Category Archives: Income and Deductions

Strict Standards for Charitable Contribution Documentation

A recent Tax Court decision highlights the IRS’ tough stance on exactly what taxpayers must have in the way of documentation in order to substantiate their charitable contributions.

In Durden, TC Memo 2012-140, the taxpayers found out the hard way that proper, complete, and (most importantly) contemporaneous written acknowledgement by the charity is what IRS insists on.

IRC Section 170(f)(8)(A) requires this for all contributions of $250 or more.

The Durdens claimed a charitable contribution deduction in 2007 for $25,171, primarily for contributions to their church, and almost all of the components of which were checks for amounts larger than $250.

It’s not enough to show the IRS the cancelled checks – they want, as the Code requires, the contemporaneous acknowledgement letters from the charity/charities to whom the taxpayer made the contributions.

Result in this case – deductions disallowed.

‘Ponzi Scheme’ Victims Claim Theft Loss Deductions

Unfortunately, modern-era taxpayers sometimes suffer losses at the hands of unscrupulous financial “deal” promoters.  Recently, the notorious Bernard Madoff was the perpetrator of such a scheme, which cost many taxpayers dearly.

And in 2009, the IRS took note of this particular scandal, and made it clear that a violation of federal criminal law can qualify Ponzi scheme losses for theft loss treatment under the Internal Revenue Code.

Taxpayers can deduct a loss suffered during a tax year and not compensated by insurance if such a loss is incurred in a trade or business, or a transaction entered into for profit if it arose from a theft.

The term “theft” includes, but is not limited to, larceny, embezzlement, and robbery.  To deduct a theft loss, a taxpayer must show that “the loss resulted from a taking of property that is illegal under the law of the state where it occurred, and that the taking was done with criminal intent.”  (Rev Rul 72-112)  And generally, this requires that the perpetrator have specific intent to deprive the victim of his property, which in turn requires a degree of privity between the perpetrator and the victim.

But pursuant to a recent Chief Counsel Advice (CCA 201213022), IRS expressed the view that Ponzi scheme losses suffered by taxpayers are theft losses, under IRC Section 165, even though the taxpayers invested through individuals other than the perpetrator himself (such as a fund manager) because of the close connection or relationship among the parties.

Muni Bond Income Not Always Tax-Exempt

Most people are familiar with the notion that interest income associated with municipal bond investments is “tax free,” which in most cases is true.  However, not all municipal bonds are created equal — some possess certain characteristics which can render their income indeed taxable.

The complication arises for taxpayers who are burdened with the alternative minimum tax, and who have invested in a certain kind of muni bond – the so-called “private activity bond.”

These are bonds which satisfy either the “private business use” test, or the “private loan financing” test defined in the Internal Revenue Code.  Generally speaking, such bonds are municipal borrowings, the proceeds of which are used to finance nongovernmental activities — such as those of private businesses which the municipality is courting for one reason or another.

So before immediately diving into a portfolio of muni bonds, taxpayers should assess their specific situation (in particular regarding whether they may otherwise be paying AMT), and then the specifics of the bonds they are purchasing, so they are not surprised when April 15 rolls around and they find they are, indeed, paying some tax on what they thought were tax-free investments.

‘Burning Down the House’ as Charitable Donation?

In recent years, more than a few taxpayers have thought they could buy that “tear down,” give the house to their local fire department for a live burn it-training exercise, and claim a charitable donation deduction.

“Not so fast,” said the 7th Circuit Court of Appeals in its recent decision in Rolfs, et al. v. Comm (109 AFTR 2d 2012-xxxx, 02/08/2012).  These taxpayers did just that, claiming a $76,000 charitable donation deduction in 1998 for the “value of their donated and destroyed house.”

In noting that charitable deductions for burning down a house in a training exercise are unusual but not unprecedented, the Court noted that the valuation of the building, valued as if the house was given away intact and without conditions, is not a complete or correct way to value such a gift.

“When a gift is made with conditions,” said the Court, “the conditions must be taken into account in determining the fair market value of the donated property…..Proper consideration of the economic effect of the condition that the house be destroyed reduces the fair market value of the gift so much that no net value is ever likely to be available for a deduction.”

More from Nolo: Tax Deductions on Charitable Contributions

Internal Revenue Code Section 83: Opportunities and Pitfalls

Generally speaking, Internal Revenue Code Section 83 requires that receipt of “property” in exchange for the performance of services creates income upon receipt of that property, measured by excess of the fair market value of the property over whatever amount is paid for the property.

An exception exists, however, when the property received is subject to a “substantial risk of forfeiture” — in that event, recognition does not occur until that risk may lapse.

In some cases, there is no easily ascertainable fair market value amount when the property is received. In that case, no problem; no income recognition. And in other cases, the fair market value is ascertainable, and further, the recipient may have an expectation that the value of the property has a good chance of increasing over time.

Let’s say, then, that an employee receives stock in a corporation, which may be subject to a substantial risk of forfeiture. He may choose to make an election under IRC Section 83 to actually go ahead and recognize compensation income on day one (fair market value less any amount he pays for the stock). If this election is made, any subsequent appreciation in the property’s value is not treated as compensation income and is not recognized until the property is disposed of. Further, the post-election appreciation would be treated as capital gain (as opposed to ordinary income) in this case, thus taxable at potentially a more favorable rate.

Be sure to follow the formalities required with respect to the election, which must be made no later than 30 days after the date of the transfer of the property.

IRS Clarifies Physical Injury Income Exclusion

IRS has issued final regulations under Code Section 104 regarding the exclusion from gross income of amounts received due to personal injury or physical sickness. The final regs reflect amendments made by the Small Business Job Protection Act of 1996 (SBJPA), and remove the requirement that in order for damages to qualify for exclusion they must be based upon “tort or tort type rights.”

Code Section 104 as amended by SBJPA provides that (1) punitive damages do not qualify for the income exclusion and (2) the income exclusion generally is limited to amounts received on account of personal “physical” injuries or “physical” sickness, and further provides that even though emotional distress is not considered a physical injury or a physical sickness, damages not in excess of amounts paid for “medical care” for emotional distress are excluded from income. The final regs reflect these statutory amendments and also provide that a taxpayer may exclude damages received for emotional distress “attributable” to a physical injury or physical sickness.

The regs apply to damages paid pursuant to a written binding agreement, court decree, or mediation award entered into or issued after September 13, 1995, and received after January 23, 2012.

Learn more:

Capital Gains Reporting — Increased Complexity

The good news for individual taxpayers who sustain long term capital gains is that the tax bite is favorable, compared with the tax on ordinary income.  Beginning with 2011 tax returns, however, the reporting complexity rises to a new level.

First of all, there’s an entirely new form to deal with now:  Form 8949, Sales and Other Dispositions of Capital Assets. Many transactions which used to go directly on our old friend, “Schedule D” must now be reported on Form 8949, though landing eventually on Schedule D.

And all of this further integrates with the new Form 1099-B rules which apply this year, and which impose upon your broker the requirement that your tax basis in any “covered security” which you sold be reported to IRS.

Use Form 8949 to “sort” both long and short term transactions among those for which your broker did or did not report the tax basis of the assets sold, and those related to which the broker-reported basis is correct or incorrect, as well as whether the type of gain or loss (short term or long term) is correct or incorrect as characterized by the broker.  Also use Form 8949 if you received a Form 1099-B as a nominee for the actual owner of the property, to report the sale of your main home at a gain, to report the sale of “qualified small business stock” with some excludable gain, to report a nondeductible loss from a “wash sale,” among other things.

Whew!

It’s probably a good idea to familiarize yourself with the 14 pages of instructions for Schedule D (and Form 8949) before starting the process, which is obviously going to create some new headaches for taxpayers this filing season.

Go “Green” and Save Some Dough at Tax Time

 

There are a couple of nice tax breaks for homeowners in 2011 in the “green energy” department.

Homeowners who install energy efficient improvements such as insulation, new windows, and furnaces qualify for a modest Federal tax credit equal to 10 percent of the cost of the “qualified energy efficiency improvements”.  The credit can also be claimed for the cost of residential energy property, including labor costs for installation.  Such property includes certain high-efficiency heating and air conditioning systems, water heaters and stoves which burn “biomass” fuels.  This “Nonbusiness Energy Property Credit” is capped at $500 for a taxpayer’s lifetime, of which only $200 may be used for windows.

But here’s another credit actually worth talking about:  the “Residential Energy Efficient Property Credit,” which equals 30 percent of whatever a homeowner spends on qualifying property such as solar electric systems, solar hot water heaters, geothermal heat pumps, wind turbines and fuel cell property.  And no cap exists, except with respect to fuel cell property.

Folks need to check with their vendor/manufacturer for evidence certifying that the property qualifies.  IRS says that, “taxpayers can normally rely on this certification statement which can usually be found on the manufacturer’s website or with the product packaging.”

Be sure to prepare IRS Form 5695 (“Residential Energy Credits”) when you file your 2011 return to document these credits.

Learn more about Finances & Taxes for Homeowners on Nolo.com.

Supreme Court Takes on Statute of Limitations Issue

An interesting issue has been batted back and forth in the courts for several years related to the matter of whether overstatement of basis is equivalent to omission of gross income, for purposes of determining whether the three year or six year statute of limitations applies.  And the Supreme Court has recently agreed to review a decision of the Fourth Circuit on the question.

In The Colony, Inc. v. Commissioner, the Supreme Court held that the longer statute applies to situations in which specific income receipts have been “left out” of the computation of gross income, as opposed to basis or deduction overstatement.  The spate of tax shelter cases which have recently come to the fore (largely resulting from basis enhancement techniques devised by some of the large accounting and law firms) once again embroiled the courts, with mixed results.  And in December, 2010, IRS issued final regulations pursuant to which an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis is (in IRS’ view) an omission of gross income for purposes of the six year statutory period.

The Fourth and Fifth circuits, as well as the Tax Court have held that an overstatement of basis does not constitute an omission of gross income.  But the Seventh, Tenth, District of Columbia and Federal circuits have agreed with IRS that an overstatement of basis is an omission of gross income.

So, stay tuned for the Supreme Court’s final word, when it rules on the case of Home Concrete & Supply, LLC.

IRS: Use of Work Cell Phones No Longer Taxable

In a rare gesture of friendliness toward taxpayers, last week the IRS allowed that personal use of employer provided cell phones generally will now be considered nontaxable — a working condition fringe benefit, the value of which is excludable from the employee’s taxable income.

It has been about a year since cell phones were removed from the “listed property” category if IRC Section 280F. And now, in Notice 2011-72, IRS states that where an employer provides employees with cell phones primarily for noncompensatory business reasons, neither the business nor personal use of the phone will result in income to the employee, and no recordkeeping of usage is required. Further, in most instances, an employer’s reimbursement for employees’ cell phone costs associated with bona fide business use won’t be taxable. This guidance applies for all tax years after 2009.

Notice 2011-72 does not address, however, the treatment of reimbursements received by employees from employers for the business use of an employee’s personal cell phone.

The Notice provides that an employer is treated as having provided an employee with a cell phone primarily for noncompensatory business purposes if there are substantial reasons relating to the employer’s business, other than providing compensation to the employee, for providing the phone.

Examples of substantial noncompensatory business reasons for requiring employees to maintain personal cell phones and reimbursing them for their use include:
1. The employer’s need to contact the employee at all times for work-related emergencies; and
2. The employer’s requirement that the employee be available to speak with clients at times when the employee is away from the office or at times outside the employee’s normal work schedule.