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The IRS has announced a significant increase in enforcement actions for syndicated conservation easement transactions. This is a "priority compliance area" for the agency.

The IRS has announced a significant increase in enforcement actions for syndicated conservation easement transactions. This is a "priority compliance area" for the agency.

Throughout the IRS, coordinated examinations are being conducted in the Small Business and Self-Employed (SB/SE) Division, Large Business and International (LB&I) Division, and Tax Exempt and Government Entities (TE/GE) Division. The IRS Criminal Investigation (CI) Division has also been initiating investigations. The audits and investigations cover billions of dollars of potentially inflated deductions, as well as hundreds of partnerships and thousands of investors.

"We will not stop in our pursuit of everyone involved in the creation, marketing, promotion and wrongful acquisition of artificial, highly inflated deductions based on these aggressive transactions. Every available enforcement option will be considered, including civil penalties and, where appropriate, criminal investigations that could lead to a criminal prosecution," said IRS Commissioner Charles "Chuck" Rettig. "Our innovation labs are continually developing new, more extensive enforcement tools that employ advanced techniques. If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options. It is always worthwhile to take advantage of various methods of getting back into compliance by correcting your tax returns before you hear from the IRS. Our continued use of ever-changing technologies would suggest that waiting is not a viable option for most taxpayers," he added.

Syndicated Conservation Easements

The IRS issued Notice 2017-10, I.R.B. 2017-4, 544, in 2016, which designated certain syndicated conservation easements as listed transactions. In these types of transactions, investors in pass-through entities receive promotional material which offer the possibility of a charitable contribution deduction worth at least two-and-a-half times their investment. The deduction taken in many transactions has been significantly higher than 250 percent of the investment.

Syndicated conservation easements were included on the IRS’s 2019 "Dirty Dozen" list of tax scams to avoid.

Not only do these transactions grossly overstate the value of the easement that was purportedly donated to charity, they often also fail to comply with the basic requirements for claiming a charitable deduction for a donated easement.

Taxpayers may avoid the imposition of penalties for improper contribution deductions if they fully remove the improper contribution and related tax benefits from their returns by timely filing a qualified amended return or timely administrative adjustment request.

Enforcement Actions

The IRS has prevailed in many cases involving the charitable deduction basic requirements, and has established a body of law that it believes supports disallowance of the deduction in a significant number of pending conservation easement cases. The IRS will soon be moving the Tax Court to invalidate the claimed deductions in all cases where the transactions fail to comply with the basic requirements, leaving only the final penalty amount to be determined.

In addition to auditing participants in syndicated conservation easement transactions, the IRS is pursuing investigations of promoters, appraisers, tax return preparers and others, and is evaluating numerous referrals of practitioners to the IRS Office of Professional Responsibility. The IRS will develop and assert all appropriate penalties, including:

• penalties for participants (40 percent accuracy-related penalty);
• penalties for appraisers (penalty for substantial and gross valuation misstatements attributable to incorrect appraisals);
• penalties for promoters, material advisors, and accommodating entities (penalty for promoting abusive tax shelters, and penalty for aiding and abetting understatement of tax liability); and
• penalties for return preparers (penalty for understatement of taxpayer’s liability by a tax return preparer).

Rettig, Desmond Highlight Heightened Focus

Rettig and IRS Chief Counsel Michael J. Desmond have each highlighted the IRS’s heightened, agency-wide focus on syndicated conservations easements.

While speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C., Rettig and Desmond both separately underscored the IRS’s increased enforcement efforts toward abuses of certain tax-advantaged land transactions under Code Sec. 170(h).

"We appreciate the value of conservation easements," Rettig said. "We do not appreciate the activities that have gone on with respect to the syndicated conservation easements—there are some artificial appraisals there… some fatal flaws."

Reiterating the IRS’s tough stance on the matter, Rettig said that the IRS is not going to "stand down." The information in IR-2019-182 issued on November 12 was "fair warning," Rettig said.

Likewise, Desmond stressed that the challenges surrounding syndicated conservation easements are an "institutional concern" for the IRS, "one that we will be responding to," he emphasized.

Treasury and the IRS are expected to release proposed rules in "early 2020" that would clarify certain limitations on the carried interest tax break, according to David Kautter, Treasury’s assistant secretary for tax policy. Kautter briefly addressed the proposed regulations’ timeline while speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C.

Treasury and the IRS are expected to release proposed rules in "early 2020" that would clarify certain limitations on the carried interest tax break, according to David Kautter, Treasury’s assistant secretary for tax policy. Kautter briefly addressed the proposed regulations’ timeline while speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C.

Carried Interest Limitation

The forthcoming regulations are expected to restrict S corporations from taking advantage of a carried interest exemption provision under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The TCJA requires certain money managers to hold investments for at least three years before becoming eligible for the lower, 20 percent capital gains rate. However, it exempted corporations from this holding period, which Treasury and many lawmakers on Capitol Hill say resulted in an unintended "loophole."

The proposed regulations are expected to clarify the law’s intent that S corporations are subject to the three-year holding period for carried interest, according to Treasury’s last press release on the matter issued in March 2018 (see "Treasury, IRS Issue Guidance On Carried Interest," at https://home.treasury.gov/news/press-releases/sm0302).

Legal Questions May Arise

Most notably, however, the TCJA does not expressly contain this limitation on S-corporations, which has left some on Capitol Hill questioning Treasury and the IRS’s authority to implement such a restriction via regulations. The IRS on November 15 directed Wolters Kluwer to Treasury for confirmation on this anticipated rule and projected timeline. As of press time, Treasury had not responded to Wolters Kluwer’s request for comment.

Hopes for a year-end tax extenders package appear to be dwindling on Capitol Hill.

Hopes for a year-end tax extenders package appear to be dwindling on Capitol Hill.

Tax Extenders Need a Legislative Vehicle

Over 30 expired or soon-to-be expired tax breaks known as tax extenders were originally considered a top contender for hitching a ride on a larger, must-pass government funding bill. Considering the lack of time left on the legislative calendar this year, a stand-alone tax bill has been considered an unlikely initiative. Thus, a must-pass appropriations bill was seen by several lawmakers as the likely legislative vehicle for tax extenders and other tax items such as technical corrections to Republicans’ 2017 tax reform law.

However, a spokesperson for Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, confirmed to Wolters Kluwer on October 28 that Grassley believes there is "no hope" for action this year on a tax extenders package if lawmakers do not move quickly with respect to its legislative driver. Many within the practitioner community following these developments have said that the chances of providing taxpayers with certain tax breaks retroactively significantly decrease if Congress moves into next year leaving them expired.

Another Stopgap Spending Bill Appears Likely

Currently, the federal government is operating on a stopgap spending bill temporarily extending fiscal year (FY) 2019 funding levels through November 21. Previously, several lawmakers, in particular Grassley, had hoped that a tax extenders package would be attached to a larger, more comprehensive appropriations bill next month. However, Senate Appropriations Committee Chair Richard Shelby, R-Ala., told reporters that another short-term stopgap spending bill is the more likely option to keep the government open after November 21. "Unless a miracle happens around here with the House and Senate, we will have to put forth another [continuing resolution] CR," Shelby told reporters.

Notably, another short-term government funding bill is considered unlikely to have any policy riders. Generally, stop gap spending bills are usually considered "clean," for the most part. Also playing a role in tax extenders’ fate is whether President Trump would sign a more comprehensive appropriations bill. At this time, his support for a larger FY 2020 funding bill, apart from tax policy reasons, remains unclear.

Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, and other top Senate tax writers are calling for Senate action on the bipartisan Setting Every Community Up for Retirement Enhancement Secure bill (HR 1994) (SECURE Act). The House-approved, bipartisan retirement savings bill has remained stalled in the Senate since May.

Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, and other top Senate tax writers are calling for Senate action on the bipartisan Setting Every Community Up for Retirement Enhancement Secure bill (HR 1994) (SECURE Act). The House-approved, bipartisan retirement savings bill has remained stalled in the Senate since May.

SECURE Act’s Route to Senate Floor Remains Unclear

Grassley’s communications director Michael Zona told Wolters Kluwer on October 21 that it remains "unclear at this point" whether the SECURE Act will move through committee, reach the Senate floor by unanimous consent, or be attached to a larger, year-end tax package. "Grassley supports the House-passed SECURE Act. There are several holds on the bill, and he is working to get them lifted," Zona said.

The SECURE Act cleared the House on May 23 by a 417-to-3 vote. The bipartisan measure, which proposes sweeping changes to retirement savings tax policy, was originally expected to quickly clear the Senate after its approval in the House. However, Sen. Ted Cruz, R-Tex., blocked the bill from reaching the Senate floor. Cruz blocked the bill in protest of House Democrats’ 11th hour-removal of a provision from the original bill that would have expanded tax-advantaged Section 529 education savings plans to include homeschooling and certain elementary and secondary expenses. Cruz and Sen. Patty Murray, D-Wash., are reportedly still holding up the measure from reaching the Senate floor.

Catch-All Tax Package

However, the SECURE Act, among other bipartisan tax-related items including tax extenders, could be attached to a catch-all tax package that is expected on Capitol Hill to hitch a ride on a year-end government funding bill. A "must-pass" appropriations bill, like the one currently being negotiated to keep the government open after funding expires on November 21, could serve as the tax package’s legislative vehicle, thus fast tracking its approval.

"As the economy continues to change, the way we approach retirement savings must change as well. Otherwise, too many Americans will be left behind," Grassley said on October 21, noting that the SECURE Act is under "active consideration."

Similar to Grassley’s push, Sen. Tim Scott, R-S.C., led a letter sent to Senate Majority Leader Mitch McConnell, R-Ky., urging immediate Senate consideration of the SECURE Act. "This bipartisan legislation would expand access to retirement plans for millions of Americans, allow older workers and retirees to contribute more to their retirement accounts, increase 401(k) coverage to part-time employees, prevent as many as 4 million people in private-sector pension plans from losing future benefits, protect 1,400 religiously affiliated organizations whose access to their defined contribution retirement plans is in jeopardy, and do the right thing for Gold Star families," according to Scott.

The Senate blocked a Democratic resolution on October 23 to overturn Treasury rules preventing certain workarounds to the $10,000 state and local tax (SALT) federal deduction cap.

The Senate blocked a Democratic resolution on October 23 to overturn Treasury rules preventing certain workarounds to the $10,000 state and local tax (SALT) federal deduction cap.

SALT Cap Workaround

Senate Democrats’ resolution, S.J. Res. 50, forced a vote on Wednesday to nullify Treasury regulations that block taxpayers from circumventing the SALT cap through certain states’ programs that convert state and local taxes into fully deductible charitable contributions. The resolution failed by a largely party-line vote of 43-to-52.

Sen. Michael Bennet, D-Colo., voted against the Democratic measure while Sen. Rand Paul, R-Ky., supported it. While the resolution would not repeal the SALT cap itself, House Democrats are reportedly crafting legislation to do so. Democrats and some Republicans, particularly from high-tax states, have criticized the SALT cap since its enactment in 2017 under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97).

Debate on SALT Cap, Treasury Rules

"Without any clear authority to do so, the Treasury Department reversed a long-standing IRS position that had allowed taxpayers a full deduction for charitable contributions to state tax credit programs," Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said on the Senate floor before the vote. "My view is the Treasury Department should not be putting its thumb on the scale on behalf of Republican interests, and it shouldn’t be using phony regulatory justifications to fix Republicans’ extraordinarily poorly drafted law."

However, several Republicans cited to a recent report from the nonpartisan Joint Committee on Taxation (JCT), which estimated that repealing the SALT cap beginning in 2019 would result in over $40 billion of the associated tax cut going to taxpayers with incomes of at least $1 million ( JCX-35-19).

"It’s bad enough that my Democratic colleagues want to unwind tax reform, but it’s downright comical that their top priority is helping wealthy people in blue states find loopholes to pay even less," Senate Majority Leader Mitch McConnell, R-Ky., said from the Senate floor on October 23. "Repealing the SALT cap would give millionaires an average tax cut of $60,000. Meanwhile, the average tax cut for taxpayers earning between $50,000 and $100,000 would be less than ten dollars."

Vaping Tax

In other news, the House Ways and Means Committee approved a bipartisan vaping tax bill, ( HR 4742), on October 23 by a 24-to-15 vote. The bill would establish a $27.81 tax per gram of nicotine used in vaping devices.

Treasury and the IRS on October 31 announced the release of a new, draft form implementing certain reporting requirements under the Tax Cuts and Jobs Act Opportunity Zone program.

Treasury and the IRS on October 31 announced the release of a new, draft form implementing certain reporting requirements under the Tax Cuts and Jobs Act Opportunity Zone program.

The proposed Form 8996 for Qualified Opportunity Funds (QOFs) comes after numerous calls on Capitol Hill for more transparency within the Opportunity Zone program. "The form is designed to collect information on the amount of investment by opportunity funds in business property by census tract," according to a Treasury press release.

Opportunity Zones’ Architect Applauds Treasury’s Steps Toward Reporting Requirements

Ken Farnaso, press secretary for Sen. Tim Scott, R-S.C., chief architect of the TCJA’s bipartisan Opportunity Zone program, told Wolters Kluwer on October 31 that reporting requirements, "an important piece of the puzzle," were, in fact, originally in the bill. "Unfortunately, during the tax reform process, Senate Democrats blocked these requirements from being included in the Tax Cuts and Jobs Act. Since then, Senator Scott has continued working to restore those reporting requirements," Farnaso said.

Additionally, Farnaso told Wolters Kluwer that Scott applauds Treasury’s steps to ensure a clearer picture of the impact the Opportunity Zones initiative can have on the country. "Senator Scott will also continue to push for his current bill restoring robust reporting requirements to create a holistic picture of how the initiative is functioning," Farnaso said. "Overall, today is a good day for Opportunity Zones. We look forward to the more than $44 billion in currently anticipated investment being deployed in distressed communities across the nation, and that number growing even larger in the future."

Opportunity Zones Tax Incentive

The Opportunity Zone Program enacted under TCJA ( P.L. 115-97) is considered on Capitol Hill as one of the most generous and ambitious tax incentives for investors in distressed communities. Under Code Sec. 1400Z-2, investors may defer taxation of capital gains that are invested in a QOF.

Generally, the following investor tax benefits were created under the Opportunity Zone program:

• a temporary tax deferral for capital gains realized on the sale of appreciated assets and reinvested within 180 days in a QOF;
• the elimination of up to 10 or 15 percent of the tax on the capital gain that is invested in the QOF and held between five and seven years; and
• the permanent exclusion of tax when exiting a qualified opportunity fund investment held for at least 10 years.

Draft IRS Form 8996

Specifically, the new, draft Form 8996 for the 2019 tax year requires QOFs to report the following information:

• the Employer Identification Number (EIN) of each business in which the QOF has an ownership interest;
• the census tract location of the tangible property of the business;
  the value of the QOF’s investment; and
• the value and census tract location of qualified business property directly owned or leased.

"This is an important step towards a thorough evaluation of the Opportunity Zone tax incentive," Treasury Secretary Steven Mnuchin said. "We want to understand where Opportunity Zone investments are going and strengthening the economy so that investors and communities can learn from the successes of this bipartisan, pro-growth policy."

Generally, the collection of this information will play a role in allowing lawmakers and the public to evaluate the effects of the tax incentive and to understand why some locations may be more successful than others at attracting investment, according to Treasury.

Opportunity Zones Criticism

The Opportunity Zone program has not come to fruition without its share of criticism, however. Although lawmakers have called for reporting requirements related to QOFs since the TCJA’s enactment, the program has recently come under increased scrutiny and criticism. Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., has said that the lack of reporting requirements are "inexcusable."

"Requiring taxpayers to prove they’re actually following the rules of the Opportunity Zone program is a positive first step, but it’s one that should have been taken two years ago…," Wyden said in an October 31 statement. "The Opportunity Zone program has been operating without any effort to ensure compliance and that’s inexcusable."

A California-based medical marijuana dispensary corporation’s motion for summary judgment challenging the constitutionality of Code Sec. 280E was denied. The Tax Court also addressed whether Code Sec. 280E applies to marijuana businesses legally operating under state (California) law, and whether the prohibition on deductions is limited to ordinary and necessary business expenses.

A California-based medical marijuana dispensary corporation’s motion for summary judgment challenging the constitutionality of Code Sec. 280E was denied. The Tax Court also addressed whether Code Sec. 280E applies to marijuana businesses legally operating under state (California) law, and whether the prohibition on deductions is limited to ordinary and necessary business expenses.

Section 280E

Congress enacted Code Sec. 280E after the court had allowed certain deductions for expenses incurred in connection with an illegal drug trade. Generally, Code Sec. 280E disallows any deductions attributable to a taxpayer’s illegal drug related trade or business. Taxpayers may reduce their income by the cost of goods sold (COGS), and Code Sec. 280E does not generally disallow deductions attributable to a taxpayer’s non-drug-related business.

Constitutionality

The Eighth Amendment of the Constitution prohibits excessive fines or penalties. The dispensary in this case claimed that Code Sec. 280E is a punitive provision that violates the Eighth Amendment. However, because Congress generally has the power to levy taxes under the Sixteenth Amendment, the Tax Court found that the law’s denial of certain deductions cannot be construed as a penalty.

Legality Under State Law

The dispensary also argued that its actions could not be considered "trafficking" for purposes of Code Sec. 280E because its activities were not illegal under California law. The court noted that because marijuana is still considered a Schedule I controlled substance and is banned under federal law, the application of Code Sec. 280E does not depend on the legality of marijuana sales under California law.

Additional Deductions

Finally, the dispensary argued that Code Sec. 280E only applies to deductions under Code Sec. 162, and that other deductions such as those under Code Secs. 164 and 167 should be permitted. However, the text of Code Sec. 280E broadly states that "no deduction or credit shall be allowed." It does not limit the deductions to those claimed under Code Sec. 162.

Dissenting Opinions

The Tax Court decision included several concurring and dissenting opinions, which primarily addressed the issue as to whether Code Sec. 280E is in fact a penalty provision that would violate the Eighth Amendment.

The dissenting opinions found that Code Sec. 280E is punitive in nature. One dissenter noted that rather than specify a narrow range of disallowed expenses, Code Sec. 280E attacks the entire marijuana industry with a broad denial of otherwise allowable deductions. The opinion stated that Congress passed Code Sec. 280E order to deter the sale of controlled substances and to penalize the drug trade. That intent was found to be "clearly in the nature of a penalty." Both dissents concluded with two additional questions, which the dissenters felt need to be addressed:

• Is the punitive nature of Code Sec. 280E excessive to the point where it violates the Eighth Amendment?, and
• Does the Eighth Amendment apply to corporation taxpayers?

The IRS has proposed regulations that define an eligible terminated S corporation (ETSC), and provide rules relating to distributions of money by an ETSC after the post-termination transition period (PTTP). The proposed regulations also extend the treatment of distributions of money during the PTTP to all shareholders of the corporation, and update and clarify the allocation of current earnings and profits to distributions of money and other property.

The IRS has proposed regulations that define an eligible terminated S corporation (ETSC), and provide rules relating to distributions of money by an ETSC after the post-termination transition period (PTTP). The proposed regulations also extend the treatment of distributions of money during the PTTP to all shareholders of the corporation, and update and clarify the allocation of current earnings and profits to distributions of money and other property.

Code Sec. 1371(f), as added by the Tax Cuts and Jobs Act ( P.L. 115-97) extends the period during which C corporation shareholders can benefit from the corporation’s accumulated adjustment account (AAA) generated during its former status as an S corporation. Specifically, the provision allows the C corporation to source qualified distributions of money to which Code Sec. 301 would otherwise apply to in whole or part to AAA. The provision only applies if the corporation is an ETSC as defined in Code Sec. 481(d).

Under the proposed regulations, the revocation of S corporation status may be made during the two-year period beginning on December 22, 2017, even if the effective date for the revocation occurs after the conclusion of the two-year period.

Shareholder Identity Requirement

A former S corporation is not an ETSC unless the owners of its stock are the same owners (and in identical proportions) on December 22, 2017, and on the date of the S corporation revocation. The proposed regulations identify various categories of stock transfers that are not considered an ownership change for purposes of this rule.

ETSC Proration

A distributing ETSC’s AAA is allocated to qualified distributions and the distributions are chargeable to the ETSC’s accumulated earnings and profits (AE&P) based on the ETSC proration. The ETSC proration is implemented in a manner that facilitates the prompt distribution of AAA and full transition to C corporation status. Specifically, the proposed regulations:

• specify the time at which amounts of AAA and AE&P are determined for purposes of the ETSC proration;

• provide AAA and AE&P ratios used to the implement the proration; and

• describe in detail the method of characterizing qualified distributions.

The proposed regulations adopt a "snapshot" approach under which amounts of AAA and AE&P are determined on a specified date. As a result, the same ETSC proration is applied to all qualified distributions. Under the proposed regulations, the determination date is the date when the S corporation revocation election is effective. A "dynamic" approach that recalculated the amounts before each qualified distribution was rejected as administratively cumbersome.

The proposed regulations provide two ratios for determining the part of a qualified distribution that is sourced from AAA and from AE&P. The AAA ratio is the ratio of historical AAA to the sum of historical AAA and historical AE&P. The AE&P ratio is the ratio of historical AE&P and the sum of historical AAA and historical AE&P. The qualified distribution is multiplied by these ratios to determine the amount sourced from AAA and AE&P.

The proposed regulations provide a priority rule under which ETSC proration first applies to qualified distributions during the tax year. The rules of Code Sec. 301 and allocation rules of Code Sec. 316 then apply to any nonqualified distributions that are not fully accounted for by the ETSC proration because the corporation’s AAA or AE&P are exhausted.

Effective Date

The proposed regulations will be effective in tax years beginning after the date they are published as final regulations. A taxpayer may apply the regulations in their entirely to tax years that begin on or before the date of publication as final regulations.

In 2013, a new and unique tax will take effect—a 3.8 percent "unearned income Medicare contribution" tax as part of the structure in place to pay for health care reform. The tax will be imposed on the "net investment income" (NII) of individuals, estates, and trusts that exceeds specified thresholds. The tax will generally fall on passive income, but will also apply generally to capital gains from the disposition of property.

In 2013, a new and unique tax will take effect—a 3.8 percent "unearned income Medicare contribution" tax as part of the structure in place to pay for health care reform. The tax will be imposed on the "net investment income" (NII) of individuals, estates, and trusts that exceeds specified thresholds. The tax will generally fall on passive income, but will also apply generally to capital gains from the disposition of property.

Specified thresholds

For an individual, the tax will apply to the lesser of the taxpayer's NII, or the amount of "modified" adjusted gross income (AGI with foreign income added back) above a specified threshold, which is:

• $250,000 for married taxpayers filing jointly and a surviving spouse;
• $125,000 for married taxpayers filing separately;
• $200,000 for single and head of household taxpayers.

Examples. A single taxpayer has modified AGI of $220,000, including NII of $30,000. The tax applies to the lesser of $30,000 or ($220,000 minus $200,000), the specified threshold for single taxpayers. Thus, the tax applies to $20,000.

A single taxpayer has modified AGI of $150,000, including $60,000 of NII. Because the taxpayer's income is below the $200,000 threshold, the taxpayer does not owe the tax, despite having substantial NII.

For an estate or trust, the tax applies to the lesser of undistributed net income, or the excess of AGI over the dollar amount for the highest tax rate bracket for estates and trusts ($11,950 for 2013). Thus, the tax applies to a much lower amount for trusts and estates.

Application of tax

The tax applies to interest, dividends, annuities, royalties, and rents, and capital gains, unless derived from a trade or business. The tax also applies to income and gains from a passive trade or business.

Other items are excluded from NII and from the tax:  distributions from IRAs, pensions, 401(k) plans, tax-sheltered annuities, and eligible 457 plans, for example. Items that are totally excluded from gross income, such as  distributions from a Roth IRA and interest on tax-exempt bonds, are excluded both from NII and from modified AGI.

The tax does not apply to nonresident aliens, charitable trusts, or corporations.

Tax planning techniques

Taxpayers are concerned about having to pay the tax. One technique for avoiding the tax is to sell off capital gain property in 2012, before the tax applies. This can be particularly useful if the taxpayer is facing a large capital gain from the sale of a principal residence (after taking the $250,000/$500,000 exclusion from income). Older taxpayers who do not want to sell their property may want to consider holding on to appreciated property until death, when the property gets a fair market value basis without being subject to income tax.

The technique of "gain harvesting" may be even more attractive if tax rates increase on dividends, capital gains, and AGI in 2013, with the potential expiration of the Bush-era tax cuts. However, the status of these tax rates will not be determined until after the election, potentially in a lame-duck Congressional session. It is also possible that Congress will simply extend existing tax rates for another year and "punt" the decision until 2013, as tax reform discussions heat up.

Taxpayers may also want to change the source of their income. Investing in tax-exempt bonds will be more attractive, since the interest income does not enter into AGI or NII. Converting a 401(k) account or traditional IRA to a Roth IRA will accomplish the same purpose. Income from a Roth conversion is not net investment income, although the income will increase modified AGI, which may put other income in danger of being subject to the 3.8 percent tax. Increasing deductible or pre-tax contributions to existing retirement plans can also lower income and help the taxpayer stay below the applicable threshold.

Trusts and estates should make a point of distributing their income to their beneficiaries. A trust's NII will be taxed at a low threshold (less than $12,000), while the income received by a beneficiary is taxed only if the much higher $200,000/$250,000 thresholds are exceeded.

Uncertainty

There was some uncertainty about the tax taking effect because of litigation challenging the health care law providing the tax, but a June 2012 Supreme Court decision upheld the law. The application of the tax is also uncertain because the Republican leadership has vowed to pursue repeal of the health care law if the Republicans win the presidency and take control of both houses of Congress in the November 2012 elections. But this is speculative. In the meantime, the Supreme Court decision guarantees that the tax will take effect on January 1, 2013.

These can be difficult decisions. While economic considerations for managing assets and income are important, it also makes sense for a taxpayer to look at the tax impact if the certain asset sales or shifts in investment portfolios are otherwise being considered.

Taxpayers recovering from the current economic downturn will get at least some relief in 2013 by way of the mandatory upward inflation-adjustments called for under the tax code, according to CCH, a Wolters Kluwer business. CCH has released estimated income ranges for each 2013 tax bracket as well as a growing number of other inflation-sensitive tax figures, such as the personal exemption and the standard deduction.

Taxpayers recovering from the current economic downturn will get at least some relief in 2013 by way of the mandatory upward inflation-adjustments called for under the tax code, according to CCH, a Wolters Kluwer business. CCH has released estimated income ranges for each 2013 tax bracket as well as a growing number of other inflation-sensitive tax figures, such as the personal exemption and the standard deduction.

Projections this year, however, are clouded by the uncertainty of expiring provisions in the tax code. If Congress allows the so-called Bush-era tax cuts to expire at the end of 2012, many taxpayers could lose more ground than they will otherwise gain. These tax cuts, first enacted within Economic Growth Tax Recovery and Reconciliation Act of 2001 (EGTRRA) with a ten-year life, were last extended by the 2010 Tax Relief Act, but only for two years through 2012.

When there is inflation, indexing of brackets lowers tax bills by including more of taxpayers' incomes in lower brackets – in the existing 15-percent rather than the existing 25-percent bracket, for example. The formula used in indexing showed an average amount of inflation this year of about 2.5 percent – the highest in several years. Most 2013 figures therefore have moved higher.

Tax Rates

The current 10, 15, 25, 33 and 35-percent rates are now officially scheduled to sunset to the pre-EGTRRA rate structure of 15, 28, 31, 36 and 39.6-percent. While no one in Washington is calling for a full sunset of all the current tax rates, congressional gridlock might produce a cliffhanger on what will happen until after the November elections, and perhaps not even before January when the new, 113th Congress convenes. In the meantime, there are three possible alternative scenarios being debated by lawmakers:

• Extend the current tax bracket structure in its entirety;
• As proposed by President Obama, keep the current rate structure except revive the 36 and 39.6-percent rates, starting at a higher-income bracket level of $200,000 for single filers, $250,000 for joint filers, $225,000 for head-of-households and $125,000 for married taxpayers filing separately, also indexed for inflation since initially proposed in 2009 but keyed to adjusted gross income (AGI) rather than taxable income (indexed 2013 projections for those AGI levels, based on the Administration's FY 2013 Budget, are $213,200 / $266,500 / $239,850 / and $133,250, respectively); or
• As proposed by certain Senate Democrats, raise the top tax rate only for individuals making more than $1 million.

Tax Brackets

Here is a sample of how inflation will raise rate brackets in 2013, assuming a full extension of tax rates:

• Joint returns. For married taxpayers filing jointly and surviving spouses, the maximum taxable income subject to the 10-percent bracket will rise from $17,400 in 2012, to $17,850 in 2013; the top of the 15-percent tax bracket will increase from $70,700 to $72,500. The bracket amounts for the remaining tax rates will show similarly proportionate increases: $146,400 as the maximum for the 25-percent bracket (up $3,700 from 2012); $223,050 for the 28-percent bracket (up $5,600 from 2012); and $398,350 for the 33-percent bracket (up $10,000 from 2012). Amounts above the $398,350 level will be taxed at the 35-percent rate.

• Single filers. For single taxpayers, the maximum taxable income for the 10-percent bracket will increase to $8,925 for 2012 (up from $8,700 in 2012). The remainder of the rate brackets show inflation increases of: $900 for the top of the 15-percent bracket (to $36,250); $2,200 for the 25-percent bracket (to $87,850); $4,600 for the 28-percent bracket (to $183,250); and $10,000 for the top of the 33-percent bracket (to $398,350).

Standard Deductions

The 2013 standard deduction will increase for all taxpayers. The standard deduction amounts for 2013 is projected to be $6,100 for single taxpayers; $8,950 for heads of households; $12,200 for married taxpayers filing jointly and surviving spouses; and $6,100 for married taxpayers filing separately. The standard deduction for dependents rises $50 to $1,000 (or earned income plus $350). The additional standard deduction for those have reached 65 or are blind will rise to $1,200 for married taxpayers; $1,500 for unmarried individuals.

Personal Exemptions

The amount of personal and dependency exemptions for 2013 will increase to $3,900 from the 2012 level of $3,800.

Gift Tax Exclusion

The gift tax annual exclusion, which rose from a base of $10,000 to $11,000 in 2002; $12,000 in 2006, and $13,000 in 2009, once again will rise in 2013 to $14,000. Pursuant to the IRC, the exemption can rise only when the inflation adjustment produces an increase of $1,000 or more.

Whether for a day, a week or longer, many of the costs associated with business trips may be tax-deductible. The tax code includes a myriad of rules designed to prevent abuses of tax-deductible business travel. One concern is that taxpayers will disguise personal trips as business trips. However, there are times when taxpayers can include some personal activities along with business travel and not run afoul of the IRS.

Business travel

You are considered “traveling away from home” for tax purposes if your duties require you to be away from the general area of your home for a period substantially longer than an ordinary day's work, and you need sleep or rest to meet the demands of work while away. Taxpayers who travel on business may deduct travel expenses if they are not otherwise lavish or extravagant. Business travel expenses include the costs of getting to and from the business destination and any business-related expenses at that destination.

Deductible travel expenses while away from home include, but are not limited to, the costs of:

• Travel by airplane, train, bus, or car to/from the business destination.
• Fares for taxis or other types of transportation between the airport or train station and lodging, the lodging location and the work location, and from one customer to another, or from one place of business to another.
• Meals and lodging.
• Tips for services related to any of these expenses.
• Dry cleaning and laundry.
• Business calls while on the business trip.
• Other similar ordinary and necessary expenses related to business travel.

Business mixed with personal travel

Travel that is primarily for personal reasons, such as a vacation, is a nondeductible personal expense. However, taxpayers often mix personal travel with business travel. In many cases, business travelers may able to engage in some non-business activities and not lose all of the tax benefits associated with business travel.

The primary purpose of a trip is determined by looking at the facts and circumstances of each case. An important factor is the amount of time you spent on personal activities during the trip as compared to the amount of time spent on activities directly relating to business.

Let’s look at an example. Amanda, a self-employed architect, resides in Seattle. Amanda travels on business to Denver. Her business trip lasts six days. Before departing for home, Amanda travels to Colorado Springs to visit her son, Jeffrey. Amanda’s total expenses are $1,800 for the nine days that she was away from home. If Amanda had not stopped in Colorado Springs, her trip would have been gone only six days and the total cost would have been $1,200. According to past IRS precedent, Amanda can deduct $1,200 for the trip, including the cost of round-trip transportation to and from Denver.

Weekend stayovers

Business travel often concludes on a Friday but it may be more economical to stay over Saturday night and take advantage of a lower travel fare. Generally, the costs of the weekend stayover are deductible as long as they are reasonable. Staying over a Saturday night is one way to add some personal time to a business trip.

Foreign travel

The rules for foreign travel are particularly complex.  The amount of deductible travel expenses for foreign travel is linked to how much of the trip was business related.  Generally, an individual can deduct all of his or her travel expenses of getting to and from the business destination if the trip is entirely for business.

In certain cases, foreign travel is considered entirely for business even if the taxpayer did not spend his or her entire time on business activities. For example, a foreign business trip is considered entirely for business if the taxpayer was outside the U.S. for more than one week and he or she spent less than 25 percent of the total time outside the U.S. on non-business activities. Other exceptions exist for business travel outside the U.S. for less than one week and in cases where the employee did not have substantial control in planning the trip.

Foreign conventions are especially difficult, but no impossible, to write off depending upon the circumstances. The taxpayer may deduct expenses incurred in attending foreign convention seminar or similar meeting only if it is directly related to active conduct of trade or business and if it is as reasonable to be held outside North American area as within North American area.

Tax home

To determine if an individual is traveling away from home on business, the first step is to determine the location of the taxpayer’s tax home. A taxpayer’s tax home is generally his or her regular place of business, regardless of where he or she maintains his or her family home. An individual may not have a regular or main place of business. In these cases, the individual’s tax home would generally be the place where he or she regularly lives.  The duration of an assignment is also a factor. If an assignment or job away from the individual’s main place of work is temporary, his or her tax home does not change. Generally, a temporary assignment is one that lasts less than one year.

The distinction between tax home and family home is important, among other reasons, to determine if certain deductions are allowed. Here’s an example.

Alec’s family home is in Tucson, where he works for ABC Co. 14 weeks a year.  Alec spends the remaining 38 weeks of the year working for ABC Co. in San Diego. Alec has maintained this work schedule for the past three years. While in San Diego, Alec resides in a hotel and takes most of his meals at restaurants.  San Diego would be treated as Alec’s tax home because he spends most of his time there. Consequently, Alec would not be able to deduct the costs of lodging and meals in San Diego.

Accountable and nonaccountable plans

Many employees are reimbursed by their employer for business travel expenses. Depending on the type of plan the employer has, the reimbursement for business travel may or may not be taxable. There are two types of plans: accountable plans and nonaccountable plans.

An accountable plan is not taxable to the employee. Amounts paid under an accountable plan are not wages and are not subject to income tax withholding and federal employment taxes. Accountable plans have a number of requirements:

• There must be a business connection to the expenditure. The expense must be a deductible business expense incurred in connection with services performed as an employee. If not reimbursed by the employer, the expense would be deductible by the employee on his or her individual income tax return.

• There must be adequate accounting by the recipient within a reasonable period of time. Employees must verify the date, time, place, amount and the business purpose of the expenses.

• Excess reimbursements or advances must be returned within a reasonable period of time.

Amounts paid under a nonaccountable plan are taxable to employees and are subject to all employment taxes and withholding.  A plan may be labeled an accountable plan but if it fails to qualify, the IRS treats it as a nonaccountable plan. If you have any questions about accountable plans, please contact our office.

As mentioned, the tax rules for business travel are complex. Please contact our office if you have any questions.

Exempt organizations

Charitable organizations often are organized as tax-exempt entities. To be tax-exempt under Code Sec. 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes in Code Sec. 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization; that is, it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates. Churches that meet the requirements of Code Sec. 501(c)(3) are automatically considered tax exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS.

Tax-exempt organizations must file annual reports with the IRS. If an organization fails to file the required reports for three consecutive years, its tax-exempt status is automatically revoked. Recently, the tax-exempt status of more than 200,000 organizations was automatically revoked. Most of these organizations are very small ones and the IRS believes that they likely did not know about the requirement to file or risk loss of tax-exempt status.  The IRS has put special procedures in place to help these small organizations regain their tax-exempt status.

Contributions

Contributions to qualified charities are tax-deductible. They key word here is qualified. The organization must be recognized by the IRS as a legitimate charity.

The IRS maintains a list of organizations eligible to receive tax-deductible charitable contributions. The list is known as Publication 78, Cumulative List of Organizations described in Section 170(c) of the Internal Revenue Code of 1986.  Similar information is available on an IRS Business Master File (BMF) extract.

In certain cases, the IRS will allow deductions for contributions to organizations that have lost their exempt status but are listed in or covered by Publication 78 or the BMF extract.  Additionally, private foundations and sponsoring organizations of donor-advised funds generally may rely on an organization's foundation status (or supporting organization type) set forth in Publication 78 or the BMF extract for grant-making purposes.

Generally, the donor must be unaware of the change in status of the organization. If the donor had knowledge of the organization’s revocation of exempt status, knew that revocation was imminent or was responsible for the loss of status, the IRS will disallow any purported deduction.

Churches

As mentioned earlier, churches are not required to apply for tax-exempt status. This means that taxpayers may claim a charitable deduction for donations to a church that meets the Code Sec. 501(c)(3) requirements even though the church has neither sought nor received IRS recognition that it is tax-exempt.

Foreign charities

Contributions to foreign charities may be deductible under an income tax treaty. For example, taxpayers may be able to deduct contributions to certain Canadian charitable organizations covered under an income tax treaty with Canada.  Before donating to a foreign charity, please contact our office and we can determine if the contribution meets the IRS requirements for deductibility.

The rules governing charities, tax-exempt organizations and contributions are complex. Please contact our office if you have any questions.

President Obama unveiled his fiscal year (FY) 2012 federal budget recommendations in February, proposing to increase taxes on higher-income individuals, repeal some business tax preferences, reform international taxation, and make a host of other changes to the nation's tax laws. The president's FY 2012 budget touches almost every taxpayer in what it proposes, and in some cases, what is left out.

Roadmap

Every federal budget proposal is just that: a proposal, or a list of recommendations from the White House to Congress. Ultimately, it is for Congress to decide whether to fund a particular government program and at what level. The same is true for tax cuts and tax increases. The final budget for FY 2012 will be a compromise. Nonetheless, President Obama's FY 2012 budget is a helpful tool to predict in what direction federal tax policy may move.

Individuals

In his FY 2012 budget, President Obama repeats his call for Congress to end the Bush-era tax cuts for higher-income individuals (which the president generally defines as single individuals with incomes over $200,000 and married couples with incomes over $250,000). The top individual income tax rates would increase to 36 percent and 39.6 percent, respectively, after 2012. For 2011 and 2012, the top two individual income tax rates are 33 percent and 35 percent, respectively. The president also proposes to limit the deductions of higher income individuals.

Additionally, the president wants Congress to extend the reduced tax rates on capital gains and dividends, but not for higher-income individuals. Single individuals with incomes above $200,000 and married couples with incomes above $250,000 would pay capital gains and dividend taxes at 20 percent rather than at 15 percent after 2012.

The president's FY 2012 budget, among other things, also proposes:

• An AMT patch (higher exemption amounts and other targeted relief) after 2011;
• A permanent American Opportunity Tax Credit (enhanced Hope education tax credit) after 2012;
• A permanent enhanced earned income credit;
• A new exclusion from income for certain higher education student loan forgiveness;
• One-time payments of $250 to Social Security beneficiaries, disabled veterans and others with a corresponding tax credit for retirees who do not receive Social Security; and
• A temporary extension of certain tax incentives, such as the state and local sales tax deduction and the higher education tuition deduction, for one year.

Some of the proposals in the president's FY 2012 budget impact how individuals interact with the IRS. Many taxpayers complain that when they call the IRS, the wait times to speak to an IRS representative are so long they hang up. The president proposes to increase the IRS's budget to hire more customer service representatives. The president also proposes to allow the IRS to accept debit and credit card payments directly, thereby enabling taxpayers to avoid third party processing fees.

Businesses

The tax incentives for businesses in the president's FY 2012 budget are generally targeted to specific industries. One popular but temporary business tax incentive would be made permanent. President Obama proposes to extend permanently the research tax credit. The president also proposes to permanently abolish capital gains tax on investments in certain small businesses.

Other business proposals include:

1. Employer tax credits for creating jobs in newly designated Growth Zones;
2. Additional tax breaks for investments in energy-efficient property;
3. More funds for grants in lieu of tax credits for specified energy property;
4. One-year extensions of some temporary business tax incentives, such as the Indian employment credit and environmental remediation expensing;
5. Modifying Form 1099 business information reporting; and
6. Extending and reforming Build America Bonds.

The president's FY 2012 budget does not include a cut in the U.S. corporate tax rate. Any reduction in the U.S. corporate tax rate is likely to come outside the budget process. The president has spoken often in recent weeks about reducing the U.S. corporate tax rate but he wants any reduction to be revenue neutral; that is, the cost of cutting the U.S. corporate tax rate must be paid for. President Obama has discussed closing some unspecific tax loopholes.

IRS operations

President Obama proposes a significant increase in funding for the IRS. Most of the money would go to hiring new revenue officers and boosting enforcement activities. The White House predicts that investing $13 billion in the IRS over the next 10 years will generate an additional $56 billion in additional tax revenue over the same time period.

Estate tax

Late last year, the White House and the GOP agreed on a maximum federal estate tax rate of 35 percent with a $5 million exclusion for 2010, 2011 and 2012. In his FY 2012 budget, the president proposes to return the federal estate tax to its 2009 levels after 2012 (a maximum tax rate of 45 percent and a $3.5 million exclusion). President Obama also proposes to limit the duration of the generation skipping transfer (GST) tax exemption and to make other estate-tax related changes.

Revenue raisers

The White House and Congress are both looking at ways to cut the federal budget deficit. Taxes are one way. The president's FY 2012 budget proposes a number of revenue raisers, especially in the area of international taxation and in fossil fuel production.

International taxation. The president's budget proposes to reduce tax incentives for U.S.-based multinational companies. One goal of this strategy is to encourage multinational companies to invest in job creation in the U.S. The president's FY 2012 budget calls for, among other things, to limit earnings stripping by expatriated entities, to limit income shifting through intangible property transfers, and to make more reforms to the foreign tax credit rules. If enacted, all of the proposed international taxation reforms would raise an estimated $129 billion in additional revenue over 10 years.

LIFO. President Obama proposes to repeal the last-in, first-out (LIFO) inventory accounting method for federal income tax purposes. Taxpayers that currently use the LIFO method would be required to write up their beginning LIFO inventory to its first-in, first-out (FIFO) value in the first tax year beginning after December 31, 2012. This proposal would raise an estimated $52.8 billion over 10 years.

Fossil fuel tax preferences. The Tax Code includes a number of tax incentives for oil, gas and coal producers. President Obama proposes to repeal nearly all of these tax breaks for oil, gas and coal companies. These proposals would raise an estimated $46.1 billion over 10 years.

Financial institutions. President Obama proposes to impose a financial crisis responsibility fee on large U.S. financial institutions. The fee, if enacted, would raise an estimated $30 billion in additional revenue over 10 years.

Carried interest. The president's FY 2012 budget proposes to tax carried interest as ordinary income. This proposal would raise an estimated $14.8 billion in additional revenue over 10 years.

Insurance company reforms. Insurance companies are subject to specific and very technical tax rules. President Obama proposes to overhaul the tax rules for insurance companies. If enacted, these reforms would raise an estimated $14 billion over 10 years.

These are just some of the revenue raisers in the president's FY 2012 budget. All of them will be extensively debated in Congress in the coming months. Our office will keep you posted on developments. If you have any questions about the president's FY 2012 budget proposals, please contact our office.

Have you already mailed (on paper or electronically) your Form 1040 for the 2010 tax year but only now noticed you made an error when preparing the return? If you need to correct a mistake on your federal income tax return that you’ve already filed with the IRS, it’s not too late to correct the mistake by filing an amended return, Form 1040X, Amended U.S. Individual Income Tax Return. The IRS considers an amended return filed on or before the due date of a return to be the taxpayer’s return for the period.

How Do I? Correct a mistake on a tax return I’ve already filed?

Have you already mailed (on paper or electronically) your Form 1040 for the 2010 tax year but only now noticed you made an error when preparing the return? If you need to correct a mistake on your federal income tax return that you’ve already filed with the IRS, it’s not too late to correct the mistake by filing an amended return, Form 1040X, Amended U.S. Individual Income Tax Return. The IRS considers an amended return filed on or before the due date of a return to be the taxpayer’s return for the period.

Correcting a mistake

Taxpayers cannot file more than one original tax return per tax year. If you have already filed an original Form 1040 with the IRS, but want to correct an error on the return (such as claiming a deduction or credit you discovered you were entitled to, or removing a credit or deduction you are not qualified to take, changing your filing status, or income, for example) file and amended return, Form 1040X, on or before April 18, 2011 (the filing deadline for this tax season). If the return is filed on or before the deadline for filing, the IRS considers the amended return to be your return for the tax period. If you file an amended return reporting income taxes due after April 18, however, you may be subject to the assessment of interest and penalties.

Example. You filed your 2010 individual income tax return, Form 1040, on February 1, 2011. But in late February you discovered that you made a mistake on your return. You can file an amended return on or before April 18, 2011 (in most other tax years, it is April 15, but due to the Emancipation Day holiday celebrated in Washington, D.C., the deadline for filing returns this year has been moved to April 18). The last return filed on or before April 18 (your amended return) will be your official tax return. Thus, the last filed return you send before the filing deadline (April 18) is the one that counts as the original return for IRS purposes.

Amended returns after April 18

If you discover the error on your return after April 18 has passed, you still file an amended return, Form 1040X, to correct your previously filed return. Certain tax elections once made on the original return, however, are irrevocable.  Also, any tax not paid with the original return accrues interest.  However, as long as a mistake is corrected on an amended return before the original return is audited, penalties are generally waived.

With the end of the 2010 tax year rapidly approaching, there is only a limited amount of time for individuals to take advantage of certain tax savings techniques. This article highlights some last-minute tax planning tips before the end of the year.

Make a charitable contribution by cash or credit card. Charitable contributions can be made at any time, in cash or in property. Taxpayers may also want to accelerate dues and fees for church or synagogue memberships. While a pledge is not deductible, an actual payment will qualify when the payment is made, not when it is received. Thus, putting a check in the mail qualifies as a payment when the payer gives up control of the check (assuming there are sufficient funds and the check is eventually honored), not when the check is received, deposited, or honored.

Charging a contribution is another means of accelerating payment. Payment by credit card is in effect a loan to the payer and is deductible when the charge is made, not when the bill is paid or the charge is honored. Thus, if you make the charge in 2010 but it is not honored until 2011, you can still take the charitable deduction on your 2010 return. Payment by debit card again is a payment when the transaction occurs, even if the amount is not debited until the following day.

Note: special rules may apply to contributions of property, especially motor vehicles.

Adjust withholding. State and local income taxes are deductible when withheld, paid as estimated taxes or paid with a return. If you anticipate owing taxes for 2010, you can increase withholding or make an additional payment to cover the expected liability. The payment must be made in good faith and be based on a reasonable estimate of your tax liability. Taxpayers paying estimated taxes can make the final payment before the end of 2010.

Itemized deductions. In past years, there have been limits on itemized deductions taken by higher-income taxpayers. These limits do not apply in 2010, so taxpayers should not feel constrained to limit their payments and contributions. For higher-income taxpayers, this is especially beneficial.

Deduction for health insurance costs. If you are self-employed, you can take a deduction for your health insurance costs when computing self-employment tax and the self-employment tax deduction.

Small business stock. If you sell qualified small business stock before January 1, 2011, and are eligible for the increased exclusion from income, you may be able to exclude 100 percent of the gains from the sale of stock. Speak with your tax professional before selling such stock, however, since the rules on eligibility and holding periods can be complex. For a majority of taxpayers, the traditional rules for accelerating/deferring income and/or maximizing or deferring deductions to lower your tax bill may still apply in 2010, despite the threat of higher income tax rates next year still possible. Depending on your situation, you may want to:

- Accelerate income if possible, including bonuses, into 2010;
- Defer selling capital assets at a loss until 2011 and later years;
- Sell capital assets that have appreciated in 2010 to take advantage of the lower capital gains rates (the maximum capital gains rate is 15 percent for 2010);
- Move some assets into tax-free instruments, like municipal bonds, that are not subject to federal tax;
- Accelerate billings and/or provide incentives for clients or customers to make payments in 2010 (if you are a self-employed and/or cash-basis taxpayer);
- Take taxable retirement plan distributions before 2011 (for taxpayers over age 59 1/2); and
- Bunch itemized or business deductions into the 2011 tax year.

Maximize "above-the-line" deductions. Above-the-line deductions are especially valuable because they reduce your adjusted gross income (AGI). Many tax benefits may be limited for taxpayers whose AGI is too high. Common above-the-line deductions include contributions to traditional Individual Retirement Account (IRA) and Health Savings Account (HSA), moving expenses, self-employed health insurance costs, and alimony payments.

Claim "green" credits. You may be able to claim tax credits for purchasing particular property. Certain hybrid cars, such as the Nissan Altima, qualify for an energy credit under Code Sec. 30B. It may be necessary to consult with an auto dealer or check IRS rulings to see what credits are in effect, because the credit for a qualifying "green" vehicle phases out over time and eventually is reduced to zero.

Another credit available for "green" taxpayers is the residential energy credit. The credit is 30 percent, up to a total of $1,500, of certain energy-efficient improvements made by a homeowner to his or her principal residence during 2009 and 2010. For example, the credit can be claimed by installing energy efficient windows and doors.

Make a tax-free gift. You can gift, tax-free, up to $13,000 per donee in 2010. A married couple can apply a combined exclusion of $26,000 to a gift of property for one person. Further amounts to any one taxpayer will be offset by the donor's lifetime exclusion before gift tax is owed. The exclusion applies per year. If it is not used, it is lost; it does not carry over to the succeeding year.

Use an installment sale. If you may be selling property at a gain, you can avoid recognizing the entire gain by using an installment sale. An installment sale has at least one payment after the year of sale. The payment is taxed when it is made, not at the time of the sale. Thus, income can be postponed. The installment method is not available for stocks and bonds, however.

There can be competing considerations, however. Tax rates may increase in 2011 and future years, although perhaps only for the highest-income taxpayers. Still, the amount of gain included in a future payment could be taxed at a higher rate. The 3.8 percent Medicare tax imposed on certain income starting in 2013 also is a factor.

Take your required minimum distributions (RMDs). RMDs have returned for 2010. Although Congress temporarily suspended the RMD requirements for distributions from IRAs and other retirement accounts in 2009, it did not extend this benefit into 2010. Therefore, taxpayers who are age 70 or older must take their RMD from a traditional IRA (Roth IRAs are not subject to the RMD rules), 401(k) or other retirement accounts by December 31. Failure to do so will subject you to a stiff penalty of 50 percent of the amount you were required to withdraw but failed to. However, for taxpayers who turned age 70 in 2010, you have until April 1, 2011 to take your first RMD.

These are just a few last-minute tax planning strategies you may want to consider as year-end approaches. As always, please contact our office if you have any questions.

The recently enacted Hiring Incentives to Restore Employment (HIRE) Act of 2010 includes a comprehensive set of foreign account compliance measures that will impact taxpayers with accounts in foreign banks and other financial institutions. Generally, for payments made beginning in 2013, taxpayers with various types of financial accounts or other interests overseas will be subject to increased reporting and disclosure requirements on those accounts, or face the imposition of 30 percent withholding.

Foreign accounts

The HIRE Act imposes on U.S. taxpayers a 30 percent withholding tax on certain assets held in a foreign financial institution, unless that foreign financial institution agrees to comply with new heightened reporting and disclosure rules. Generally, for certain payments made after December 31, 2012, a withholding agent must deduct and withhold 30 percent of any "withholdable payment" made to certain foreign financial institutions that do not agree to comply with the new rules. Generally, a "withholdable payment" is any payment of interest (including interest on deposits with foreign branches of a U.S. commercial bank), dividends, rents, fixed or determinable annual or periodical gains, gross proceeds from the sale of property that produces interest and/or dividend income.

Note. Although the new withholding rules are generally effective for payments made after December 31, 2012, they will not apply to any obligation outstanding as of two years after the enactment of the HIRE Act, which was March 18, 2010. Additionally, publicly-traded corporations and exempt organizations are excluded from the heightened reporting and disclosure rules.

Financial institutions

To avoid the 30 percent withholding requirement, the foreign institution must agree to a number of disclosure and reporting requirements on U.S. financial assets and accounts held by the foreign financial institution. Under the HIRE Act, an "account" includes any depository or custodial account maintained by the foreign financial institution, including any equity or debt interest in the institution other than equity/debt interests traded on established securities markets.

Foreign financial institutions must agree to report the identity and taxpayer identification number (TIN) of any U.S. individual with an account held at the institution (or its affiliates), and to provide annually (1) the account balance, (2) gross receipts, and (3) gross withdrawals or payments from the account. Additionally, withholding agents will be required to report the name, address and TIN of any U.S. individual that is a substantial owner of a foreign corporation, foreign partnership, or foreign trust.

Account holders

Under the HIRE Act, certain individuals holding any interest in a specified foreign financial asset must attach to his or her tax return certain information about the asset. Specified foreign financial assets include any account maintained by a foreign financial institution, among other things. Account holders must provide account numbers, the name of the financial institution maintaining the account, and the maximum value of the asset during the year. Regarding stocks and securities, account holders must provide the name and address of the issuer and the maximum value of the asset during the year. The disclosure rules apply to individuals with offshore accounts and other foreign financial assets with values of $50,000 or more during the tax year.

The new law provides an exception from the reporting requirements for certain accounts held by individuals. The aggregate value of all accounts held by the taxpayer and maintained by the same foreign financial institution must not exceed $50,000 in order to be excluded from the new reporting and withholding rules.

If you have any questions about the new reporting and disclosure rules, please contact our office.

During the presidential campaign, then candidate Barack Obama promised to close international tax loopholes and crack down on offshore tax evasion. In May, President Obama unveiled sweeping measures to reform the nation's international tax rules. The president also proposed to overhaul the rules for holding funds in offshore accounts, repeal the last-in, first-out (LIFO) accounting rules, tax carried interest as ordinary income, and provide limited business tax relief. Details of the president's proposals were released by the Treasury Department in the "Green Book" (named for the color of its cover).

International taxation

A U.S. based company is generally allowed to defer U.S. taxation on its foreign source income until the earnings are repatriated. President Obama has proposed various measures to limit the ability of U.S. companies to take deductions for offshore expenses against U.S. income. According to the president, some companies abuse the deferral rules and his proposals will close loopholes.  Opponents counter that the deferral rules are necessary to ensure American competitiveness in the global economy.

The president also proposed t

• Require corporation status under check-the-box election for certain overseas "disregarded entities" established by U.S. businesses;
• Curb income shifting through intangible property transfers;
• Curb earnings-stripping by expatriated entities through interest deductions;
• Repeal the 80/20 company rules that shelter dividends as foreign-source income;
• Prevent withholding avoidance by foreign portfolio investors through equity swaps; and
• Modify the foreign tax credit rules for dual capacity taxpayers.

Many of the details of these international proposals, especially about how to calculate the amount of deferred deductions to match foreign expenses with deferred income, need to be fleshed out. The president's proposals serve as a blueprint for Congress to use when drafting legislation. Congress may approve all or some of the proposals or make significant changes to them.

Offshore accounts

The IRS is aware that some Americans fail to report all or part of their assets in foreign bank accounts. Estimates of unreported income reach as high as $100 billion. President Obama would strengthen the rules for reporting by Americans and disclosure by foreign banks. Individuals and banks that fail to follow the heightened rules would be subject to enhanced sanctions.

LIFO

Many businesses use LIFO to account for inventory. The last units of inventory purchased are generally treated as the first units sold. The president has proposed to repeal LIFO, which would raise more than $65 billion in revenue.

Carried interest

Under current law, carried interest (partnership profits interests allocable to the performance of services) is taxed as capital gains. President Obama is asking Congress to tax carried interest as ordinary income subject to self-employment tax. Similar measures have failed in Congress before but the need to raise revenue may convince lawmakers to change the tax treatment of carried interest this time.

Business incentives

President Obama has proposed about $70 billion in tax cuts for businesses. One of the most significant incentives would be a permanent research tax credit. A temporary tax break for qualified small business stock would also be extended and expanded.

The president also called on Congress to extend the carryback period for net operating losses (NOLs). Current law allows an extended period for NOLs but is limited to small businesses. President Obama did not specify to what extent he would extend the NOL carryback but is recommending that Congress set aside significant budget resources of over $60 billion between 2009 and 2010 to carry this off.

Additionally, the president has proposed extending a number of temporary business tax incentives. These include tax breaks for restaurants, incentives to produce biodiesel and renewable diesel fuels, and tax credits for investing in economically-challenged neighborhoods. Congress could tack-on more temporary incentives.

All of the president's proposals will be debated at length in Congress over the next several months. The White House is asking Congress to move quickly on international reform and other measures to boost federal revenues. Our office will keep you posted of developments. Please contact us if you have any questions.

Taxpayers who do not meet the requirements for the home sale exclusion may still qualify for a partial home sale exclusion if they are able to prove that the sale was a result of an unforeseen circumstance. Recent rulings indicate that the IRS is flexible in qualifying occurrences as unforeseen events and allowing a partial home sale exclusion.

Generally, single taxpayers may exclude from gross income up to $250,000 of gain on sale or exchange of a principal residence and married taxpayers filing jointly may exclude up to $500,000. The exclusion can only be used once every two years.

To qualify for this exclusion, taxpayers must own and use the property as their principal residence for periods totaling two out of five years before sale. The five-year period can be suspended for up to 10 years for absences due to service in the military or the foreign service.

Partial exclusions are available when the ownership and use test or two-year test is not met but the taxpayer sells due to change of employment, health or unforeseen circumstances. Without these mitigating circumstances, all gain on the sale of a residence before the two years are up is taxed.

The IRS offers several "safe harbors," that is, events that will be considered to be unforeseen circumstances. These include the involuntary conversion of the taxpayer's residence, casualty to the residence caused by natural or man-made disasters or terrorism, death of a qualified individual, unemployment, divorce or legal separation, and multiple births from the same pregnancy.

If a taxpayer does not qualify for any of the safe harbors, the IRS can determine if a sale is the result of unforeseen circumstances by applying a facts and circumstances test. Some of the factors looked at by the IRS are proximity in time of sale and claimed unforeseen event, suitability of the property as the taxpayer's principal residence materially changes, whether the taxpayer's financial ability to maintain the property is materially impaired, whether the taxpayer used the property as a personal residence and whether the unforeseen circumstances were foreseeable when the taxpayer bought and used the property as a personal residence.

Recently, the IRS has decided that several non-safe harbor events were unforeseen circumstances. These include sales because of fear of criminal retaliation, the adoption of a child, a neighbor assaulting the homeowners and threatening their child, and a move to an assisted living facility followed by a move to a hospice.

If you think you may be eligible for a reduced home sale exclusion because of an unforeseen circumstance, give our office a call.

For U.S. taxpayers, owning assets held in foreign countries may have a variety of benefits, from ease of use for frequent travelers or those employed abroad to diversification of an investment portfolio. There are, however, additional rules and requirements to follow in connection with the payment of taxes. Some of these rules are very different from those for similar types of domestic income, and more than a few are quite complex.

Two documents do not apply directly to federal income taxation, but are nevertheless highly important. The first of these is a Treasury form, Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts. Any individual or organization that owns or has control over a bank or brokerage account must complete this form if the aggregate value of all such accounts under that taxpayer's ownership or control exceeds $10,000. The second such form is not a requirement per se, but taxpayers who have income in a foreign country with which the United States has a treaty would be seriously remiss in failing to complete it. IRS Form 8802, Application for United States Residency Certification, helps to speed and simplify the application process for eligible taxpayers claiming the benefits of tax treaties in connection with foreign taxes paid. Requirements for organizations that may have dual or layered status offer complications that depend on the type of entity, so these instructions must be parsed carefully.

Taxes on real and personal property held overseas are treated quite differently for purposes of federal income taxation, as opposed to the treatment of domestic property. Individuals may claim foreign real property taxes as itemized deductions on Schedule A of Form 1040, just as they would with U.S. real estate. However, taxes on personal property may only be deductible if used in connection with a trade or business or in the production of income.

U.S. taxpayers who own homes in foreign countries are eligible for the capital gains exclusion on the sale of a principal residence subject to the same requirements as domestic homeowners. Likewise, if a taxpayer derives rental income from a home, the rules for reporting income and deductions are the same. However, claiming depreciation expenses in connection with rental income subjects taxpayers to a different set of rules. Code Sec. 168(g) indicates that tangible property used predominantly outside the United States must be depreciated using the alternative depreciation system (ADS), rather than the modified accelerated cost recovery system (MACRS), and involves longer recovery periods. This is true whether the tangible property in question is the residence itself or household appliances contained therein, as well as any other tangible property.

Intangible property such as patents, licenses, trademarks, copyrights and securities produce a variety of types of income, and the taxation of such income may be subject to different rules than similar domestic income. The provisions for taxation of foreign income are often subject to modification by treaty, and the United States has negotiated treaties with over sixty nations.

Income from all sources must be reported in U.S. dollars, regardless of how it is paid. One exception to this rule is that if income is received in a currency that is not convertible to U.S. dollars because of prohibitions placed on conversion by the issuing country, then the taxpayer may choose when to report the income. The income may be reported either in the year earned, according to the most accurate valuation means available, with the taxes paid from other income, or the taxpayer may choose to wait until the currency becomes convertible again.

Saving money, whether for retirement, education, travel, or any reason, requires a lot of self-discipline. If you're like most people, the thought of saving money conjures up visions of endless budgeting. All those hours of budgeting take away from scarce free time. One method of saving is relatively painless...at least, once you have the money to save. It's often described as the magic of compound interest.

Compound interest is interest earned on interest. The trick is to keep your money in an account paying compound interest for as long as possible. The longer interest is earned on top of interest, the better for you.

Compound interest is different from simple interest. Let's say you invest $10,000 at two percent interest paid annually. At the end of one year, you will have earned $200 in interest for a total of $10,200. Simple interest calculates interest only on the principal, the $10,000 you invested. Compound interest, on the other hand, calculates interest on the principal and previously paid interest. The more often interest is compounded, or added to your account, the more you earn.

If you keep that same $10,000 in an account that pays compound interest, it will grow over time because of interest you earn on interest. Interest may be compounded daily, monthly, quarterly, or annually. Here's an example:

Investment return by year:

In this example, the yearly compounding interest rate is two percent. The quarterly rate is 2.015%, the monthly rate is 2.018% and the daily rate is 2.020%.

Of course, if you are earning interest you will need to pay income tax on it each year unless it is earned in a tax-favored savings vehicle such as a 401(k) plan or an individual retirement account. You'll want to figure in which type of account you want to save and in what proportion, depending an your anticipated needs.

Time and compound interest can be your best friends when it comes to maximizing your savings. As our example shows, your initial $10,000 grows significantly year after year. No matter how small the amount you save, the sooner you start, time and compound interest can help make that small amount grow larger. Give our office a call and we can explore different savings plans and help you tailor one to your needs.

The answer to this question would depend on a number of facts and circumstances. To be able to deduct work-related educational expenses as a business expense, you must: work as an employee or be self-employed; itemize your deductions on Schedule A (Form 1040) if you are an employee; file Schedule C (Form 1040) or Schedule F (Form 1040) if you are self-employed; and have expenses for education that meet certain criteria under the "qualifying work-related education" tests, explained below.

The answer to this question would depend on a number of facts and circumstances. To be able to deduct work-related educational expenses as a business expense, you must:

--Work as an employee or be self-employed;

--Itemize your deductions on Schedule A (Form 1040) if you are an employee;

--File Schedule C (Form 1040) or Schedule F (Form 1040) if you are self-employed; and

--Have expenses for education that meet certain criteria under the "qualifying work-related education" tests, explained below.

Education required by employer or by law

Once you have the minimum educational requirements for your job, your employer or the law may require you to get more education. Additional education is considered qualifying education if all three of the following requirements are met:

--The additional education or training is required for you to keep your present salary, status, or job;

--The requirement serves a business purpose of your employer; and

--The education is not part of a program that will qualify you for a new trade or business.

Example

You are a teacher who has satisfied the minimum requirements for teaching. Your employer requires you to take an additional foreign language class to keep your teaching job as teacher of foreign language. If the courses will not qualify you for a new trade or business, they are "qualifying education" even if you eventually receive a master's degree or an increase in salary because of this extra education.

Education to maintain or improve skills

If the education or training is not required by your employer or by law, it can be qualifying work-related education only if it maintains or improves skills needed in your present work. This could include refresher courses, courses on current developments, and academic or vocational courses.

Example

Your business is global and you work with many business people from France. To keep up with the latest changes, you take a French language course. These courses maintain and improve your skills in communicating more effectively with your clients and are deductible.

If you stop working for a year or less in order to get education to maintain or improve skills needed in your present work and then return to the same general type of work, your absence is considered temporary. Education that you get during a temporary absence is qualifying education if it maintains or improves skills needed in your present work.

Example

You quit your teaching job to become a full-time graduate language student for one year. If you return to work as a foreign language teacher after completing the courses, the education is related to your present work even if you do not go back to work with the same employer.

If you file a joint return and your taxable income is less than that of your spouse, the "spousal" IRA rules may allow you to contribute up to $5,000 in 2009 (or $6,000 if you are 50 or older) to an individual retirement account (IRA) this year. A "spousal IRA" is a term more commonly used to describe an IRA set up for a nonworking, stay-at-home spouse.

If you file a joint return and your taxable income is less than that of your spouse, the "spousal" IRA rules may allow you to contribute up to $5,000 (or $6,00 if you are 50 or older) to an individual retirement account (IRA) this year. A "spousal IRA" is a term more commonly used to describe an IRA set up for a nonworking, stay-at-home spouse.

Traditional IRA

Individuals under the age of 70 1/2 can make contributions to traditional IRAs. Contributions are deductible and amounts earned in a traditional IRA are not taxed until distributions are made. As an alternative, the contribution may be made to a Roth IRA, in which case it is not deductible (but neither will any qualified withdrawals be taxed later on).

2009 contribution limits

In 2009, the maximum contribution is $5,000. An individual who will be at least 50 years old by the end of the tax year is able to make an additional contribution to an IRA. For 2009, the maximum amount of the catch-up contribution is $1,000.

Impact of employer-sponsored plans on contributions

A spouse's participation in a qualified retirement plan (through an employer or self-employment), affects whether, and how much, the other spouse can contribute to an IRA. The deduction for an IRA contribution is limited if one spouse is an active participant in an employer-maintained retirement plan (an individual is not considered an active participant in an employer-sponsored plan merely because his or her spouse is treated as an active participant).

One participating spouse

An individual spouse can make a deductible contribution to an IRA of up to $5,000 in 2009 (if 50 or older, $6,000). For 2009, the working spouse's ability to take an IRA contribution deduction must be reduced if he or she is an active participant in a plan and the couple's combined AGI falls between $89,000 and $109,000.

The maximum deductible contribution for a nonworking spouse whose husband or wife is an active participant in a retirement plan, phases-out when the couple's combined AGI falls between $166,000 and $176,000. Thus, the deductibility of the nonworking spouse's contribution to an IRA begins to phase-out when the couples' AGI exceeds $166,000, if the working spouse participates in a qualified retirement plan.

Non-participating spouses

When neither spouse participates in a qualified retirement plan both the nonworking spouse and the working mate can make deductible contributions of up to $5,000 to traditional IRAs -- $10,000 in total for 2009 -- regardless of AGI. For example, say the couple's joint AGI is $400,000 from one spouse's self-employment activity. If that spouse has no retirement plan, each spouse can make a $5,000 deductible IRA contribution for 2009 ($6,000 each if both are age 50 or older).

Impact of filing status on contributions

Filing status also affects the amount of the IRA contribution deduction. If either spouse is covered by a retirement plan through his or her employer, the deduction may be reduced or eliminated depending upon the couple's filing status. For example, if separate returns are filed, the lower compensated spouse may only be able to contribute up to the amount he or she earned in taxable compensation that year.

Example

Wendy, who is 45 years of age, is not employed, but her husband Harold participates in a 401(k) plan sponsored by his employer. The couple files a joint income tax return and reports an AGI of $105,000. Wendy can make a deductible contribution to a traditional IRA up to the full $5,000 because she is not an active participant in an employer-sponsored retirement plan and their combined AGI is below $166,000.

Wendy's contribution to an IRA can be as much as $5,000 in 2009, since she's less than 50 years old, a nonworking spouse, and her husband is a qualified plan participant. However, Harold cannot make a deductible IRA contribution because their combined AGI is above the 2009 phase-out range for plan participants who are married and filing jointly ($166,000 to $176,000 in 2009).

If Wendy and Harold filed separate returns, however, the amount that Wendy could contribute to her IRA, and still be able get a deduction, could be less than $5,000 if her taxable income for 2009 is less than $5,000. That is, her deductible contribution amount would be limited to the amount of her gross income this year.

U.S. citizens and resident aliens working abroad may exclude up to $91,400 of their foreign earned income for 2009. Additionally, expatriates may deduct or exclude their foreign housing costs in excess of a base amount. The housing exclusion is for reimbursed expenses while the deduction is for unreimbursed costs.

Earned foreign income

Before being able to claim these exclusions, you must meet some primary requirements. Foreign earned income is an individual's earned income from foreign sources during the time period that he or she has a foreign tax home and either satisfies the bona fide or physical residence test.

Tax home

Your tax home also must be in a foreign country. Generally, the IRS and the courts hold that your principal place of business or employment is your tax home.

Status

Finally, you must be a:

U.S. citizen who is a bona fide resident of a foreign country or countries for a continuous time period including the entire tax year;

U.S. resident alien who is a citizen or national of a country having an income tax treaty with the U.S. and who satisfies the continuous residency requirement; or

U.S. citizen or resident alien physically present in a foreign country or countries for a minimum of 330 days during any consecutive 12 month period.

For homeowners, the exclusion of all or a portion of the gain on the sale of their principal residence is an important tax break.

For homeowners, the exclusion of all or a portion of the gain on the sale of their principal residence is an important tax break. The maximum amount of gain from the sale or exchange of a principal residence that may be excluded from income is generally $250,000 ($500,000 for joint filers).

Unfortunately, the $500,000/$250,000 exclusion has a few traps, including a "loophole" closer that reduces the homesale exclusion for periods of "nonqualifying use." Careful planning, however, can alleviate many of them. Here is a review of the more prominent problems that homeowners may experience with the homesale exclusion and some suggestions on how you might avoid them:

Reduced homesale exclusion. The Housing Assistance Tax Act of 2008 modifies the exclusion of gain from the sale of a principal residence, providing that gain from the sale of principal residence will no longer be excluded from income for periods that the home was not used as a principal residence. For example, if you used the residence as a vacation home prior to using it as a principal residence. These periods are referred to as "nonqualifying use." This income inclusion rule applies to home sales after December 31, 2008 and is based on nonqualified use periods beginning on or after January 1, 2009, under a generous transition rule. A specific formula is used to determine the amount of gain allocated to nonqualifying use periods.

Use and ownership. Moreover, in order to qualify for the $250,000/$500,000 exclusion, your home must be used and owned by you as your principal residence for at least 2 out of the last 5 years of ownership before sale. Moving into a new house early, or delaying the move, may cost you the right to exclude any and all gain on the home sale from tax.

Incapacitated taxpayers. If you become physically or mentally incapable of self-care, the rules provide that you are deemed to use a residence as a principal residence during the time in which you own the residence and reside in a licensed care facility (e.g., a nursing home), as long as at least a one-year period of use (under the regular rules) is already met. Moving in with an adult child, even if professional health care workers are hired, will not lower the use time period to one year since care is not in a "licensed care facility." In addition, some "assisted-living" arrangements may not qualify as well.

Pro-rata sales. Under an exception, a sale of a residence more frequently than once every two years is allowed, with a pro-rata allocation of the $500,000/$250,000 exclusion based on time, if the sale is by reason of a change in place of employment, health, or other unforeseen circumstances to be specified under pending IRS rules. Needless to say, it is very important that you make certain that you take steps to make sure that you qualify for this exception, because no tax break is otherwise allowed. For example, health in this circumstance does not require moving into a licensed care facility, but the extent of the health reason for moving must be substantiated.

Tax basis. Under the old rules, you were advised to keep receipts of any capital improvements made to your house so that the cost basis of your residence, for purposes of determining the amount of gain, may be computed properly. In a rapidly appreciating real estate market, you should continue to keep these receipts. Death or divorce may unexpectedly reduce the $500,000 exclusion of gain for joint returns to the $250,000 level reserved for single filers. Even if the $500,000 level is obtained, if you have held your home for years, you may find that the exclusion may fall short of covering all the gain realized unless receipts for improvements are added to provide for an increased basis when making this computation.

Some gain may be taxed. Even if you move into a new house that costs more than the selling price of the old home, a tax on gain will be due (usually 20%) to the extent the gain exceeds the $500,000/$250,000 exclusion. Under the old rules, no gain would have been due.

Home office deduction. The home office deduction may have a significant impact on your home sale exclusion. The gain on the portion of the home that has been written off for depreciation, utilities and other costs as an office at home may not be excluded upon the sale of the residence. One way around this trap is to cease home office use of the residence sufficiently before the sale to comply with the rule that all gain (except attributable to recaptured home office depreciation) is excluded to the extent the taxpayer has not used a home office for two out of the five years prior to sale.

Vacation homes. As mentioned, in order to qualify for the $250,000/$500,000 exclusion, the home must be used and owned by you or your spouse (in the case of a joint return) as your principal residence for at least 2 out of the last 5 years of ownership before sale. Because of this rule, some vacation homeowners who have seen their resort properties increase in value over the years are moving into these homes when they retire and living in them for the 2 years necessary before selling in order to take full advantage of the gain exclusion. For example, doing this on a vacation home that has increased $200,000 in value over the years can save you $40,000 in capital gains tax. However, keep in mind the reduced homesale exclusion for periods of nonqualifying use.

As you can see, there is more to the sale of residence gain exclusion than meets the eye. Before you make any decisions regarding buying or selling any real property, please consider contacting the office for additional information and guidance.

The United States is currently experiencing the largest influx of inpatriates (foreign nationals working in the U.S.) in history. As the laws regarding United States taxation of foreign nationals can be quite complex, this article will answer the most commonly asked questions that an inpatriate may have concerning his/her U.S. tax liability and filing requirements.

The United States is currently experiencing the largest influx of inpatriates (foreign nationals working in the U.S.) in history. As the laws regarding United States taxation of foreign nationals can be quite complex, this article will answer the most commonly asked questions that an inpatriate may have concerning his/her U.S. tax liability and filing requirements.

I am a foreign national working in the United States and am paid by my foreign employer. Do I need to file a tax return and pay income taxes?

The general rule is that all wages earned while working in the United States, regardless of who pays for it or the locations of the employer, is taxable in the United States. This is true whether you are treated as a U.S. resident or not.

What is the difference in taxation of a resident alien versus a nonresident alien?

The difference in being taxed as a resident versus a nonresident is as follows: a resident alien is taxable in the U.S. on all worldwide income, regardless of what country it is earned or located in. A nonresident alien is generally taxable only on what is referred to as "effectively connected income". This is normally wages earned while in the U.S., along with earnings on property located in the United States. Certain deductions, exemptions, and filing statuses are not available to nonresidents.

I am not a resident for immigration purposes as I am here on a temporary visa. Can I still be a resident for U.S. tax purposes?

The determination of residency for tax purposes does not bear any relationship to your legal or immigration status. It is quite common for a foreign national to be a nonresident for legal or immigration purposes and yet be a resident for tax purposes. In addition, being a resident for income tax purposes can be different than being a resident for estate tax or even social security tax purposes. In some cases, it is actually more beneficial to be treated as a resident than as a nonresident. As a result, it is important to have all of the information we request in order to make the best decision for you.

How do you determine whether you are a resident or nonresident for U.S. income tax purposes?

As a foreign national working in the U.S., you must first determine if you are a "resident" for U.S. income tax purposes. There are two tests to determine whether you are a U.S. tax resident. These two tests are:

• The lawful permanent residence test
• The substantial presence test.

If you meet the requirements of either of these two tests, you will be treated as a U.S. tax resident (unless a treaty overrides this).

Lawful Permanent Resident Test - In its simplest form, this is when you have been issued a green card or alien registration card allowing for permanent residency.

Substantial Presence Test - This is a more complicated test that looks at the number of days of physical presence in the U.S. over a three-year period of time. If the number of days of U.S. presence exceeds 183 days in the current year, or 183 equivalent days during a three-year period, you are a resident for U.S. tax purposes. An "equivalent day" is defined as:

• In the current year, each partial day counts as one full equivalent day
• In the first preceding year, each day counts as 1/3 of an equivalent day
• In the second preceding year, each day counts as 1/6 of an equivalent day.

There are exceptions to the counting of days, but in general, any part of a day counts as a full day.

31 Day Exception - If you are present in the States for less than 31 days in the current year, the substantial presence test is not applied.

Closer Connections Exception - If you are present in the U.S. for fewer than 183 days in the current year AND you maintain a "tax home" in another country during the entire year AND you maintain a closer connection to the foreign country in which you have a tax home, then this test will not apply.

J-1 Visa - Subject to some limitations, you do not count days in the U.S., for calculating the substantial presence test, while you are here on a J-1 visa (generally for up to two years). This does not exempt the earnings, but just allows you to be treated as a nonresident alien, not a resident alien.

Treaty - Some countries have treaties with the U.S. which, in some cases, will override either the U.S. Internal Revenue Code or the income tax law of the foreign country.

If I become a U.S. taxable resident during the year, when does my residency begin?

In general, residency begins on the first physically present day in the U.S. during the year you meet the substantial presence test. There are exceptions for "nominal" days along with the closer connection exception, which can apply here. Remember that residency determines from what point you are taxable on your worldwide income, not when you are taxable.

Likewise, your residency is deemed to end on the last day that you are present in the U.S. within the year that you move from the United States. Problems can arise if you return back to the U.S. within a short period of time.

First Year Election - Sometimes it can be better to be treated as a resident than as a nonresident. There is an election available that allows a foreign national to be taxed as a resident in the initial year of a U.S. assignment even if one of the residency tests is not met for the year. To qualify, you would have to satisfy the following:

• Must have been a U.S. nonresident in the year immediately preceding the initial year.
• You must satisfy the substantial presence test in the year following the initial year.
• You must be present in the U.S. for at least 31 consecutive days in the initial year.
• During the initial year, you must be present in the U.S. for at least 75% of the days from the start of your 31 consecutive day period through the end of that year.

What if my home country considers me as a taxable resident at the same time the U.S. treats me as a taxable resident? Am I double taxed?

The general rules discussed above are based on the IRS Code. The United States has entered into numerous tax treaties with other countries. The purpose of these treaties is to prevent double taxation issues that may arise due to differences in the tax laws of the two countries. It is possible to be considered a resident, subject to tax in both countries. The treaties usually provide for 'tiebreaker' rules to override the IRS Code or the foreign home country tax laws. Most treaty provisions require the filing of certain documents, though, in order to take benefit of them.

I am on a short-term assignment from my home country and my employer pays for my rent and meals while I am working here in the U.S. Is any of this taxable?

The first thing you need to do is determine whether your assignment is considered "short-term" within the definition of U.S. law. An individual is treated as being on a short-term assignment in the U.S. if their tax home has not changed from their foreign location. If the intent of the assignment is to return to the original work location within one year, the assignment is considered a temporary assignment. This does not determine whether you are a resident or not. It just determines which types of payments are taxable.

The advantage of a temporary assignment is that the employer-provided benefits such as lodging, meals travel and certain other expenses are not considered taxable wages in the U.S. In this case, a resident or nonresident would not be taxed on these payments. On a long-term assignment (more than 12 months), these are typically taxed in addition to the wages.

What happens if I am a nonresident for part of the year and a resident for another part of the year?

It is possible to be taxed in one year as both a resident and a nonresident. If this is the case, a special filing is made on a single tax return, with certain forms required. During the residency period, you would be taxed on worldwide income. During the nonresidency period, you would be taxed only on effectively connected income (usually wages earned in the U.S., as noted earlier).

Can I be exempt or excluded from tax from the U.S. federal government but still be taxed by one of the States?

Yes. Please note quite a few of the 50 states of the U.S. do not follow some, or all, of the U.S. federal tax codes or recognize the Treaties between the U.S. and other countries. So, it is possible, and highly probable, you could be taxable for State purposes but may be exempt for federal. In addition, other tax filing requirements, including estate and gift taxes, social security taxes, along with other filing forms, may be required regardless of your income tax residency determination.