IRS eases up on local lodging deduction for employees

The IRS has issued proposed “reliance” regulations that allow an employee’s deduction for local lodging that is business-related. Although the proposed regulations are technically not fully effective until published as final regulations, they allow taxpayers to deduct local lodging expenses under Code Sec. 162 (trade or business expenses) if the statute of limitations has not expired for the year of the deduction. In effect, the new rules are effective immediately.

Background

While job-related expenses for travel away from home may be deductible as trade or business expenses, the income tax regulations historically have disallowed the employee’s deduction for local lodging (described as lodging that is not incurred in traveling away from home). However, in 2007, the IRS announced it would amend the regulations to change this rule. In the meantime, it would not challenge an employee’s deduction for temporary local lodging that was necessary for the employee to participate in a business function. The new reliance regulations go even further, with more specifics that liberalize the rules.

Requirements

The new regulations provide that whether local lodging expenses are incurred in carrying on a taxpayer’s trade or business is determined under all the facts and circumstances. The regulations provide numerous examples of costs that would be deductible under these rules covering such situations as team training, late night projects, and rotating on-duty shifts.

The new regulations also provide the following safe harbor for an employee to deduct local lodging expenses:

• The lodging is necessary for the individual to participate fully or to be available for a bona fide business meeting, conference, training activity, or other function;
• The period of lodging does not exceed five calendar days and does not recur more than once  per calendar quarter;
• The employer requires the employee to remain at the activity or function overnight; and
• The lodging is not lavish or extravagant and does not provide a significant element of personal pleasure, recreation or benefit.

If the employer reimburses the employee for expenses that would be deductible, the reimbursement will be nontaxable either as a fringe benefit, or as paid under an accountable T&E plan (assuming the appropriate requirements are met).

These new rules are good news for employees, as well as for employers that want their employees relieved of any tax burden when they are needed for special assignments. If you would like to discuss whether you have any expenses that qualify for this new deduction, please contact our office.

IRS Commissioner reviews priorities/accomplishments; will step down in September

IRS Commissioner Shulman recently announced he plans to leave his position when his five-year term ends in September 2012. Speaking before the National Press Club this past April, Shulman also took the opportunity to review IRS progress during his tenure within numerous strategic areas, including computer technology modernization, tax return preparer standards, and offshore tax evasion. He urged the IRS to continue building on those improvements.

Commissioner Shulman reported that under his watch the IRS had succeeded in updating its weekly processing cycle for core accounts to a daily processing cycle. Information processed includes a taxpayer’s current account balance, outstanding amounts, and recent payments. The IRS is also developing its Customer Account Data Engine 2 (CADE-2) system, which is intended to speed tax return and refund processing.

Shulman also touted return preparer oversight as a recent accomplishment in which the IRS has implemented standards to ensure competency among paid tax return preparers. These regulations require paid return preparers—other than enrolled agents, attorneys, and CPAs—to register with the IRS, pass a competency exam, and complete 15 hours of continuing education from IRS-approved providers every year.

On the subject of international taxation, the Commissioner emphasized the successful Offshore Voluntary Disclosure Initiatives (OVDI). The programs have attracted more than 30,000 taxpayers to date and have collected more than $4.4 billion. Shulman also pointed to coordinated actions among taxing authorities on a global basis as the next step being taken to limit offshore tax evasion.

IR-2012-24, Notice 2012-21

Time for post-filing season checkup

 Your 2011 tax return has been filed, or you have properly filed for an extension. In either case, now it’s time to start thinking about important post-filing season activities to save you tax in 2012 and beyond. A few loose ends may pay dividends if you take care of them sooner instead of later.

Successful filing season

The IRS reported that the 2012 filing season moved along without significant problems. The IRS continued to upgrade its return processing programs and systems. Early in the filing season, some filers experienced a short delay in receiving refunds but the delay was quickly resolved. The IRS reported just before the end of the filing season that it had processed nearly 100 million returns and issued 75 million refunds. 

Extensions

Individuals are eligible for an automatic six-month extension until October 15 to file a return. To get the extension, taxpayers must estimate their tax liability and pay any amount due. When a taxpayer properly files for an extension, he or she avoids the late-filing penalty, generally five percent per month based on the unpaid balance, which applies to returns filed after the April 17 deadline. Any payment made with an extension request will reduce or eliminate interest and late-payment penalties that apply to payments made after April 17. The current interest rate is three percent per year, compounded daily, and the late-payment penalty is normally 0.5 percent per month.

Installment agreements

Installment agreements generally can be set up quickly with the IRS and help to spread out payments to make them more management. In 2012, the IRS increased the threshold for a streamlined installment agreement from $25,000 to $50,000. Installment agreements however, come with some costs. The IRS charges a fee to set up an installment agreement. If you cannot pay the full amount within 120 days, the fee for setting up an agreement is:

• $52 for a direct debit agreement;
• $105 for a standard agreement or payroll deduction agreement; or
• $43 for qualified lower income taxpayers.

It’s important to make your scheduled payments timely and in full. The IRS expects you to pay the minimum amount agreed on; you can always pay more if you are able. If your installment agreement goes into default, the IRS can charge a reinstatement fee.

An installment agreement does not reduce the amount of the taxes, interest, or penalties owed, and penalties and interest will continue to accrue. In determining the amount of the penalty for failure to pay tax, the penalty is reduced from 0.5 percent per month to 0.25 percent per month during any month that an installment agreement for the unpaid tax is in effect.

You must specify the amount you can pay and the day of the month (1st-28th) on which you wish to make your payment each month. The IRS expects to receive your payment on the date you select. The IRS will respond to your request, usually within 30 days, to advise you as to whether your request has been approved or denied, or if more information is needed.

Amended returns

Taxpayers can file an amended return if they find an error, uncover unreported income or discover an item that will generate a deduction. Amended returns are filed on Use Form 1040X, Amended U.S. Individual Income Tax Return, to correct a previously filed Form 1040, Form 1040A, Form 1040EZ, Form 1040NR, or Form 1040NR-EZ. If you are filing to claim an additional refund, wait until you have received your original refund. If you owe additional tax for a tax year for which the filing date has not passed, file Form 1040X and pay the tax by the filing date for that year to avoid penalties and interest. 

Generally, to claim a refund, Form 1040X must be filed within 3 years from the date of your original return or within two years from the date you paid the tax, whichever is later. Returns filed before the due date (without regard to extensions) are considered filed on the due date. Taxpayers must file a separate Form 1040X for each year they are amending.

Targeted penalty relief

This year - for the first time - the IRS offered penalty relief to qualified individuals who were unable to pay their taxes by the April 17 deadline. Unemployed filers and self-employed individuals whose business income dropped substantially can apply for a six-month extension of time to pay, the IRS explained. Eligible taxpayers will not be charged a late-payment penalty if they pay any tax, penalty and interest due by October 15, 2012. Taxpayers qualify if they were unemployed for any 30-day period between January 1, 2011 and April 17, 2012. Self-employed people qualify if their business income declined 25 percent or more in 2011, due to the economy. However, income limits apply, which excluded many taxpayers from the program.

Records

The IRS advises that taxpayers maintain tax records for three years. In many cases, especially for individuals with complex returns, records should be kept longer. Our office maintains taxpayer records with the utmost care and confidentiality.

We encourage you to contact us if you have any questions about the end of the 2011 filing season and how your 2011 return can provide a roadmap to tax savings in 2012.

FAQ: What is a family partnership?

 The family partnership is a common device for reducing the overall tax burden of family members. Family members who contribute property or services to a partnership in exchange for partnership interests are subject to the same general tax rules that apply to unrelated partners. If the related persons deal with each other at arm’s length, their partnership is recognized for tax purposes and the terms of the partnership agreement governing their shares of partnership income and loss are respected.

Interfamily gifts

Because of the tax planning opportunities family partnerships present, they are closely scrutinized by the IRS. When a family member acquires a partnership interest by gift, however, the validity of the partnership may be questioned. For example, a partnership between a parent in a personal services business and a child who contributes little or no services is likely to be disregarded as an attempt to assign the parent’s income to the child. Similarly, a purported gift of a partnership interest may be ignored if, in substance, the donor continues to own the interest through his power to control or influence the donee’s business decision. When a partnership interest is transferred to a guardian or trustee for the benefit of a family member, the beneficiary is considered a partner only if the trustee or guardian must act independently and solely in the beneficiary’s best interest.

Capital or services

The determination of whether a person is recognized as a partner depends on whether capital is a material income-producing factor in the partnership. Any person, including a family member, who purchases or is given real ownership of a capital interest in a partnership in which capital is a material income-producing factor is recognized as a partner automatically. If capital is not a material income-producing factor (for example, if a partnership derives most income from services, a family member is not recognized as a partner unless all the facts and circumstances show a good faith business purpose for forming the partnership.

If the family partnership is recognized for tax purposes, the partnership agreement generally governs the partners’ allocations of income and loss. These allocations are not respected, however, to the extent the partnership agreement does not provide reasonable compensation to the donor for services he renders to the partnership or allocates a disproportionate amount of income to the donee. The IRS can re-allocate partnership income between the donor and donee if these requirements are not met.

Investment partnerships

The general rule for determining gain recognition for marketable securities does not apply to the distribution of marketable securities by an investment partnership to an eligible partner. An investment partnership is a partnership that has never been engaged in a trade or business (other than as a trader or dealer in the certain specified investment-type assets) and substantially all the assets of which have always consisted of certain specified investment-type assets (which do not include, for example, interests in real estate or real estate limited partnerships).

If a family limited partnership (FLP) qualifies as an investment partnership, the FLP could redeem the partnership interest of an eligible partner with marketable securities without the recognition of any gain by the redeemed partner. To qualify, substantially all the assets of the FLP must always have consisted of the eligible investment assets, and the holding of even totally passive real estate interests (real estate that does not constitute a trade or business), for instance, must be kept to a minimum. In addition, any eligible partner must have contributed only the specified investment assets (or money) in exchange for his or her partnership interest.

2012 tax season ends quietly

The 2011 filing season ended quietly, apart from a few IRS reminders and last-minute tips issued just before the April 17 deadline. Practitioners generally agreed with the government’s assessment that there were no big misfires this tax season. The IRS reported no problems with the processing of returns apart from a few delays in processing refunds in the early portion of the filing season. The delays resulted from improvements the IRS was making to its e-filing systems designed to prevent refund fraud. The IRS also continued to implement its Modernized e-File (MeF) program, which has been successful thus far.

On April 16, the Treasury Inspector General for Tax Administration J. Russell George gave the IRS good marks for its performance during the 2012 filing season. Speaking with reporters, George said that the agency has worked diligently to detect tax fraud. However, George said that budgetary constraints have resulted in longer wait times for taxpayers to speak with IRS customer service representatives. George highlighted the IRS’s performance in a new report by TIGTA, “Interim Results of the 2012 Filing Season,” released on April 16.

May 2012 tax compliance calendar

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 28-May 1.

May 9

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 2-4.

May 10

Employees who work for tips. Employees who received $20 or more in tips during April must report them to their employer using Form 4070.

May 11

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 5-8.

May 16

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 9-11.

May 18

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 12-15.

May 23

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 16-18.

May 25

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 19-22.

May 31

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 23-25.

June 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 26-29.

Contemporaneous tax records: Are you keeping up?

April 2012 tax compliance calendar

 As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of April 2012.

April 4

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 28-30.

April 6

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 31-April 3.

April 10

Employees who work for tips. Employees who received $20 or more in tips during March must report them to their employer using Form 4070.

April 11

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 4-6.

April 13

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 7-10.

April 17

Individuals. Individuals file a 2011 income tax return (Form 1040 or Form 1040EZ) and pay any tax due (an automatic six-month extension to file (but not to pay) is available).

Partnerships. File of 2011 calendar year return (Form 1065). Provide each partner with a Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc., or a substitute Schedule K-1.

April 19

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 11-13.

April 20

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 14-17.

April 25

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 18-20.

April 27

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 21-24.

Unmarried co-owners must apply single mortgage interest limit

The Tax Court has found that two unmarried co-owners of two California properties cannot each individually deduct the interest paid on their personal residence indebtedness.  The debt limitations are based on the number of residences, rather than the number of taxpayers.

The Internal Revenue Code provides that for married individuals filing separate returns, the debt limits are $550,000 per taxpayer.  The court viewed this treatment as also applying to two unmarried homeowners.  As a result, the two unmarried taxpayers before the Tax Court together were allowed only a total of $1.1 million of debt on which mortgage interest payments for the year would be properly claimed itemized deductions ($1 million of acquisition indebtedness and $100,000 of home equity indebtedness).

Court sides with IRS

Siding with the IRS, the court found that the debt limits (totaling $1.1 million) applied based collectively per residence. The court rejected the taxpayers claim that, for unmarried taxpayers, the debt limits applied per taxpayer.  Relying on what it found to be the plain language of the statute, Code Sec. 163(h)(3), the court noted that the references to acquisition debt or home equity debt applied with respect to any qualified residence of the taxpayer (emphasis added). The references to indebtedness were not qualified by references to individual taxpayers. Thus, it appeared that Congress intended to apply the debt limits to the indebtedness on a residence, not to each taxpayer liable for debt on the residence.

The Tax Court’s decision may negatively impact domestic couples and partners who jointly own property. The court was adamant that the debt limits applied per residence, and rejected the taxpayers’ claims that they could deduct interest on $2.2 million of debt because they were unmarried.

Transfer of winning lottery ticket to S Corp is taxable gift

A lottery winner recently tried to get lucky twice by beating the IRS on taxes owed on the winnings.  Unfortunately, she lost that round with lady luck, with the Tax Court ruling that she was liable for gift tax on a maneuver with an S corporation designed to spread some of the winnings out to certain family members.

An Alabama waitress had received the lottery ticket as a tip, as she had regularly received from a particular patron on a regular basis.  The state courts after protracted litigation ruled in her favor that the winning ticket belonged to her rather than either the patron or her fellow employees under a claimed sharing agreement.  While those matters were still in the courts, however, she took steps to spread some of her new-found wealth to family members, assuming she would win in state court.  She did so by forming an S corporation under the Tax Code with herself as the president and several family members listed as shareholders.  What she didn’t count on by that maneuver was the IRS issuing a deficiency notice for $771,000 for gift tax owed (income tax liability was not a part of this case). The taxpayer appealed to the Tax Court for relief.

Gift tax due, with a discount

The Tax Court eventually determined that the taxpayer’s transfer of a winning lottery ticket to a family-controlled S corp was a gift.  The court found there was no enforceable contract among family members to transfer the lottery ticket to the S corp.

Code Sec. 2501(a)(1) generally imposes a tax irrespective of whether the gift is direct or indirect. A transfer of property to a corporation for less than adequate consideration represents gifts to the other individual shareholders of the corporation to the extent of their proportionate interests.

The court rejected the taxpayer’s argument that there was no gift because a family contract required transfer of the ticket.  The court found that there was no pooling of money.  There were no predetermined sharing percentages.  There was no implied partnership.  At most, the family had an unenforceable “agreement to agree.” 

Although the court found for the IRS, the decision was not a total loss for the taxpayer. At the time the gift was made to the S corp, there was that competing claim to the lottery prize made by her co-workers.  The court found that a hypothetical buyer would not have paid full value for the ticket.  The court concluded that an appropriate discount for the portion of the ticket subject to the competing claim would be 67 percent, which resulted in a $1.1 million gift to the S corp and not the $2.4 million gift determined by the IRS.