Certified Specialist In Taxation Law
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Certified Specialist In Taxation Law |
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2006 Year-end Review: What’s New In 2006 and 2007
With the end of the year fast approaching, it’s time to consider tax planning strategies in light of tax law changes that went into effect in 2006 and are set to take effect at the beginning of 2007. Several key pieces of legislation contribute to these changes, the Taxpayer Income Prevention and Reconciliation Act of 2005 (TIPRA) enacted in 2006, and the Pension Protection Act of 2006, as well as last year’s Energy Policy Act of 2005, which contains provisions that became effective in 2006.
CAUTION: This article summarizes rules that have been issued and laws passed. It does not attempt to predict what Congress will do in 2007. With the change in control of Congress resulting from November’s election, the practitioner should expect a change in direction in tax legislation next year, one that will likely shift emphasis away from economic stimulus through easing burdens on taxpayers and toward use of taxation as an instrument of income redistribution. Note also, that changes scheduled to take effect in future years may be materially altered by the new Congress.
2006 Changes
Age Limit for “Kiddie Tax” Raised
For tax years beginning in 2006 and after, kiddie tax provisions apply to those under 18 years of age. The previous age limit for the kiddie tax was 14 years of age. <1> Under the tax, if a child has unearned income above a threshold amount ($1,700 in 2006 or 2007), <2> the child’s unearned income is generally taxed at his parents’ top marginal rate if that rate results in a higher tax.
Alternative Motor Vehicle Fuel Credit
An alternative motor vehicle fuel credit is available starting in 2006 for several types of alternative fuel vehicles. The credit is equal to the sum of the:
(1) qualified fuel cell motor vehicle credit,
(2) new advanced lean-burn technology motor vehicle fuel credit;
(3) new qualified hybrid motor vehicle credit; and
(4) new qualified alternative fuel motor vehicle credit.
CAUTION: The number of combined new qualified advanced lean-burning technology and hybrid motor vehicles sold by each manufacturer after December 31, 2005, eligible for these credits is limited to 60,000. After the 60,000th vehicle is sold, a phase-out period for the credits begins, that, over the following four quarters, reduces the credit to zero. <3> Toyota reached its 60,000-vehicle limit during the calendar quarter ending June 30,2006, and therefore the credits for all of Toyota’s new advanced lean burn technology motor vehicles began to phase out on October 1, 2006. <4>
Residential and Construction Energy Credits and Deductions
A non-refundable credit is available for amounts spent on certain residential energy improvements. Taxpayers may take the credit for qualified photovoltaic property, qualified solar water heating property, or qualified fuel cell property placed in service in 2006 or 2007, provided that the property is used exclusively for purposes other than heating swimming pools or hot tubs. <5> The credit is equal to 30 percent of qualifying expenditures, with a maximum credit of $2,000 for qualified photovoltaic and qualified solar water heating property expenditures, and $500 for each 0.5 kilowatt of capacity of qualified fuel cell property expenditures. <6>
Additional tax credits and deductions generally apply in 2006 and 2007 under legislation enacted in 2005. <7> The non-business energy property credit and the residential energy efficient property credit are available for the certain types of energy-efficient property that meet eligibility requirements. A business tax credit is available for the construction of new energy-efficient homes substantially completed after 2005. A deduction is available for construction of energy efficient commercial buildings. A manufacturer’s credit is available for energy efficient dishwashers, clothes washers, and refrigerators. Available to all types of businesses is a solar tax credit for the cost of new property that is used to generate solar energy for electricity, heating or cooling, or for certain types of geothermal energy.
Tax-free IRA Charitable Contributions
Otherwise taxable IRA distributions may be excluded from gross income by those 70 1/2 and older, if the distributions are qualified charitable distributions. This provision applies in 2006 and 2007. The exclusion is limited to $100,000 per taxpayer per year. <8>
Enhanced Inventory Charitable Deductions Extended
The enhanced deduction for contributions of food inventory and qualified book inventory contributions is extended through 2007. The provision had been set to expire at the beginning of 2006. <9>
Modification to Foreign Earned Income and Employer-Provided Housing Exclusion Rules for U.S. Citizens Living Abroad
Beginning in 2006, the $80,000 maximum foreign earned income exclusion amount is indexed for inflation. <10> The 2006 amount is $82,400 if an individual qualified for the entire year. <11> For 2007, the amount is $85,700. <12>
However, also starting in 2006, taxpayers who elect to exclude foreign earned income and/or foreign housing allowances, will be subject to a higher tax rate on income in excess of the exclusion amount. Such income is taxed for both regular and minimum tax purposes by applying to that income the tax rates that would have applied had the taxpayer not elected the exclusions. <13>
Similarly, for alternative minimum tax purposes, the tentative minimum tax for the year is equal to the excess (if any) of the amount that would be the tentative minimum tax if the taxpayer’s taxable excess were increased by the amount excluded for the tax year, over the amount that would be the tentative minimum tax for the tax year if the taxpayer’s taxable excess were equal to the amount excluded for the tax year. <14> In both cases, the amount excluded is reduced by the aggregate amount of any deductions or exclusions disallowed.
A qualified individual is allowed an exclusion from gross income (or, alternatively, a deduction) for certain foreign housing costs paid or incurred by or on behalf of the individual. The amount of this housing cost exclusion is equal to the excess of a taxpayer’s “housing expenses” over a base housing amount. Beginning in 2006, an individual’s housing cost amount is the foreign housing expense paid or incurred during the tax year by the individual (limited to 30 percent of the individual’s foreign earned income exclusion amount for the tax year), less 16 percent of the individual’s foreign earned income exclusion amount for the tax year. <15>
However, the IRS may provide for an adjustment to the 30 percent limitation based on geographic differences in housing cost relative to housing costs in the United States, and has done so for 2006, setting forth higher housing cost amounts for specific locations. <16>
Temporary AMT Relief Extended Through 2006
The alternative minimum tax exemption amount for 2006 was increased to: (1) $62,550 for married individuals filing a joint return and surviving spouses; (2) $42,500 for unmarried individuals other than surviving spouses; and (3) $31,275 for married individuals filing a separate return. The exemption amount remains $22,500 for estates and trusts. <17>
For 2007, the exemption amount is scheduled to revert to the lower exemption amounts in effect before 2001.
Continuing in 2006, and also scheduled to expire in 2007, all non-refundable personal credits can be used to the full extent of the taxpayer’s regular tax and AMT. <18>
Qualified Leasehold and Restaurant Improvement Depreciation Changes
Qualified leasehold and improvement property and qualified restaurant property placed in service in 2006 and thereafter must be depreciated over 39 years, rather than the 15-year depreciation period allowed for such property placed in service in 2005. <19>
Itemized Deduction Limitation Phase-out
The reduction in itemized deductions for high-income taxpayers starts to phase out beginning in 2006. <20>
For years before 2010, an individual whose adjusted gross income (AGI) exceeds a prescribed amount must reduce his or her itemized deductions by an amount that depends on AGI. For years before 2006, the amount of the reduction was the lesser of 3 percent of the excess of AGI over the applicable amount or 80 percent of itemized deductions. For 2006 and 2007, the amount of the reduction is two thirds of this amount.
CAUTION: Certain itemized deductions are not subject to this rule.
2007 Changes
Increased Recordkeeping Requirements for Charitable Contributions
Starting with tax years beginning after August 17, 2006, to take a deduction for a cash donation to a charity, regardless of the amount of the donation, the taxpayer must have either a bank record or a written note from the charity indicating the amount of the contribution, the date of the contribution, and the name of the charity. <21>
Restrictions on Items Contributed to Charity
New restrictions went into effect on items contributed to charity. Effective for tax years beginning after August 17, 2006, no deduction is allowed for contributions of clothing or household items unless the items are in good used condition or better. There is an exception for items worth $500 or more if the taxpayer includes a qualified appraisal of the property on his or her return. <22>
IRAs, 401(k)s, and Saver’s Credits
For 2007, the applicable dollar amount used to determine the contribution limit for Roth IRAs is $156,000 for a joint return, $99,000 for all other taxpayers (except for married taxpayers filing separately), and $0 for married taxpayers filing separately.
For qualified retirement contributions in 2007, the applicable dollar amount used to determine the amount of reduction for the limitation on deduction for taxpayers who are active participants and for spouses who are not active participants in certain pension plans is $83,000 for taxpayers filing a joint return, $156,000 for the taxpayer’s spouse if the spouse is not an active participant, and $52,000 for all other taxpayers (except for married taxpayers filing separately), and for married taxpayers filing separately is $0. <23>
Legislative changes enacted in 2006 include permanent higher contributions for 401(k)s, IRAs, and other savings vehicles. <24> Roth 401(k)s have been made permanent and fiduciary protection for plans that offer automatic enrollment in 401(k)s and similar arrangements has been enhanced.
The 401(k) contribution limit for 2007 is $15,500. The 2006 limit is $15,000. The catch-up contribution amount for those 50 or over, although it too is indexed for inflation, remains at $5,000, the same amount as in 2006. <25> The maximum IRA contribution amount is $4,000 in 2006 and 2007. Those who are age 50 or over may contribute an additional $1,000. <26>
Starting in 2007, inflation adjustment of the Saver’s Credit for lower income taxpayers means higher income levels will qualify (for example, joint filers will get a 50 percent credit with income up to $31,000, 20 percent up to $34,000, and 10 percent up to $52,000). <27>
Code Section 199 Modifications
For tax years beginning after May 17, 2006, the Code Section 199 domestic production activities deduction wage limitation is modified so that taxpayers may only include amounts that are properly allocable to domestic production gross receipts. <28> Thus, the wage limitation is 50 percent of wages that are deducted in arriving at qualified production activities income.
Beginning with tax years starting in 2007, the amount deductible increases from three percent to six percent.
The special limitation on wages treated as allocated to partners or shareholders of pass-through entities was repealed. <29>
Section 179 Expensing
Current law provides that the maximum amount a taxpayer may expense under Code Section 179 is $100,000. The $100,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $400,000. The $100,000 and $400,000 are indexed for inflation for years beginning after 2003 and before 2008. Legislation enacted in 2006 extends for two years (i.e., for tax years beginning in 2008 and 2009) the increased amount that a taxpayer may deduct and the other Code Section 179 rules that currently apply. <30>
The Code Section 179 deduction limit for qualifying capital property placed in service for the tax year that would otherwise have to be depreciated is $108,000 for 2006 <31> and $112,000 in 2007 when adjusted for inflation. The amount generally is reduced (but not below zero) by the amount that the total cost of all Section 179 property placed in service during the year exceeds a threshold amount. For 2006 that amount is generally $430,000; for 2007, $450,000. <32>
Capital Gains and Dividend Rates
Lower capital gain and dividend tax rates had been scheduled to expire after 2008. They are now extended through the end of 2010. Capital gains and dividend income are taxed at a maximum rate of 15 percent through 2010. For taxpayers in the 10- and 15-percent tax brackets, the tax rate is 5 percent through 2007 and zero from 2008 through 2010. <33>
Excise Tax Refunds
Taxpayers will be eligible to file for refunds of all excise tax they have paid on long-distance service billed to them after February 28, 2003. Interest will be paid on these refunds. Taxpayers will claim this refund on their 2006 tax returns. <34>
Income Limitations for Foreign Tax Credit Simplified in 2007
Currently, in applying the foreign tax credit, the “separate” limitation of Code Section 904(d) is calculated for several designated categories of income, which are referred to as baskets. In determining a taxpayer’s separate limits, the taxpayer must compute his or her income or loss within each basket and then apply each limit separately. For taxpayers claiming the foreign tax credit in tax years beginning after December 31, 2006, foreign taxes will be subject to separate limitations for only two categories of foreign source income: passive income and general income.
OBSERVATION: Under a transition rule, taxpayers have been able to elect to treat certain foreign taxes arising in tax years beginning after December 31, 2004 as related to either financial services income or general limitation income.
Pending Issues
As Kleinrock’s Federal Tax Bulletin goes to press, several temporary tax provisions are scheduled to expire and have not yet been extended by Congress. The temporary provisions include many key deductions and credits that benefit taxpayers, and they are typically extended by Congress before they expire. However, given the change in control of Congress and the lame-duck nature of the remaining session, there is much uncertainty as to whether the temporary provisions will be extended this time around. Among the deductions scheduled to expire are the deductions for educator expenses, tuition and fees, and state and local sales taxes. Credits that have not yet been extended include the work opportunity credit, the welfare-to-work credit, the research and development credit, and the District of Columbia first-time homebuyer credit.
1/ TIPRA, Pub. L. 109-22, Section 510.
2/ Rev. Proc. 2006-53, 2006-48 I.R.B. __ ; Rev. Proc. 2005-70, 2005-2 C.B. 979.
4/ Notice 2006-78, 2006-41 I.R.B. 675.
7/ Energy Policy Act of 2005, Pub. L. 109-58.
8/ Code Section 408(d), as amended by Pension Protection Act of 2006, Pub. L. 109-280, Section 1201.
9/ Code Sections 170(e)(3)(C)(iv) and 170(e)(3)(D)(iv), as modified by Pension Protection Act of 2006, Pub. L. 109-280, Sections 1202 and 1204.
10/ Code Section 911(b)(2)(D) as amended by TIPRA, Pub. L. 109-222, Section 515(a).
11/ Notice 2006-87, 2006-43 I.R.B. 766.
12/ Rev. Proc. 2006-53, 2006-48 I.R.B __. .
13/ Code Section 911(f) as added by TIPRA, Pub. L. 109-222, Section 515(c).
14/ Code Section 911(f)(2) as added by TIPRA, Pub. L. 109-222, Section 515(c).
15/ Code Section 911(c)(2) as added by TIPRA, Pub. L. 109-222, Section 515(b)(2).
16/ Notice 2006-87, 2006-43 I.R.B. 766.
17/ Code Section 55(d)(1) as amended by TIPRA, Pub. L. 109-222, Section 301.
18/ Code Section 26(a)(2) as amended by TIPRA, Pub. L. 109-222, Section 302.
19/ Code Sections 168(e)(3)(E)(v), 168(e)(6) and (7).
21/ Code Section 170(f) as amended by Pension Protection Act of 2006, Pub. L. 109-280, Section 1217.
22/ Code Section 170(f) as amended by Pension Protection Act of 2006, Pub. L. 109-280 Section 1216.
23/ Rev. Proc. 2006-53, 2006-48 I.R.B. __.
24/ Pension Protection Act of 2006, Pub. L. 109-280, Section 811.
25/ Notice 2006-98, 2006-46 I.R.B. 906.
27/ Code Section 25B(b), amended by Pension Protection Act of 2006, Pub. L. 109-280, Section 833(a).
28/ Code Section 199(b), as amended by TIPRA, Pub. L. 109-222, Section 514(a).
29/ Code Section 199(d)(1)(A) as amended by TIPRA, Pub. L. 109-222, Section 514(b).
30/ Code Section 179 as amended by TIPRA, Pub. L. 109-222, Section 101.
31/ Rev. Proc 2005-70, 2005-2 C.B. 979.
32/ Rev. Proc. 2006-53, 2006-48 I.R.B.__; Rev. Proc 2005-70, 2005-47 I.R.B. 979.
33/ TIPRA, Pub. L. 109-222, Section 102.
34/ Notice 2006-50, 2006-25 I.R.B. 1141.
Tax Court Upholds Section 83(b) Election for Non-vested Stock
A recent Tax Court case is a cautionary tale about the potential pitfall of making a Section 83(b) election. In Kadillak v. Commissioner, <1> the taxpayer made a Section 83(b) election with respect to stock acquired under an incentive stock option (ISO) and subject to an employment termination limitation. The taxpayer paid alternative minimum tax (AMT) as a result of exercising the option but then had to give back certain non-vested stock when he left the company. The Tax Court held that the Section 83(b) election was valid and the taxpayer was stuck paying tax on the spread between the cost and the fair market value (FMV) of shares he was required to return.
Facts
Anthony Kadillak was a sales assistant with Ariba Technologies, Inc. (Ariba). In March 1998, Ariba issued Option No. 117 to Anthony. The option, which qualified as an ISO, granted Anthony the right to acquire 2,000 shares of Ariba common stock at $1.50 per share. The option was exercisable any time after the grant date.
Under the option, Anthony’s right to own the Ariba stock was subject to an employment termination restriction, whereby, if Anthony’s employment terminated for any reason before his rights in the stock fully vested, Ariba had the right to repurchase all the non-vested stock. During 1999 and in April 2000, Ariba’s common stock was subject to a 2-for-1 stock split. As a result, the number of shares granted under the option increased from 2,000 to 32,000. In 2000, Anthony exercised his option and purchased all 32,000 shares for $3,002. The shares had a FMV of over $3.2 million at the date of exercise. Ariba transferred to Anthony share certificates for the 17,333 shares that had vested and deposited the remaining 14,667 non-vested share certificates into an escrow account. As the non-vested shares vested they were transferred to Anthony. When Anthony exercised the ISO, he acquired stockholder rights in all shares subject to the ISO including the non-vested shares held in escrow. Under the agreement, Anthony had the right to receive all “regular cash dividends” on the non-vested shares held in escrow. In 2000, Anthony timely filed a Section 83(b) election for the 32,000 exercised shared granted under the option.
On his 2000 tax return, Anthony reported approximately $3.2 million of gain resulting from the exercise of the ISOs on the vested and the non-vested stock for AMT purposes. Anthony left the company before all the shares vested and the company repurchased the non-vested shares at cost. Anthony subsequently filed amended returns for 2000 and 2001 in which he claimed he was not subject to AMT for the non-vested stock because the Section 83(b) election was invalid. The amended 2001 return reflected Anthony’s assertion that the 2000 Section 83(b) election was invalid as to the non-vested shares. As a result, that amended return reported $340,000 of AMTI, which was the spread between the FMV and the exercise price for the Ariba stock granted under the option which vested in Anthony throughout 2001.
According to Anthony, the Section 83(b) election was invalid as to the non-vested Ariba stock because the non-vested shares were not legally transferred to him. Thus, he should not have recognized as AMTI the excess of the FMV of the non-vested stock on the date of exercise over the exercise price until the underlying shares vested. The IRS rejected Anthony’s amended returns and Anthony petitioned the Tax Court.
Section 83 Impact on the Exercise of ISOs for AMT Purposes
Code Section 83(a) generally requires a taxpayer to recognize as AMTI the spread between the stock’s FMV and the exercise price when a taxpayer is transferred a share of stock pursuant to the exercise of an ISO and its FMV exceeds the exercise price on the date of exercise. <2> A taxpayer generally does not recognize income for AMT purposes under Code Section 83(a) if the stock included in an ISO is subject to a substantial risk of forfeiture on the date of exercise.
Thus, under Code Section 83(a), when Anthony exercised his option, he would recognize as AMTI almost $1.8 million, the excess of the vested stock’s FMV over its exercise price on the date of exercise. Absent a Code Section 83(b) election, Anthony would not recognize AMTI of approximately $1.5 million on the non-vested shares.
Code Section 83(b) allows a taxpayer to elect to include in income in the year of receipt the excess of the value of the stock subject to a substantial risk of forfeiture (determined without regard to any restriction other than a non-lapse restriction) over any amount paid for the stock. Although a taxpayer who makes a Code Section 83(b) election after exercising ISOs does not recognize income for regular tax purposes, <3> the taxpayer does recognize ordinary income for AMT purposes.
PRACTICE TIP: The advantage of a Section 83(b) election is that the appreciation of the restricted stock after the grant date may be taxed at capital gains tax rates, rather than at ordinary income tax rates. The election should only be made if: (1) the stock has a low FMV on the date of grant; (2) the FMV is expected to increase substantially; and (3) there is a low likelihood that the restricted shares will be forfeited.
Tax Court’s Holding
The Tax Court concluded that Anthony made a valid Section 83(b) election and thus he was required to recognize as AMTI the excess of his vested and non-vested stock’s FMV over its exercise price on the date of exercise. Anthony acquired beneficial ownership of the non-vested stock, the court said, when he exercised his ISO. Because Anthony was not required to return the non-vested stock upon the happening of an event that was certain to occur, the non-vested shares were properly transferred to him for purposes of Code Section 83. The court also held that, under Code Section 83(b)(1), Anthony is not entitled to a 2001 tax deduction under Code Section 1341 for the loss attributable to his forfeited non-vested stock.
1/ 127 T.C. No. 13 (11/7/06).
2/ Code Sections 55(b)(2), 56(b)(3), 83(a); Tanner v. Commissioner, 117 T.C. 237, 242 (2001), aff’d, 65 Fed. Appx. 508 (5th Cir. 2003).
3/ As a result of the application of Code Section 421.
IRS Releases 2007 Inflation Adjustments and Tax Rate Tables
The IRS released inflation-adjusted items for 2007, including the tax rate tables for tax years beginning in 2007. Rev. Proc. 2006-53, 2006-48 I.R.B. __.
The IRS has released the 2007 inflation-adjusted amounts. This year, three new items have been indexed for inflation courtesy of the Pension Protection Act of 2006. For the first time, inflation adjustments will raise the income limits that apply to the retirement savings contributions credit, contributions to a Roth IRA, and deductible contributions to a traditional IRA where the taxpayer or the taxpayer’s spouse is covered by a retirement plan at work.
Standard Deduction
For 2007, the standard deduction amounts under Code Section 63 are: $10,700 for married individuals filing jointly and surviving spouses; $7,850 for heads of household; $5,350 for unmarried individuals; and $5,350 for married individuals filing separately. The additional standard deduction amounts for taxpayers who are at least 65 years old or blind are $1,050 for each. These amounts are increased to $1,300 if the individual is also unmarried and not a surviving spouse. Finally, the standard deduction amount for an individual who may be claimed as a dependent by another taxpayer may not exceed the greater of $850 or the sum of $300 and the individual’s earned income.
Overall Limitation on Itemized Deductions
For tax years beginning in 2007, the applicable amount of adjusted gross income above which the amount of a taxpayer’s otherwise allowable itemized deductions will begin to be phased out is $156,400 ($78,200 for a married individual filing separately).
Personal Exemption
The personal exemption amount for tax years beginning in 2007 is $3,400. For joint return filers and surviving spouses, the personal exemption amount begins to phase out when adjusted gross income reaches $234,600 and is completely phased out at $357,100. For heads of household, the phase-out begins at $195,500 and is complete at $318,000. For unmarried individuals (other than heads of households and surviving spouses), the phaseout begins at $156,400 and is complete at $278,900. For married individuals filing separately, the amounts are $117,300 and $178,550.
Kiddie Tax
The amount used to reduce net unearned income on a child’s return subject to the kiddie tax in 2007 is $850 (which is the same amount as the standard deduction allowed to a taxpayer who can be claimed as a dependent by another taxpayer). The same $850 is also used for the determination of whether a parent may elect to include a child’s gross income in the parent’s gross income.
For tax years beginning in 2007, for a child to whom the kiddie tax applies, the exemption amount for the alternative minimum tax may not exceed the sum of: (1) the child’s earned income, plus (2) $6,300.
Child Tax Credit
For tax years beginning in 2007, the value used in determining the amount of credit that may be refundable is $11,750.
Adoption Credit and Assistance Programs
For 2007, the maximum credit allowed for the adoption of a child is the amount of the qualified adoption expenses up to $11,390. The maximum credit allowed in the case of an adoption of a child with special needs is $11,390, regardless of the amount of expenses (if any) paid or incurred. The available adoption credit begins to phase out for taxpayers with modified adjusted gross income in excess of $170,820 and is completely phased out for taxpayers with modified adjusted gross income of $210,820.
The maximum amount that can be excluded from an employee’s gross income in connection with the adoption by the employee of a child with special needs is $11,390. The maximum amount that can be excluded from an employee’s gross income for the amounts paid or expenses incurred by the employer for qualified adoption expenses furnished under an adoption assistance program in connection with other adoptions by the employee is $11,390. The amount excludable from an employee’s gross income begins to phase out for taxpayers with modified adjusted gross income in excess of $170,820 and is completely phased out for taxpayers with modified adjusted gross income of $210,820.
Hope and Lifetime Learning Credits
The modified gross income taken into account in 2007 in determining the reduction of both the Hope and Lifetime Learning credits is the amount in excess of $47,000 ($94,000 in the case of a joint return). In addition, 100 percent of qualified tuition and related expenses not in excess of $1,100 plus 50 percent of such expenses in excess of $1,100 but not in excess of $2,200 are taken into account in determining the amount of the Hope Scholarship Credit. The maximum credit for 2007 is $1,650.
Retirement Contributions
For 2007, the adjusted gross income amounts that determine the applicable percentage in calculating the retirement savings contribution credit are:
For the 50 percent applicable percentage, not over $31,000 on a joint return, $23,250 for a head of household, and $15,500 for all other returns;
For the 20 percent applicable percentage, not over $34,000 on a joint return, $25,500 for a head of household, and $17,000 for all other returns;
For the 10 percent applicable percentage, not over $52,000 on a joint return, $39,000 for a head of household, and $26,000 for all other returns.
The applicable dollar amount used to determine the dollar limit for the contribution limit to Roth IRAs is $156,000 for a joint return, $99,000 for all other taxpayers (except for married taxpayers filing separately), and $0 for married taxpayers filing separately.
For qualified retirement contributions in 2007, the applicable dollar amount used to determine the amount of reduction for the limitation on deductions for taxpayers who are active participants and for spouses who are not active participants in certain pension plans is $83,000 for taxpayers filing a joint return, $156,000 for the taxpayer’s spouse if the spouse is not an active participant, and $52,000 for all other taxpayers (except for married taxpayers filing separately), and $0 for married taxpayers filing separately.
Expensing Depreciable Assets
For tax years beginning in 2007, the aggregate cost of depreciable property a taxpayer can elect to expense cannot exceed $112,000. This $112,000 limitation is reduced on a dollar-for-dollar basis (but not below zero) to the extent the total cost of eligible property placed in service during the year by the taxpayer exceeds $450,000.
Earned Income Credit
The earned income amounts, i.e., the amounts of earned income at or above which the maximum amount of earned income is allowed, are: for taxpayers with one qualifying child, $8,390; for taxpayers with two or more qualifying children, $11,790; and $5,590 for taxpayers with no qualifying children. The maximum amount of the credit is $2,853 for taxpayers with one qualifying child; $4,716 for taxpayers with two or more qualifying children; and $428, for taxpayers with no qualifying children.
The threshold phaseout amounts, i.e. the amount of adjusted gross income (or, if greater, earned income) above which the maximum amount of the credit begins to phase out, are: for taxpayers with one qualifying child, $15,390; for two or more children, $15,390; and for taxpayers with no children, $7,000. The amounts at which the phaseout is complete are $33,241 for one child; $37,783 for two or more children; and $12,590 for no children.
For married filing jointly taxpayers, the threshold phaseout amounts are: $17,390 for taxpayers with one qualifying child; $17,390 for taxpayers with two or more qualifying children; and $9,000 for taxpayers with no qualifying children. The completed threshold phaseout amount for married filing jointly taxpayers with one qualifying child is $35,241; two or more qualifying children, $39,783; and no qualifying children, $14,590.
In addition, the earned income tax credit is denied if the aggregate amount of certain investment income exceeds $2,900 in 2007.
Qualified Transportation Fringe Benefit Exclusion
The monthly limitation on the aggregate fringe benefit exclusion amount for transportation in a commuter highway vehicle and any transit pass is $110. The monthly limitation on the fringe benefit exclusion amount for qualified parking is $215.
Interest on Education Loans
The $2,500 maximum deduction for interest paid on qualified education is reduced when modified adjusted gross income exceeds $55,000 ($110,000 for joint returns), and is completely eliminated when modified adjusted gross income is $70,000 ($140,000 for joint returns).
Income From U. S. Savings Bonds
For 2007, the exclusion for income from United States savings bonds for taxpayers who pay qualified higher education expenses begins to phase out for modified adjusted gross income above $98,400 for joint returns and $65,600 for other returns. This exclusion completely phases out for modified adjusted gross income of $128,400 or more for joint returns and $80,600 or more for other returns.
Long Term Care Insurance Premiums
For 2007, the amount of long-term care premiums eligible to be deducted as medical care expenses is set at $290 for an individual age 40 or less at the close of the tax year; $550 for an individual over age 40 but not over age 50; $1,110 for an individual over age 50 but not over age 60; $2,950 for an individual over age 60 but not over age 70; and $3,680 for an individual over age 70.
The dollar amount of the per diem limitation on periodic payments received under a qualified long-term care insurance contract or periodic payments received under a life insurance contract that are treated as paid by reason of the death of a chronically ill individual is $260.
Medical Savings Accounts
A high-deductible health plan for self-only coverage is defined as a health plan that has an annual deductible that is not less than $1,900 and not more than $2,850, and under which the annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits does not exceed $3,750. A high-deductible health plan for family coverage is defined as a health plan that has an annual deductible that is not less than $3,750 and not more than $5,650, and under which the annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits does not exceed $6,900.
Health Savings Accounts
For health savings accounts, the monthly limitation on deductions for an individual with self-only coverage under a high deductible plan as of the first day of such month is 1/12 of the lesser of: (1) the annual deductible; or (2) $2,850. For an individual with family coverage under a high deductible plan as of the first day of such month is 1/12 of the lesser of: (1) the annual deductible; or (2) $5,650. Also, for 2007, a high deductible plan is defined as a health plan with an annual deductible that is not less than $1,100 for self-only coverage or $2,200 for family coverage, and the annual out-of-pocket expenses do not exceed $5,500 for self-only coverage or $11,000 for family coverage.
Annual Exclusion for Gifts
For 2007, the first $12,000 of gifts to any person (other than gifts of future interests in property) is not included in the total amount of taxable gifts made during that year.
Miscellaneous Items
The value of fuel, provisions, furniture, and other household personal effects exempt from levy may not exceed $7,720. The value of books and tools for the taxpayer’s trade or business exempt from levy may not exceed $3,860.
The dollar amount used to determine interest on estate tax payable in installments is $1,250,000.
The attorney fee award limitation is $170 per hour for 2007.
The $5, $25, and $50 guidelines for disregarding the value of insubstantial benefits received by a donor in return for a fully deductible charitable contribution are, in 2007, $8.90, $44.50, and $89, respectively.
The foreign earned income exclusion amount for 2007 is $85,700.
IRS Provides Guidance on Wage Payments to Pass-through Entities
Wage payments made by employers to pass-through entities are subject to income tax withholding in the same manner as if the payments were made directly to the employee, and an individual who is the wage recipient may claim the withholding credit even if the income was paid to a pass-through entity. CCM 200644018.
A question was presented to the IRS’s Office of Chief Counsel on whether and how withholding credits for income paid by employers or other parties (payors) to trusts, estates, partnerships, or S corporations (pass-through entities) may be allowed to the beneficiaries of a trust or estate, partners in a partnership, or shareholders in an S corporation (individuals) on the individuals’ federal income tax returns.
In some cases, payors have made payments of amounts subject to withholding to pass-through entities and withheld amounts from those payments. The payments made to the pass-through entities should have been paid directly to an individual as remuneration for services performed as an employee of the payor. Pass-through entities and individuals have filed returns, with the withholding credit included on the individuals’ Forms 1040 rather than on the returns of the pass-through entities. Some pass-through entities and individuals have attached additional forms or statements purporting to allocate the credit to the individuals. As the Forms W-2 filed by payors were directed to the pass-through entities, this results in a mismatch in the accounts of the pass-through entities.
The Office of Chief Counsel advised that the recipient of the income subject to withholding is the person entitled to the credit. Payments made to a pass-through entity in its capacity as a separate legal entity are not wages and are not subject to income tax withholding. However, instead of making wage payments directly to an individual performing services as an employee, employers sometimes make the payments to a pass-through entity, subjecting the payments to income tax withholding in the same manner as if the payments were made directly to the employee. If an individual is the recipient, then the individual may claim the withholding credit even if the income was paid to a pass-through entity.
COMPLIANCE TIP: Current IRS procedures do not offer a method for ensuring that the credit is allocated to the account of the correct taxpayer. Therefore, payors, individuals, and pass-through entities may have to file amended returns (including Forms W-2 or 1099) to receive proper treatment if they did not initially file consistent with the proper determination of the recipient.
With respect to estates, the Office of Chief Counsel said that Forms W-2 should be issued to employees, not estates. If a payor has indicated an estate rather than a beneficiary as the recipient on Form W-2, the estate or the beneficiary should request that the payor issue a corrected Form W-2 with appropriate reporting in the name of the employee with the employee’s social security number. Any Forms W-2 issued in the name of estates should be corrected by reflecting zero entries in each box and new Forms W-2 should be issued to the employees of the compensation erroneously reported on the estate’s Form W-2.
With respect to partnerships, if payments are for services performed by the partners as employees of the payor, the partners are the recipients or the income, and the withholding credit should appear on the partners’ Forms 1040, not on the partnership’s Form 1065, in accordance with the partners’ distributive share of that credit. Forms W-2 should be issued to employees, not partnerships. If a payor has indicated the partnership as recipient on Form W-2, then the partnership or the partner should request that the payor issue a corrected Form W-2 to the partnership reflecting zero entries in each box, and a new Form W-2 should be issued to the employee/partner in the name of the employee with the employee’s social security number reporting the payments erroneously reported on the partnership’s Form W-2. Additionally, the parties would have to file amended returns to allocate the credit to the proper recipient.
S corporation shareholders should be treated in a manner similar to partners. The withholding credit should not appear on the S corporation’s Form 1120S. Similar corrective filings may be necessary if the corporation was treated as recipient by a payor.
For a discussion of the credit for tax withheld, see TaxExpert’s Analysis and Explanation, Section 59.1.
Abusive Reimbursement Plan Results in All Payments Being Treated as Wages
An abusive reimbursement arrangement results in all payments under the arrangement, including those meeting accountable plan requirements, being treated as taxable wages. Rev. Rul. 2006-56, 2006-46 I.R.B. 874.
In Rev. Rul. 2006-56, a taxpayer employs truck drivers and pays compensation based on miles driven. The taxpayer also reimburses its drivers for meal and incidental expenses (M&IE) paid or incurred while traveling away from home during the monthly payroll period. The drivers are reimbursed for these expenses through an allowance for each day the driver is away from home for company business.
The taxpayer requires its drivers to provide logs to substantiate the time, place, and business purpose of the travel away from home for each day. It does not require its drivers to substantiate the amount of actual M&IE. Instead, for its drivers’ substantiation of the amount of M&IE paid or incurred by the drivers, the taxpayer relies on administrative guidance published annually by the IRS under which the amount of ordinary and necessary business expenses of an employee for M&IE paid or incurred while traveling away from home is deemed substantiated when the employer provides a per diem allowance to cover the expenses.
The guidance applicable for per diem allowances paid to an employee on or after October 1, 2005, with respect to travel away from home on or after October 1, 2005, is Rev. Proc. 2005-67, 2005 42 I.R.B. 729. For 2006, the taxpayer elects to treat $52 per day as the federal M&IE rate for all localities of travel under Section 4.04 of Rev. Proc. 2005-67. Thus, for 2006, $52 or less per day of M&IE paid or incurred by a driver while traveling away from home may be deemed substantiated. The allowances paid by the taxpayer to many of its drivers for M&IE incurred on travel away from home during the monthly payroll period routinely exceed $52 per day, even when computed on a monthly basis pursuant to the periodic rule provided in Section 4.04 of Rev. Proc. 2005-67.
While the taxpayer requires its drivers to return any amounts paid to them for M&IE with respect to days they were not away from home on business travel, it does not require drivers to return the portion of the allowance paid for days they were away from home on business travel that exceeds the $52 per day that may be deemed substantiated. Neither the policies nor actual practices of the taxpayer’s expense allowance arrangement include any process for tracking the amount of the cents-per-mile M&IE allowance paid to each driver on a per diem basis, nor is there any mechanism in place to determine when the allowances exceed the amount of expenses that may be deemed substantiated under Rev. Proc. 2005-67. The taxpayer does not treat the excess allowances over $52 per day as wages for withholding or employment tax purposes and does not report the excess allowances as wages on the drivers’ Forms W-2.
A reimbursement or other expense allowance arrangement is considered made under an accountable plan if it meets three requirements: (1) the business connection requirement; (2) the substantiation requirement, and (3) the returning amounts in excess of substantiated expenses requirement. Amounts treated as paid under an accountable plan are excluded from the employee’s gross income, are not reported as wages or other compensation on the employee’s Form W-2, and are exempt from the withholding and payment of employment taxes. Conversely, if the arrangement fails any one of these requirements, amounts paid under the arrangement are treated as paid under a non-accountable plan and are included in the employee’s gross income, must be reported as wages or other compensation on the employee’s Form W-2, and are subject to withholding and payment of employment taxes.
The question arose as to whether the taxpayer’s arrangement causes all payments made under the expense allowance arrangement to be treated as made under a non-accountable plan, thus subjecting all payments under the plan to being treated as wages.
The IRS ruled that, where an expense allowance arrangement has no mechanism or process to determine when an allowance exceeds the amount that may be deemed substantiated and the arrangement routinely pays allowances in excess of the amount that may be deemed substantiated without requiring actual substantiation of all the expenses or repayment of the excess amount, the failure of the arrangement to treat the excess allowances as wages for employment tax purposes causes all payments made under the arrangement to be treated as made under a non-accountable plan. Thus, the taxpayer in this case must include all amounts paid under the arrangement to reimburse drivers’ M&IE, not just the excess allowances, in the drivers’ wages on Forms W-2 and must treat all these amounts as wages for the withholding and payment of employment taxes.
For a discussion of the rules relating to accountable and non-accountable plans, see TaxExpert’s Analysis and Explanation, Section 29.5.
Assignment of Decedent’s IRA Results in Income to Trust Beneficiary
A trust that was the beneficiary of a decedent’s IRA had gross income on the assignment of a portion of the decedent’s IRA to charities in satisfaction of a pecuniary legacy but was not entitled to a deduction for the portion of the IRA assigned to the charities. CCM 200644020.
At the time of a taxpayer’s death, he owned an individual retirement account (IRA), of which the designated beneficiary was revocable trust. One article of the trust provided that, on the taxpayer’s death, the sum of $100,000 would be distributed “in cash or in kind” to three charities.
The trustee had the discretion and power to make distributions or divisions of principal in cash or in kind, or both, at fair market values current at a date of distribution fixed by the trustee, without any requirement that each item be distributed or divided ratably. The trust completed the distribution of the IRA by instructing the IRA custodian to divide the IRA into shares, each titled in the name of a beneficiary under trust. Thus, each of the charities became the owner and beneficiary of an IRA equal in value, at the time of division, to the dollar amount it was entitled to under trust.
The Office of Chief Counsel noted that Code Section 691(a)(1) provides that the amount of all items of gross income in respect of a decedent (IRD) are included in the gross income, for the tax year when received, of the estate of the decedent, if the right to receive the amount is acquired by the decedent’s estate from the decedent. If a right, under Code Section 691(a)(1) to receive an amount is transferred by the estate of the decedent, there will be included in the gross income of the estate the fair market value of such right at the time of such transfer. Further, Rev. Rul. 92-47, 1992-1 C.B. 198, holds that a distribution to the beneficiary of a decedent’s IRA that equals the amount of the balance in the IRA at the decedent’s death is IRD that is includible in the gross income of the beneficiary for the tax year the distribution is received.
Code Section 642(c)(1) provides that in the case of an estate or trust, there is a deduction in computing its taxable income for any amount of the gross income which under the terms of the governing instrument is paid for a purpose specified in Code Section 170(c). The amount of the balance in an IRA at the taxpayer’s death is IRD. If an estate or trust satisfies a pecuniary legacy with property, the payment is treated as a sale or exchange.
The Office of Chief Counsel advised that because the trust used the IRA to satisfy its pecuniary legacies, the trust must treat the payments as sales or exchanges. Therefore, the payments are transfers of the rights to receive the IRD and the trust must include in its gross income the value of the portion of IRA which is IRD to the extent IRA was used to satisfy the pecuniary legacies. The terms of the trust, however, do not require that the trustee pay the pecuniary legacies from the trust’s gross income. Accordingly, the transfer of a portion of the IRA in satisfaction of the pecuniary legacies does not entitle the trust to a deduction under Code Section 642(c)(1).
End to Taxpayer Nightmare Means An End to Interest Assessments
The IRS could not assess additional interest on the taxpayers after the taxpayers reached agreements with the IRS to “end their nightmare.” Larosa’s International Fuel Co. Inc. v. United States, No. 97-834T (Fed. Cl. 10/27/06).
Joseph LaRosa and his company, LaRosa’s International Fuel Co., Inc., had an ongoing battle with the IRS regarding tax assessments for over 20 years. In 1990, the parties settled certain Tax Court cases with the entry of two stipulated decisions. Each decision provided that LaRosa and his company reserved the right to pursue an action in the appropriate federal court with respect to the interest claimed to be due by the IRS on the respective deficiencies. Elsewhere in the decisions, the parties stated that LaRosa and his company entered into the settlement with the IRS “for the sole and only purpose of finally disposing of these United States Tax Court cases with the IRS.” The decisions also stated that LaRosa and his company wanted to “end this nightmare.”
Following entry of the decisions, the parties engaged in further settlement discussions and reached another agreement in March 1991 (Form 906 agreement). Under the Form 906 agreement, LaRosa and his company submitted full payment of their tax liabilities, the IRS released all funds and interest held in escrow, and LaRosa and his company’s IRS account transcripts were adjusted to reflect a zero balance.
Nearly two years later, and in reliance on the reservation of rights in the stipulated decisions, LaRosa and his company initiated proceedings to recover what they believed were excessive payments of interest on their former tax liabilities. In 1993, they filed claims for refund with the IRS, asserting that the IRS erroneously assessed interest for the period when their assets remained in escrow. The IRS denied the claims for refund. The IRS then counterclaimed more than eight years after LaRosa and his company had paid their tax liability in full -- arguing that they owed additional interest on unpaid taxes.
In 2003, the Federal Claims Court granted partial summary judgment to the IRS, reserving for later the issue of additional interest raised in the IRS’s counterclaim. With the issuance of that decision, the only remaining issue was whether LaRosa and his company owed additional interest for 1979 as alleged in the IRS’s counterclaim.
The Court of Federal Claims held that LaRosa and his company did not owe the additional interest. According to the court, despite ambiguities inherent in the stipulated decisions, by viewing the decisions in their entirety and within their respective “four corners,” the decisions unambiguously included all tax, penalty, and interest liability. Relevant to this determination, the court said, were the stated reasons that LaRosa and his company entered into the stipulated decisions to finally dispose of the Tax Court cases with the IRS. This desire, the court observed, is plainly inconsistent with an interpretation in which the question of interest due is left open.
Moreover, the court said, the stipulations provided that LaRosa and his company “want to end this nightmare.” The “end” to a “nightmare,” the court concluded, carries with it a strong suggestion of finality, which in this case, by necessity, would include settlement of interest payments. Combined with the statement regarding an “end” to the Tax Court cases, this language evidenced to the court that the parties already included the interest in the stipulated settlement amount.
Everson Addresses AICPA Tax Conference; Cites “Balance” at IRS as Hallmark of His Term
On November 6, IRS Commissioner Mark Everson spoke before the AICPA National Conference on Federal Taxes in Washington, D.C. He said that the IRS has been “brought into balance” during his term, and that “the pendulum has stopped swinging back and forth” between service and enforcement at the agency. Everson stated that since his five-year term began in 2003, there has been an increase in enforcement against corporations and high-income individuals and that IRS service has continued to improve.
Everson said that audits are up, but that the agency has not “let services go,” contrasting this with the 90s when, according to Everson, the focus was on services and enforcement was let go.
Everson remarked that the IRS has been able to increase enforcement with “limited noise.” That is, there has not been an outcry over abuse of rights as there had been in the 90s.
Other highlights cited by Everson were the Volunteer Income Tax Assistance (VITA) program that he said prepared 2.2 million returns at 14,000 sites last year. Everson cited audits of credit counseling agencies and the IRS’s initiative concerning political intervention by churches and charitable organizations as evidence that tax-exempt and government agencies have come under increased scrutiny. Everson claimed that access to the IRS (getting through to the agency) is up to 80 percent, which is comparable to the rate in private industry, and that the accuracy of answers to tax questions is above 90 percent.
Deductions
Kirkeby v. Commissioner, T.C. Summary 2006-180 (11/6/06): The Tax Court held that an individual’s signature on Form 8332 affirmatively consented to the release of the dependency exemption deduction for her child to the non-custodial parent and also prevented her from claiming a child tax credit. Code Section 151.
Arevalo v. Commissioner, No. 05-61129 (5th Cir. 11/7/06): The Fifth Circuit held that a taxpayer who had legal title to two pay phones didn’t have a depreciable interest in the phones. Thus, the taxpayer couldn’t claim a depreciation deduction for the pay phones. The court also concluded that the taxpayer was not entitled to a disabled access credit because he did not have any obligation to comply with the Americans with Disabilities Act. Code Section 167.
Gross Income
Notice 2006-101, 2006-47 I.R.B. __: The IRS provided an updated list of the U.S. tax treaties that are satisfactory for purposes of determining whether an individual shareholder of a foreign corporation receiving a dividend from such corporation will be subject to tax at the reduced rates applicable to certain capital gains. Code Section 1.
Svoboda v. Commissioner, T.C. Memo. 2006-235 (11/2/06): The Tax Court held that a taxpayer’s exercise of non-qualified options resulted in additional compensation income, not capital gain. However, he was not liable for an accuracy-related penalty because his reporting of the income from the stock option transactions was an honest misunderstanding of the law that was reasonable. Code Section 83.
Humphrey v. Commissioner, T.C. Memo. 2006-242 (11/9/06): The Tax Court held that a taxpayer was not a common law employee after he retired and was not an employee within three months of exercising his ISOs, which was eleven months after his retirement. As a result, he recognized ordinary gain on the exercise of the ISOs. Code Section 83.
Information Reporting
CCM 200644017: The Office of Chief Counsel advised that a wholesaler that hired another party to receive, transport, and deposit cash payments received from a high-volume customer did not have a reporting requirement for the cash received by the hired party. However, the hired party was required to report the cash in excess of $10,000 that it received from the customer for the account of the wholesaler. Code Section 6050I.
Procedure
T.D. 9295, 71 Fed. Reg. 64,458 (11/2/06): The IRS has issued proposed, temporary, and final regulations modifying rules relating to the disclosure of reportable transactions and the maintenance of lists required to be kept by material advisors of such transactions. Code Section 6011.
CCM 200645019: The Office of Chief Counsel advised that a company’s filing of a second Form 1120 does not revoke the remaining extension of time to file that was originally granted, and its second Form 1120 filed within the extension period is the return that starts the statute of limitations on assessment. Code Section 6501.
Tax-Exempt Organizations
Announcement 2006-93, 2006-48 I.R.B. __: The IRS issued procedures for tax-exempt organizations to use when requesting a change in their public charity classification. Code Section 501. |
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