimed a lien would hurt his business and credit rating and was overkill. The Tax Court ruled that the officer abused her discretion by insisting on a lien and sent the case back for another hearing (Budish, TC Memo. 2014-239).

BUSINESS TAXES:  You can get a tax write-off for helping your kids, as this case shows. A father owned an S firm in the real estate development business. His teenage son was a local celebrity for his successful motocross racing, so the father had the company become a sponsor for his son’s racing. Over a two-year period, the firm paid $160,000 for motorcycles, equipment and other costs. Funding ceased when the son turned pro. The Tax Court said that most of the $160,000 was a deductible business expense because the firm got new business connections, favorable construction financing deals and other similar benefits from its sponsorship (Evans, TC Memo. 2014-237).

  A transfer of an interest in a mine for a royalty is a lease for tax purposes, the Service privately rules. A mining firm sold its stake in a joint mining venture in exchange for two royalties: A bonus royalty if the reserves top a certain amount and a sliding scale royalty triggered only after a production goal has been reached. Since the production royalty is treated for income tax purposes as a retained interest in the minerals, the transfer is not treated as a sale. Therefore, the royalty payments are taxed as ordinary income, and the firm can claim depletion on the income.

  Businesses paying limited liability companies have to issue 1099 forms if annual payments total $600 or more, IRS lawyers reaffirm in a memo to the field. There’s an exception if the LLC has filed Form 8832 with IRS and elected to be taxed as a corporation. Most LLCs choose to be taxed as partnerships or sole proprietorships.

  Income from data-mining software licensed to vendors is tax-favored, IRS says in a private ruling. The income is eligible for the 9% domestic production deduction. On audit, IRS agents took the position that the income was attributable to services and therefore did not qualify for the write-off, but IRS headquarters overruled them.

YEAR-END TIPS:  Our final set of 2014 tax reminders…to help you avoid last-minute errors. Check the balance in your flexible spending account. You must clean it out by Dec. 31 if your employer has not implemented either the 2½-month grace period or the $500 carryover rule. Otherwise, you will forfeit any money left in your account.

  Be sure you don’t run afoul of the gift tax rules with your year-end gifts. If you are making a gift by check, be sure the donee deposits it in 2014 if you want the money to count as a 2014 gift for gift tax purposes. Alternatively, deliver a certified check to the recipient this year. That will count as a 2014 gift, even if the donee does not deposit it into his or her bank account until next year. Remember that if you don’t use up the full $14,000-per-donee exclusion this year, you lose the shortfall forever. You can’t give a donee extra next year to make up for it. If you’re giving securities, endorse them over to the donee and deliver them by year-end if you want the gift to count for 2014. If you send them to the corporation late in the year to be retitled, the transfer process might not be completed by Dec. 31.

  Mail checks for tax-deductible items before Dec. 31 to ensure a 2014 write-off. You’re able to claim the deduction for this year even if the checks don’t clear until Jan. Thus, mailing a charitable donation in late Dec. will nail down the deduction for 2014. And make sure you know the tax rules if you are charging deductible items. For charges that you make with a retail store credit card, you are allowed to claim the deduction for the item only in the tax year in which you pay the bill. For transactions made with a bank credit card, you take the write-off in the tax year that you charged the goods, even if you pay the bill next year.

  More on escaping the estimated tax penalty. In our Nov. 21 Tax Letter, we suggested that if you expect to owe tax to IRS, having more income tax withheld from your Dec. paychecks or a retirement plan payout can help you beat the penalty. But we misstated the penalty exception based on last year’s tax. The levy won’t apply if you prepay 100% of your 2013 tax liability…110% if your 2013 AGI topped $150,000. We said that the 110% rule was based on your AGI for 2014. We regret the error.

ENFORCEMENT: IRS OKs too many improper fuel-tax-credit claims, Treasury inspectors say. Taxpayers who use fuel for off-road business purposes, such as on a farm or commercial fishing boat, can take a credit for the federal fuel tax they pay. However, the Service failed to follow procedures and manually screen about 4,000 credit claims of $10,000 or more. And the agency allowed many claims of around $600 or less, even though no business income was reported on the returns. The IRS now says it will tighten up screening of large claims and, if its limited audit resources permit, lower the threshold for examining small claims on returns without business income.

  More phony returns filed by prisoners are slipping through the cracks, according to Treasury inspectors. Unfortunately, IRS is still working out the kinks on sharing data with federal and state prison officials so the offenders can be punished.

  Unreported tip income is in IRS’s crosshairs. It will do a nationwide survey of consumer tipping practices so agents will have a better idea if workers in industries such as restaurants, hair salons and taxis are reporting all their tips. The last time the Service did a study on tips was over 30 years ago, so its statistics are outdated.
Yours very truly,

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