Tax Breaks and More

Dear Client:
Review your gift giving plans this summer, while there is still plenty of time to act. Don’t wait until the last minute to take advantage of tax breaks that can reduce your estate and income tax bills.

Make sure to use your gift tax exclusion. This year, you can give up to $14,000 to a child, grandkid or other person without gift tax consequences. If you are married, your spouse also can give $14,000 to the donee, doubling the tax-free amount to $28,000. The exclusion is going to remain $14,000 next year, too. If you don’t use up the full exclusion amount this year, any shortfall is lost forever. The unused amount cannot be carried over to 2016. Annual exclusion gifts help save estate taxes, too. The amount of these gifts aren’t added back to your estate, and future appreciation on them is out of your estate.

Some other gift giving strategies pack an additional bang for the buck. Direct tuition payments for students get two breaks. They don’t count against the $14,000 gift tax exclusion, and they reduce the size of your taxable estate. The same rule applies for direct payments of a person’s medical expenses. And note this easing for payments to 529 plans to help your kids or grandkids with college. You can put in as much as $70,000 per child free of gift tax this year… $140,000 if your spouse agrees. In most cases, the payins are out of your estate. Withdrawals are tax-free if used to pay for tuition, fees or books, plus room and board if the student is pursuing at least half the normal course load. But giving the maximum will wipe out your 2015 and 2016 gift tax exclusion and most of it for 2017-2019, too. Larger gifts are slightly less tax-favored. You will not owe any gift tax on gifts over $14,000 as long as you haven’t used up your $5.43-million estate tax exemption. And any future rise in the value of the assets you give away isn’t part of your estate. But the amount by which a gift exceeds $14,000 is added back to your taxable estate.

Turbocharge your donations to charity by giving away appreciated assets, such as stocks. The appreciation escapes capital gains tax and you get a deduction for the full value in most cases, as long as you’ve owned the asset for more than a year. But remember, deductions for donations are reduced when adjusted gross income tops $258,250 for singles, $284,050 for household heads and $309,900 for marrieds. Don’t donate an asset that has declined in value. If you do, the capital loss is wasted. You are better off taxwise selling the asset and donating the proceeds. The same goes if you plan to make a gift to a person. If you give the donee an asset that has lost value, he or she can’t turn around and sell the asset and deduct the loss.

One last idea: Consider a charitable lead annuity trust. It pays an annuity to charity for a set term, after which what’s left goes to the donor or other beneficiaries. Although interest rates have ticked up, the donor still gets a nice up-front write-off. That deduction can be used to offset income generated from a Roth IRA conversion, for example, letting the donor enjoy a lifetime of tax-free withdrawals from the Roth.

BENEFIT PLANS: Pension plans generally won’t be able to cash out retirees in pay status. IRS had been privately OKing plan sponsors’ requests to amend their plans to offer retirees in pay status a limited onetime window to take the actuarial value of their monthly benefit payments in a lump sum. This way, the pension liabilities of employees who take the buyout are wiped off the firm’s balance sheet. In addition, having fewer pensioners means that the company’s PBGC premiums are reduced. Now, the Service says it will issue new regulations banning this practice. They’ll provide that these types of plan amendments violate the minimum payout rules. The changes aren’t intended to apply to lump-sum offers made upon plan termination. The changes apply as of July 9, 2015. But lump-sum offers authorized prior to July 9 or firms that got private rulings before this date won’t be affected. Go to to see the complete details. 

States are starting to take the lead to boost retirement savings for workers. Some want firms without retirement plans to offer payroll deduction IRAs and enroll employees who don’t opt out. At the front of the pack is Ill. Under its law, employers in business there for at least two years and with 25 or more employees must offer automatic IRAs if the firm has no other plan. It’s set to begin in 2017, but could be delayed. The IRAs would be funded with employee payroll deductions at 3% of salary, but workers could change the paying percentage. No employer matching is required. Other states spearheading automatic IRAs include Ore., Calif. and Mass. Illinois’ program is similar to one repeatedly proposed by President Obama, except that his idea would cover even more businesses…those with at least 11 workers. 

A health-related tax break for retired public safety officers comes with a twist. A 2006 law allows them to exclude from income up to $3,000 a year of pension payouts that are used to pay for medical insurance or for premiums on long-term-care policies. To qualify, retirees must opt for the premiums to be deducted from their distributions and paid directly by the plan to a third-party insurer. Folks whose former employers don’t offer the election are not eligible for tax-free treatment, IRS confirms privately. They cannot claim the $3,000 exclusion by paying the medical premiums themselves.

DONATIONS: Failing to substantiate property donations costs a charitable write-off in this case. A veterinarian donated over $100,000 of fossils to a charity. Although he attached Form 8283 to his return and received letters from the group acknowledging the gifts, the fossils weren’t properly appraised by a qualified expert, which is mandatory when claiming a deduction over $5,000 for noncash donations. Nor did he obtain a contemporaneous written acknowledgment from the organization stating that he got nothing of value in return for his gift (Isaacs, TC Memo. 2015-121). 

EXEMPT GROUPS: A foundation that benefits a single family is not a tax-exempt charity. After a taxpayer died, the executors of his estate formed an organization to award scholarships in the performing arts to students of Hungarian descent. The Service originally OK’d its exemption, and the estate donated $2.6 million to it. But when the IRS later learned on audit that the group had provided scholarships only to nieces and nephews of the decedent, it revoked the exemption retroactively and a district court concurred (Educational Assistance Foundation, D.C., D.C.). 

Will IRS challenge religious nonprofits that oppose same-sex marriage? It’s unlikely. Last month, the Supreme Court ruled that same-sex couples have the constitutional right to marry. Some groups and lawmakers are concerned that IRS could revoke or deny the exemptions of organizations whose religious beliefs conflict with the case. But the Service has enough on its plate and doesn’t have the time or inclination to step into this divisive social issue. It’s still paying the consequences with Congress for playing politics when it targeted conservative tax-exempt groups. 

BUSINESS TAXES: An Uber driver is an employee of the company, a state agency decides. The firm claimed the driver should be treated as an independent contractor because she used her own vehicle to transport customers. The company asserted that supplying the driver with leads of people needing transportation didn’t indicate that it exercised control over her activities. But the agency said the firm had control over her because it screens prospective drivers and requires them to use vehicles that are 10 years old or less. Since the driver is an employee, Uber must reimburse her for mileage and tolls (Berwick v. Uber Technologies, Office of the Calif. Labor Comm.). The decision has been appealed. It’s important to note that the ruling applies only to the particular driver. It doesn’t mean all Uber drivers are employees. We will watch the case closely and report back on any developments. As we noted in our June 19 Letter, employee misclassification is a key issue for businesses. 

IRS says its worker classification settlement program has been a success. Firms that have consistently treated workers as contractors and given them 1099s come in and pay a modest fine and receive audit protection for prior years. Thereafter, the workers are treated as employees, get W-2s and become more tax-compliant. 

Employers get another reason to gear up early for the health reporting rules: Higher fines for incorrect forms. A new law substantially raised the penalties for firms that file incorrect information returns, as we noted in our July 2 Letter. The fines range from $50 a return if a mistake is corrected within 30 days of filing to $500 per return for intentional errors. These penalties aren’t limited to 1099s. The increased fines also apply to health care information returns. Employers with 50 or more full-time employees must report 2015 coverage data for each full-timer to IRS and workers on Form 1095-C, and give more information to IRS on Form 1094-C. Companies that have fewer than 50 employees that self-insure will use Form 1095-B and 1094-B for these purposes. So with the higher penalties, accuracy is paramount. 

Firms will be able to seek filing extensions for the health reporting forms. Employers can get an automatic 30-day extension for the Feb. 29, 2016, deadline (March 31 if e-filing) to file the 1094s and 1095s with the IRS by using Form 8809. Companies needing extra time can ask the Revenue Service for 30 additional days. IRS will soon announce the procedures for firms that want to extend the Feb. 1 date to give 1095 forms to employees. In that case, the maximum extension will be limited to 30 days, and businesses must give a valid reason why the extra time is needed. 

INCOME: IRS’s computers aren’t programmed to sniff out only under-reported income. They also flag over-reported income, as this case shows. A low-income filer with very little wage income claimed she made a $17,000 profit from a side business selling used clothing at a flea market. The $2,100 self-employment tax on her profit was dwarfed by the $8,000 in additional child tax credit and earned income credit that the extra income made her eligible for. But IRS’s computers froze her refund, and she couldn’t substantiate a large chunk of her profit, so the Tax Court decided that she was entitled to take just $700 in credits (Cadet, TC Summ. Op. 2015-39). 

Getting a 1099 form doesn’t always mean you have income for that year. A retired pro football player helped co-found and operate a nonprofit organization. He charged personal expenses on the charity’s credit card. When he left the group, it sent him a 1099 for that year reflecting that he had taxable income from charges incurred several years earlier that he hadn’t paid back. According to the Tax Court, the unpaid advances are taxable, but only for the years in which they weren’t repaid. Since the 1099 was issued well after that, it is invalid (Starke, TC Summ. Op. 2015-40). So in all likelihood, the Service won’t be able to collect tax on the unpaid advances because the statute of limitations has almost certainly expired for the earlier years.

PREPARERS: The fee to obtain or renew a preparer tax ID number is under attack again. It’s a serious challenge. The class action lawsuit alleges that the Service lacks the authority to assess the fees, which are now set at $64.25 for first-timers and $63 for renewals. In 2012, an appeals court in another case said the user fees are valid. The plaintiffs in this case say the 2012 decision was wrong and are hoping for a preparer-favorable result in a different court. We’ll report on any developments. 

ALIMONY: A lump-sum payment made to settle alimony obligations isn’t deductible. When finalizing a couple’s divorce, the court ordered the ex-husband to pay lump-sum alimony of $45,000 to his former spouse. He deducted the amount, but the Tax Court said no. Under state law, she had a vested right to the money, even if she died before payment. That nixes his write-off (Muniz, TC Memo. 2015-125). 

Transferring realty to pay alimony costs the deduction, the Tax Court says. A couple split up, and the court ordered the ex-wife to pay her former husband alimony. She decided to satisfy part of her alimony by transferring a home to him, and claimed that she could deduct the value of the transfer to him. But only alimony paid in cash or a cash equivalent, such as a check, is deductible (Mehriary, TC Memo. 2015-126). 

LIFE INSURANCE: Directing investments in a life insurance policy costs a taxpayer big-time: He’s taxed on all of the income earned in the policy, the Tax Court decides. Acting on the advice of his estate lawyer, a venture capitalist set up a grantor trust to buy private-placement variable life insurance contracts. The insurance company used the premiums to invest primarily in start-up companies in which the taxpayer owned an interest, acted as manager or sat on the board. The Court found in substance that through his agents, he chose investments, voted shares and was able to take cash. That’s enough to make him the tax owner of the assets (Webber, 144 TC No. 17). 

MARIJUANA: Businesses that sell marijuana have a heavy tax burden, as this case shows. They’re taxed on their income but can’t write off their business expenses, such as rent. A taxpayer in Calif. ran a center where users of medical marijuana could purchase and consume the drug and socialize. Even though it is legal in Calif. to sell and use medical marijuana, an appeals court said U.S. tax law bars write-offs for sellers of controlled substances that are illegal under federal law (Olive, 9th Cir.). The only exception is that these firms can deduct the cost of the marijuana. Even the Service now concedes this after originally having fought it tooth and nail. 

TAXPAYER SERVICE: On IRS’s wish list for the future: Offering taxpayers more online services. For example, giving them the ability to access their accounts electronically to review if they have a balance due, check their tax history and make online payments. Letting them self-correct their returns and update their names and addresses online. And allowing them to send secure electronic correspondence to the IRS and vice versa. But it has a long way to go to implement these technological priorities. With an ever-shrinking budget and no extra money in its coffers, don’t expect IRS to be at the forefront of technological innovation when it comes to taxpayer service.
Yours very truly,

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