Kurzman, Dempsey & Kowalker

WASHINGTON ― The Internal Revenue Service warned taxpayers today to be on the lookout for a new scam mailing that tries to mislead people into believing they are owed a refund.

https://www.irs.gov/newsroom/irs-security-summit-partners-warn-taxpayers-of-new-scam-unusual-delivery-service-mailing-tries-to-trick-people-into-sending-photos-bank-account-information

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An IRS online account is an safe an easy way for individual taxpayers to view specific details about their federal tax account. Here are some of the benefits and features of this online system.

Here’s why taxpayers should have an IRS online account

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The IRS has issued proposed and temporary regulations under Code Sec. 530A, regarding general requirements for Trump accounts, the establishment of an initial account, including automatic enrollment by the Secretary of the Treasury, and qualified general contributions. Proposed regulations issued in March 2026 (NPRM REG-117270-25) that provided guidance on establishing Trump accounts, but did not establish automatic enrollment due to time constraints in resolving legal and administrative issues, are withdrawn. The temporary regulations apply to tax years beginning on or after January 1, 2026, and expire on September 30, 2029.

General Requirements and Establishment of an Account

A Trump account is either (1) an initial Trump account, created or organized by the Treasury Secretary for an eligible individual or (2) a rollover Trump account, which is an account created during the growth period and funded by a qualified rollover contribution from the account beneficiary's existing Trump account. The written governing instrument of a Trump account must generally meet the rules of Code Sec. 408(a)(1) through (6) and Code Sec. 530A(b)(1)(C)(i) through (iii). Any person approved by the IRS as of December 31, 2025, to be a nonbank trustee of an IRA would have automatic approval to act as a trustee of a Trump account. The written instrument must clearly identify the account as a Trump account at the time of creation.

The Secretary may make an election to establish an auto account for a qualifying individual. Another person may elect to establish a Trump account for an eligible individual by filing Form 4547 or via the electronic application or webpage made available by the Secretary. A person may claim an auto account pursuant to Temp. Reg. §1.530A-1T(d)(1)(iv) by establishing a claimed initial Trump account and having the funds in the auto account transferred to the claimed initial Trump account. On or about October 1, 2026, the Secretary shall establish an auto account for each person whom the Secretary has determined to meet the requirements of Temp. Reg. §1.530-A-1T(b)(2) to be an eligible individual, and from whom no prior election has been made. Periodic elections to establish accounts for eligible individuals will be made after that date.

Administration of an auto account is the Secretary's responsibility. During the growth period, an account may only accept qualified general contributions under Code Sec. 530A(f) and a $1,000 pilot program contribution. An auto account's only investment must be its equitable interest in the master group trust, which is a trust established for the exclusive benefit of account beneficiaries of auto accounts for purposes of holding investments of those auto accounts and meets the applicable requirements of Rev. Rul. 81-100, as modified, and is exempt from tax under Code Sec. 408(e).

Qualified General Contributions and Qualified Stock Contributions

Temp. Reg. §1.530A-7T establishes the framework for qualified general contributions to Trump accounts. A qualified general contribution must originate from an eligible donor, be accepted by the Secretary through a Treasury acceptance agreement, be made to beneficiaries within an approved class, and be allocated equally among all beneficiaries in that class. An approved class must include at least 5,000 account beneficiaries and include all account beneficiaries who are still in their growth period, reside in the specified geographic location, and born in one or more years identified in the Treasury acceptance agreement.

The regulations also create rules for qualified stock contributions, allowing eligible donors to contribute certain publicly traded stock issued by domestic corporations directly to Trump accounts. Such stock is generally subject to a minimum holding period ending on the earlier of five years after contribution or the beneficiary’s growth period ending.

Contributions made to qualifying Code Sec. 501(c)(3) organizations to fund general funding contributions are deductible under applicable charitable deduction rules, and gifts to eligible donor organizations are treated as qualifying charitable transfers. A Code Sec. 501(c)(3) organization furthers its exempt purposes by making a qualifying general funding contribution, whether directly or through a donor-advised fund. In addition, such contributions are treated as expenditures for charitable purposes and generally are not considered grants or distributions to individuals for purposes of the private foundation and donor-advised fund expenditure responsibility rules.

T.D. 10056

CC-00226466-26

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The IRS has released the 2026-2027 special per diem rates. Taxpayers use the per diem rates to substantiate certain expenses incurred while traveling away from home. These special per diem rates include:

1. the special transportation industry meal and incidental expenses (M&IE) rates,
2. the rate for the incidental expenses only deduction,
3. and the rates and list of high-cost localities for purposes of the high-low substantiation method.

The IRS has released the 2026-2027 special per diem rates. Taxpayers use the per diem rates to substantiate certain expenses incurred while traveling away from home. These special per diem rates include:

1. the special transportation industry meal and incidental expenses (M&IE) rates,
2. the rate for the incidental expenses only deduction,
3. and the rates and list of high-cost localities for purposes of the high-low substantiation method.

Transportation Industry Special Per Diem Rates

The special M&IE rates for taxpayers in the transportation industry are:

$80 for any locality of travel in the continental United States (CONUS), and
$86 for any locality of travel outside the continental United States (OCONUS).

Incidental Expenses Only Rate

The rate is $5 per day for any CONUS or OCONUS travel for the incidental expenses only deduction.

High-Low Substantiation Method

For purposes of the high-low substantiation method, the 2026-2027 special per diem rates are:

$329 for travel to any high-cost locality, and
$230 for travel to any other locality within CONUS.

The amount treated as paid for meals is:

$86 for travel to any high-cost locality, and
$74 for travel to any other locality within CONUS

Instead of the meal and incidental expenses only substantiation method, taxpayers may use:

$86 for travel to any high-cost locality, and
$74 for travel to any other locality within CONUS.

Taxpayers using the high-low method must comply with Rev. Proc. 2019-48, I.R.B. 2019-51, 1390. That procedure provides the rules for using a per diem rate to substantiate the amount of ordinary and necessary business expenses paid or incurred while traveling away from home.

Notice 2025-54, I.R.B. 2025-41, 479 is superseded.

Notice 2026-60

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For 2027, the Social Security wage cap will be $192,300, and Social Security and Supplemental Security Income (SSI) benefits will increase by 3.6 percent. These changes reflect cost-of-living adjustments to account for inflation.

Wage Cap for Social Security Tax

The Federal Insurance Contributions Act (FICA) tax on wages is 7.65 percent each for the employee and the employer. FICA tax has two components:

a 6.2 percent social security tax, also known as old age, survivors, and disability insurance (OASDI); and
a 1.45 percent Medicare tax, also known as hospital insurance (HI).

For self-employed workers, the Self-Employment tax is 15.3 percent, consisting of:

a 12.4 percent OASDI tax; and
a 2.9 percent HI tax.

OASDI tax applies only up to a wage base, which includes most wages and self-employment income up to the annual wage cap.

For 2027, the wage base is $192,300. Thus, OASDI tax applies only to the taxpayer’s first $192,300 in wages or net earnings from self-employment. Taxpayers do not pay OASDI tax on earnings that exceed $192,300.

There is no wage cap for HI tax.

Maximum Social Security Tax for 2027

For workers who earn $192,300 or more in 2027:

an employee will pay a total of $11,922.60 in social security tax ($192,300 x 6.2 percent);
the employer will pay the same amount; and
a self-employed worker will pay a total of $23,845.20 in social security tax ($192,300 x 12.4 percent).

Additional Medicare Tax

Higher-income workers may have to pay an Additional Medicare tax of 0.9 percent. This tax applies to wages and self-employment income that exceed:

$250,000 for married taxpayers who file a joint return;
$125,000 for married taxpayers who file separate returns; and
$200,000 for other taxpayers.

The annual wage cap does not affect the Additional Medicare tax.

Benefit Increase for 2027

Finally, a cost-of-living adjustment (COLA) will increase social security and SSI benefits for 2027 by 3.6 percent. The COLA is intended to ensure that inflation does not erode the purchasing power of these benefits.

Social Security Fact Sheet: 2027 Social Security Changes

SSA Press Release: Social Security Announces 3.6 Percent Benefit Increase for 2027

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The IRS established the IRA Compliance Resolution System (ICRS) to permit IRA owners and custodians to correct failures related to individual retirement arrangements by submitting a request to the IRS. Failures eligible for ICRS include required minimum distribution failures and nonspouse beneficiary rollover failures. The revenue procedure will also govern requests for waivers from the 60-day rollover requirement from IRAs as well as qualified employer-sponsored plans. The revenue procedure is effective May 1, 2027.

Self-Correction Not Available

The new system implements provisions of the SECURE 2.0 Act of 2022, P.L. 117-328, requiring expansion of the Employee Plans Compliance Resolution System (EPCRS) for qualified retirement plans to allow IRA custodians to address eligible inadvertent failures involving IRAs. The new ICRS consists of the IRA Voluntary Correction Program (IVCP), although additional correction programs may be introduced later. Self-correction of IRA failures is not currently available under ICRS. Instead, the IRA custodian or owner must make a submission to the IRS using the provided procedures and pay a fee on the Pay.gov website.

60-Day Rollover Waiver Requests

The procedure also establishes a process for requesting waivers of the 60-day rollover requirement under Code Secs. 402 and 408 through ICRS. During 2027, eligible applicants may request waivers through either ICRS or the existing private letter ruling process. Beginning in 2028, the IRS anticipates that such requests will be permitted only under ICRS.

Waiver requests may involve eligible rollover distributions from IRAs, qualified retirement plans, annuity plans, tax-sheltered annuities and governmental deferred compensation plans. Automatic waivers and waiver relief under previous guidance remains available.

Rev. Proc. 2026-33

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The IRS updated the Employee Plans Compliance Resolution System (EPCRS), its comprehensive system of corrections programs for employer-sponsored qualified retirement plans. The updates reflect significant changes to EPCRS made by the SECURE 2.0 Act (P.L. 117-328) and subsequent guidance. Former procedures under Rev. Proc. 2021-30 are modified and superseded. The revised procedures are effective October 22, 2026.

The bulk of the changes in the revised procedures reflect the SECURE 2.0 Act’s expansion of EPCRS’s Self Correction Program component to permit self-correction of eligible inadvertent failures, including plan loan failures. Other changes made by SECURE 2.0 and incorporated into the revised EPCRS include safe harbor corrections under Code Sec. 414(cc) and the recovery of retirement plan overpayments under Code Sec. 414(aa).

Other changes made in the revised revenue procedure include:

References to the availability of a separate compliance resolution system for IRA failures.
Updates reflecting changes to the determination letter and opinion letter programs.
Revisions to correction methods for SEPs and SIMPLE IRA plans.
Revisions to procedures for locating lost participants.
Revisions to the correction principle for failure to obtain spousal consent.
Changes to the Voluntary Correction Program (VCP) and the Audit Closing Agreement Program (Audit CAP), such as revised procedures for a group submission under VCP.

Rev. Proc. 2026-34

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The IRS has issued final regulations under Code Sec. 6311 implementing changes made by the Taxpayer First Act. The regulations permit the IRS to pay fees under contracts for processing tax payments by credit or debit card, provided the fees are fully recouped from taxpayers making those payments. The regulations remove restrictions on the IRS’s payment of fees under such contracts and on the imposition of reimbursement fees on persons paying taxes by credit or debit card.

Payment Processing Fees

The regulations authorize the IRS to enter into contracts for receiving tax payments by credit or debit card if the contracts are cost beneficial to the government. Under certain contracts, the IRS may pay fees, charges, or other monetary consideration to payment processors. If the IRS pays fees under these contracts, it must recoup the full amount from taxpayers making payments by credit or debit card. The reimbursement fees are payable at the time of, and in addition to, the tax payment and are limited to the amounts paid by the IRS under the contracts. The IRS must seek to minimize the fees paid under these arrangements.

Under other contracts, the IRS may elect not to pay fees to payment processors. Such arrangements do not prohibit card issuers, financial institutions, or other persons participating in the transactions from imposing their own fees or charges. The IRS may not receive any portion of those fees.

Error Resolution Procedures

Payments of taxes by credit or debit card, including reimbursement fees paid under the regulations, are subject to applicable error-resolution procedures under the Truth in Lending Act, the Electronic Fund Transfer Act, or similar state or local laws. These procedures apply to errors relating to the credit or debit card account but do not apply to disputes, errors, or adjustments concerning the underlying tax liability. Reimbursement fees paid under the regulations are not taxes imposed by the Internal Revenue Code and are not eligible for refund or credit under Code Sec. 6402.

Applicability

The final regulations amend existing regulations under Code Sec. 6311 to implement changes made by the Taxpayer First Act. The rules apply to tax payments and reimbursement fees made on or after the date of publication in the Federal Register.

T.D. 10060

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The IRS has issued proposed and temporary regulations providing guidance on the new federal scholarship tax credit under Code Sec. 25F. Beginning after 2026, an individual may claim a nonrefundable federal income tax credit for contributions to certified scholarship granting organizations (SGOs) issuing scholarships to students in K-12 schools. The regulations clarify how the credit is calculated, including the treatment of state tax credits, credit carryforwards, and substantiation requirements. They also establish immediate administrative rules for SGOs and states that opt into the program and identify SGOs.

Credit Eligibility and Calculation

An individual may claim a credit for qualified cash contributions made directly to eligible SGOs. The annual credit is generally limited to $1,700 per taxpayer or $3,400 for married individuals filing jointly. Contributions made through pass-through entities, including partnerships and S corporations, are not eligible for the credit. The taxpayer must reduce the federal tax credit by the amount of any state tax credit attributable to the same contribution before applying the federal limitation. Unused credit amounts may be carried forward for up to five years.

A taxpayer claiming the credit may not claim a charitable contribution deduction for the same contribution and must satisfy specified substantiation and reporting requirements. This includes use of a unique donor identification number on new Form 8525. The taxpayer donor must designate contributions as eligible for the credit at the time they are made. Once made, the designation is irrevocable.

A taxpayer may contribute to an eligible SGO regardless of their state of residence, allowing them to support qualifying SGOs across participating states.

Scholarship Granting Organizations

To qualify as an SGO, an organization must be recognized as a tax-exempt public charity, maintain separate accounts for qualified contributions and scholarship funds, and devote at least 90 percent of required expenditures to scholarships. SGOs must verify student eligibility, ensure scholarship funds are used solely for qualified elementary and secondary education expenses, and adopt procedures to prevent scholarships from benefiting disqualified persons. The regulations also require SGOs to register with the IRS, furnish acknowledgments to contributors, file annual reports, and maintain records demonstrating compliance with federal requirements.

State Participation

A state may elect to participate the federal scholarship tax program either through an advanced election or through the submission of a state SGO list. A state seeking to participate must annually certify eligible SGOs and provide the IRS with information demonstrating that the organizations satisfy federal requirements. The IRS will maintain and publish a nationwide list of eligible SGOs upon which taxpayers may generally rely when making contributions and claiming credits.

Applicability

Taxpayers, SGOs, and states may rely on the proposed regulations for qualified contributions beginning on or after January 1, 2027. The temporary regulations apply on or after September 1, 2026, and expire on October 1, 2029.

T.D. 10057

Proposed Regulations, NPRM REG-117199-25

IR 2026-117

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The Treasury Department and IRS have issued proposed regulations under Code Sec. 1062 governing the election to pay tax attributable to gain from qualified sales or exchanges of qualified farmland property in four annual installments. The proposed regulations define qualified farmland property and qualified farmers, provide rules for making the election, and address pass-through entities and acceleration events.

Qualified Farmland Property

Qualified farmland property generally is U.S. real property that was used by the taxpayer as a farm for farming purposes, or leased to a qualified farmer for farming purposes, during substantially all of the 10 years preceding the sale or exchange. The property also must be subject to a covenant prohibiting nonfarm use for 10 years following the sale or exchange. A copy of the covenant must be attached to the taxpayer's return for the taxable year of the sale or exchange.

The proposed regulations provide that certain periods of nonuse will be disregarded in applying the 10-year farming use requirement. These include periods during which property is removed from production under a government program, pursuant to recognized farming practices, or because of unforeseen events outside the taxpayer's control, provided the property continues to be maintained for farming purposes.

Election and Installment Payments

Taxpayers would make the election by filing Form 1062, Deferral of Tax on Gain from the Sale or Exchange of Qualified Farmland Property to Qualified Farmers, and Schedule A (Form 1062). Once made, the election generally may be revoked only by paying the remaining unpaid applicable net tax liability. Each installment payment equals 25 percent of the taxpayer's applicable net tax liability. The first installment generally must be paid by the return due date, determined without regard to the extensions, for the taxable year of the sale or exchange.

Pass-Through Entities and Acceleration Events

Under the proposed regulations, partners, S corporation shareholders, beneficiaries, and other owners generally may make the election with respect to applicable net tax liability arising from a qualified sale or exchange by a pass-through entity. Pass-through entities must furnish Schedule A information and the covenant to owners and beneficiaries and report each owner's allocable share of gain.

The proposed regulations also provide rules accelerating unpaid installment payments following certain events. Acceleration events include failure to timely pay an installment, the death of an individual taxpayer, and certain liquidations, dispositions of substantially all assets, and other specified events involving corporations, trusts, and estates. The proposed regulations also provide procedures under which an eligible transferee may assume the remaining installment obligations in certain transactions.

The proposed regulations would apply to qualified sales and exchanges occurring in taxable years ending after publication of final regulations in the Federal Register. Taxpayers may rely on the proposed regulations for qualified sales and exchanges occurring in taxable years beginning after July 4, 2025, provided they apply the rules consistently and in their entirety. Treasury and the IRS requested comments on the proposed regulations and requests for a public hearing within 60 days after publication in the Federal Register.

Proposed Regulations, NPRM REG-117095-25

IR 2026-115

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As the excitement of understanding what artificial intelligence can do for the tax profession starts to subside, the conversation is beginning to shift to risk management and risk assessment. To that end, the American Institute of CPAs has launched a new initiative – the Council on AI Risk in Tax (CART) – to help tax professionals manage risk.

CART was born out of a risk assessment framework recently developed by former IRS Commissioner Daniel Werfel that was published by AICPA after asking representatives of state tax authorities what he could do for them following his departure from the IRS.

“They said, ‘you know Danny, we are seeing so many interesting, exciting demos of AI products that really have paradigm-shifting productivity … but we don’t know what the risks are. We don’t know what questions we should ask ourselves to make sure that, as a tax authority, we are ready to deploy these powerful AI tools responsibly,” Werfel, senior fellow at Johns Hopkins University School of Government & Policy, said in an interview, adding that they also inquired about questions they should be asking vendors about safety features and other risks they should be looking out for.

“I did some immediate research and learned that there wasn’t an AI risk framework or risk register specific to tax,” he added, leading him develop version one of the recently published risk framework.”

From there, he approached AICPA as the place to publish the framework and through those conversations, created CART as a place for tax professionals and state tax administrators to collaborate on AI risk and further refine the framework.

“With AI, it’s obviously new,” Melanie Lauridsen, AICPA vice president of tax policy and advocacy, added. It’s ever evolving. There’s a huge interest. There’s a lot of unknowns, and there’s nothing really out there right now beyond what I have seen what Danny put forward to help guide people in this area.”

The Framework

The published framework states that it is more than a simple list of “relevant risks. The formulation and activation of the list means the organization has learned to:

Define how risks show up in practice;
Assign controls;
Establish indicators; and
Make course corrections as the environment evolves.

In this way the register is part of a broader risk governance framework to help organizations chart a sensible path forward from strategy to implementation.”

The publication includes distinct frameworks for both tax authorities and tax preparers. For tax authorities, the publication highlights 20 risk areas across four categories:

Information integrity – The wrong information reaching taxpayers at scale.
Fairness and legitimacy – Disparate or unfair treatment across groups.
Security and data – Compromised systems, corrupted data, or the exploitation of sensitive taxpayer information at AI systems aggregate, surface, or make newly accessible to band actors.
Institutional capacity – Loss of the knowledge and capacity by the institution needed to govern AI responsibility over time.

For tax preparers, there are 15 risk areas across 5 categories:

Technical – Incorrect or unreliable AI outputs that establish the conditions for downstream errors.
Practice – Failures of professional judgement, documentation, or oversight.
Legal and regulatory – Increased exposure to legal liability (e.g., malpractice claims, regulatory sanctions).
Business – Erosion of client trust and firm relationships.
Workforce and Strategic – Loss of the expertise and institutional knowledge needed to practice responsibly.

The framework “establishes a notional risk register for tax authorities and presents that side-by-side with a distinct register for tax preparers,” the framework document states. “It also identifies important areas of overlap across the two.”

A Living Framework

Werfel noted that this is not intended to be a one-and-done framework, but rather a living document that he anticipates will be updated on a regular basis.

“I wanted to give myself six months of feedback and iteration,” he said. “I told CART at our kickoA meeting [that] once we issue version two after six months, then I think it’s an annual [update] from there. But in this form, version one to version two, I wanted to put a little bit more accelerated because that’s the highest risk point for it missing something big in the risk register itself.”

Lauridsen add that convening CART regularly and discussing risks and best practices associated with those risks and updating the framework “is the right approach” as opposed to trying to build a firm set of standards for risk assessment and risk management of AI.

“We don’t know what it’ll be in a month, two months, much less six months or a year,” Lauridsen said, noting the fast evolution AI is currently experiencing. “I think it would be a disservice to come forward with a standard right now.”

She continued: “Right now, it’s more best practices. Everybody’s trying to get their minds and arms around it and how to implement it.”

Werfel added that the feedback will be very important when the framework goes through future iterations, as the CART members will be able to report back when the framework works and more importantly, when it “missed the bullseye” by the cross section of accounting, law firms, government associations and AI vendors.

“My hope is that if it’s oA bullseye, we’ll hear about it and update it,” Werfel said.

He did not rule out seeing the framework converted into an industry standard somewhere down the line, but for now, the focus is to just keep this a framework that users can use as a best practices guide to assessing risks of AI tools that states and practitioners are considering for implementation.

In the near term, Werfel said that an idea was floated to CART to make a voluntary pledge to follow the framework that CART produces. It would be completely voluntary, but a pledge to follow it would be “hopefully helpful to rally attention to AI risk.”

By Gregory Twachtman, Washington News Editor

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Taxpayers generally prefer to accelerate deductions to reduce their current year income and taxes. In some situations, the tax code's accounting rules allow an accrual-basis employer to deduct a year-end employee bonus in the current year, even though the bonus will not be paid until the following year. A recent IRS Chief Counsel memorandum (FAA 20134301F) highlights some of the pitfalls that can affect when bonus compensation is deductible.

Accrual Method

Under the accrual-method of accounting (in contrast to the cash-method of accounting), a liability is incurred, and can be deducted, in the year in which:

All the events have occurred that establish the fact of the liability;
The amount of the liability can be determined with reasonable accuracy; and
Economic performance has occurred.

The first factor, the all-events test, is met when the event fixing the liability occurs and payment is unconditionally due. Although an expense may be deductible before it is payable, liability must be firmly established. The "fact of liability" depends on whether legal rights or obligations exist as of the close of the year, not the probability that the rights will arise in the future.

Bonus Plans

An employer may establish an arrangement or plan that will pay a bonus to its employees in the succeeding year, based on an evaluation of current year performance. Performance could be determined by objective factors, such as numerical goals set for the company or the employee. These bonuses may be deductible in the earlier year even though the employee, who must figure taxes on the cash method, won't need to recognize the income until it is paid. Or performance may be based on more subjective factors, such as an individual performance appraisal or the employer's discretion. These bonuses may be deductible in the later year. The requirements for awarding the bonus must be scrutinized, to determine when the liability becomes certain.

Is the liability deductible?

The IRS has stated that a bonus can be deducted in the current year if, under a bonus plan, the employee is notified in the current year the employee will receive a bonus, even though the bonus is not calculated or paid until the following year. An employer's bonus liability that is ascertainable by a fixed standard, such as a percentage of profits at the close of the year, accrues and is deductible in the current year even though the computations are not made until the following year.

A bonus is not deductible prior to payment if an employee must remain employed until the time of payment, and if a forfeited bonus reverts to the employer. However, even if an employee must be employed until paid, the IRS has ruled that a bonus is deductible under a pooled arrangement providing that any forfeited bonuses are reallocated to the employees as a group, where the minimum amount payable to the group is determinable through a fixed formula at the end of the year or by board action before the end of the year.

Employers may be denied a deduction in the current year if there are uncertainties or conditions on payment. As stated above, a condition that the employee must remain with the company until payment prevents accrual before the payment. A deduction is not available if the payment is subject to significant contingencies involving corporate affairs, such as approval by the board, or a requirement that the company attain a particular cash position. If there is no set formula, and bonuses will not be determined until after the close of the year, the bonuses do not accrue until the later year.

In the IRS memorandum, Chief Counsel determined that a bonus could not be accrued in the earlier year in the following situations:

The employer retained the right to unilaterally modify or eliminate the bonus plan or the bonuses themselves at any time, in its discretion. The employer had no legal obligation to pay the bonus until it was actually paid.
The plan requires a committee of the board of directors to act in the following year to approve the bonus computation and the payment of bonuses. There is no legal obligation because the committee must approve the bonuses, and that approval is not automatic.
The bonus depends not only on objective formulas but also on the employee's individual performance score, based on appraisals that are not performed until after the end of the year.

There is a tension between the employer's desire to accelerate the deduction and its desire to retain maximum control over the payment of bonuses. An employer that wants to deduct the bonuses in an earlier year must be willing to relinquish some of its discretion to determine the bonus.

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A child with earned income above a certain level is generally required to file a separate tax return as a single taxpayer. However, a child with a certain amount of unearned income (from investments, including dividends, interest, and capital gains) may find that this income becomes subject to tax at his or her parent's highest marginal tax rate. This is referred to as the "kiddie tax," and it is designed to prevent parents from transferring income-producing investments to their children, who would generally be taxed at a lower rate.

Does the kiddie tax apply to my situation?

The kiddie tax applies if:

The child has investment income greater than the annual inflation-adjusted amount ($1,900 for 2013; $2,000 for 2014);
At least one of the child's parents was alive at the end of the tax year;
The child is required to file a tax return for the tax year;
The child does not file a joint return for the tax year; and
The child meets one of the following requirements relating to age and income:

The child was under age 18 at the end of the tax year; or
The child was age 18 at the end of the tax year and the child's earned income does not exceed one-half of the child's own support for the year; or
The child was a full-time student who was under age 24 at the end of the tax year and the child's earned income does not exceed one half of the child's own support for the year (This does not include scholarships.)

Computing the kiddie tax

If the kiddie tax applies to a child, the child's tax is calculated as the greater of one of two items:

The tax on all of the child's income, calculated at the rates applicable to single individuals; or
The sum of two things:

The tax that would be imposed on a single individual if the child's taxable income were reduced by net unearned income, plus
The child's share of the allocable parental tax.

The allocable parent tax is the amount of the increase in the parent's tax liability that results from adding to the parent's taxable income the net unearned income of the parent's children who are subject to the kiddie tax. If a parent has more than one child with unearned income subject to the kiddie tax, then each child's share of the allocable parental tax would be assigned pro rata according to the ratio that its net unearned income bears to the aggregate net unearned income subject to the kiddie tax.

Which tax form should I use?

A parent with a child or children whose unearned income is subject to the kiddie tax must generally complete and file Form 8615, Tax for Certain Children Who Have Investment Income of More Than $1,900, along with his or her tax return. However, if the child's interest and dividend income (including capital gain distributions) total less than $9,500 for 2013 ($10,000 for 2014), the parent may be able to elect to include that income on the parent's return rather than file a separate return for the child. In this case, the parents should complete Form 8814, Parents Election To Report Child's Interest and Dividends. However, the IRS cautions that the federal income tax owed on a child's income may be lower if the parent files a separate tax return for the child, which would enable him or her to take certain tax benefits that cannot be taken on the parents' return.

Divorced, separated, or unmarried parents

The kiddie tax is based on a parent's tax return, but what happens when parents do not file joint returns? Several special rules determine what should happen. If the parents are married, but file separate returns, then the child should use the return of the parent with the largest taxable income to figure the kiddie tax.

If the parents are married, but do not live together, and the custodial parent is considered unmarried then generally the custodial parent's return would be used. However, if the custodial parent is not considered unmarried, the child should use the return of the parent with the largest amount of taxable income.

If the child's parents are divorced or legally separated, and the custodial parent has not remarried, the child should use the custodial parent's return. If the custodial parent has remarried, the child's stepparent, rather than the noncustodial parent, is treated as the child's other parent. Similarly, if the child's parent is a widow or widower who has remarried, the new spouse is treated as the child's other parent.

If the child's parents never married each other, but lived together all year, the child should use the return of the parent with the greater taxable income. If the parents were never married and did not live together all year, the rules are the same as the rules for parents who are divorced.

Calculating the kiddie tax can become confusing as a taxpayer attempts to sort through the numerous rules governing who is subject to the tax, which income is subject to the tax, and how to report it properly. Please do not hesitate to contact our offices with any questions.

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The scheduled January 1, 2014 rollout of withholding, reporting and other rules in the Foreign Account Tax Compliance Act (FATCA) has been delayed six months, the Treasury Department and the IRS have announced. The six-month delay is expected to give the U.S. more time to conclude negotiations and sign agreements to implement FATCA with foreign governments. The Treasury Department and the IRS have not, however, delayed the rules for reporting by individuals.

Far-reaching scope

FATCA 's scope is very far reaching. FATCA requires certain foreign financial institutions (FFIs) to report information about financial accounts held by U.S. taxpayers or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. The reporting institutions include not only banks, but also other financial institutions, such as investment entities, brokers, and certain insurance companies. Some non-financial foreign entities will also have to report certain of their U.S. owners.

FATCA also requires that some individuals holding financial assets outside the U.S. must report those assets to the IRS. The IRS has developed Form 8938, Statement of Specified Foreign Financial Assets. This reporting requirement is separate from the long-time reporting requirement under the Bank Secrecy Act to file an "FBAR" (Form TD F 90.22-1, Report of Foreign Bank and Financial Accounts).

Final rules

In early 2013, the Treasury Department and the IRS issued final FATCA regulations. The final rules require withholding agents to withhold 30 percent of certain payments (called "withholdable payments") to FFIs unless the FFI has entered into a reporting agreement with the IRS. To avoid withholding under FATCA, a participating FFI must enter into an agreement with the IRS to:

Identify U.S. accounts,
Report certain information to the IRS regarding U.S. accounts, and
Withhold a 30 percent tax on certain U.S.-connected payments to non-participating FFIs and account holders who are unwilling to provide the required information.

Delay

The final regulations called for the gradual phasing-in of the FATCA rules beginning in 2014 and continuing through 2017. Now, the Treasury Department and the IRS have further delayed the start of some of the FATCA rules, including rules on withholding, reporting and due diligence by FFIs. Withholding agents generally will be required to begin withholding on withholdable payments made after June 30, 2014 instead of December 31, 2013.

Withholding agents also generally will be required to implement new account opening procedures by July 1, 2014. In addition, Treasury and the IRS intend to modify the final regulations so that the information reports previously required from certain FFIs on U.S. accounts for the 2013 and 2014 calendar years will be required only for 2014 (with respect to U.S. accounts identified by December 31, 2014). Reporting by these FFIs would be required by March 31, 2015. Additionally, all qualified intermediary agreements that would otherwise expire on December 31, 2013 will be extended to June 30, 2014. The launch date of the IRS's online FATCA registration site has also been delayed to August 19, 2013.

Agreements

Since FATCA became law, the U.S. has been negotiating with foreign jurisdictions to implement its reporting requirements. The U.S. has developed two model intergovernmental agreements (IGAs). The first model agreement (Model I) generally requires an FFI to report account information to its government, which, in turn, will exchange the information with the IRS. Under the second model agreement (Model II), an FFI registers with the IRS and reports account information directly to the IRS. As of August 1, 2013, the U.S. has entered into IGAs with nine countries (Denmark, Germany, Ireland, Japan, Norway, Mexico, Spain, Switzerland, and the U.K.). The Treasury Department has reported that it hopes to conclude negotiations before 2014 with Argentina, Belgium, Korea, Malaysia, New Zealand, South Africa, and many other countries.

Individuals

FATCA's rules for reporting by individuals are not delayed. Generally, FATCA requires taxpayers to file Form 8938 if he or she is a U.S. citizen, a resident alien, and in some cases, a nonresident alien. The taxpayer also must own a "specified foreign financial asset," which includes any financial account maintained by an FFI unless specifically excluded. Additionally, the aggregate value of the specified foreign financial asset must exceed certain reporting thresholds.

For single individuals living in the U.S., the total value of the specified foreign financial assets must be more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. For married couples filing a joint return and living in the U.S these amounts are $100,000 and $150,000. The threshold amounts are higher for taxpayers living outside the U.S.

Form 8938 is not a substitute for the FBAR. The forms have different filing requirements. Please contact our office for more details about the two forms and their filing requirements. The IRS is also expected to issue rules on FATCA reporting by domestic entities if the entity is formed or used to hold specified foreign financial assets and the assets exceeds the appropriate reporting threshold. Until the IRS issues regulations, only individuals must file Form 8938.

FATCA is a very complex law, which impacts many taxpayers here and abroad. Please contact our office if you have any questions about FATCA.

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A business can deduct only ordinary and necessary expenses. Further, the amount allowable as a deduction for business meal and entertainment expenses, whether incurred in-town or out-of-town is generally limited to 50 percent of the expenses. (A special exception that raises the level to 80 percent applies to workers who are away from home while working under Department of Transportation regulations.)

Related expenses, such as taxes, tips, and parking fees must be included in the total expenses before applying the 50-percent reduction. The 50-percent reduction is made only after determining the amount of the otherwise allowable deductions. However, allowable deductions for transportation costs to and from a business meal are not reduced.

The 50-percent deduction limitation also applies to meals and entertainment expenses that are reimbursed under an accountable plan to a taxpayer's employees. In that case, it doesn't matter if the taxpayer reimburses the employees for 100 percent of the expenses.

Employee-only meals. If the value of any property or service provided to an employee is so minimal that accounting for the property or service would be unreasonable or administratively impracticable, it is a de minimis fringe benefit that is excluded for income and employment tax purposes. Such benefits that are food-related may include occasional parties or picnics, occasional supper money due to overtime work, and employer-furnished coffee and doughnuts.

A subsidized eating facility can be a de minimis fringe if it is located on or near the business premises and the revenue derived from it normally equals or exceeds direct operating costs. Further, if more than one-half of the employees are furnished meals for the convenience of the employer, all meals provided on the premises are treated as furnished for the convenience of the employer. Therefore, the meals are fully deductible by the employer, instead of possibly being subject to the 50-percent limit on business meal deductions, and excludable by the employees.

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Facilitated by the speed, ubiquity, and anonymity of the Internet, criminals are able to easily steal valuable information such as Social Security numbers and use it for a variety of nefarious purposes, including filing false tax returns to generate refunds from the IRS. The victims are often unable to detect the crime until it is too late, generally after the IRS receives the legitimate tax return from the actual taxpayer. By that time the first return has often been long accepted and the refund processed. Because of the ease, speed, and difficulty involved in policing cybercrime, identity theft has grown rapidly. One estimate from the National Taxpayer Advocate Service has calculated that individual identity theft case receipts have increased by more than 666 percent from fiscal year (FY) 2008 to FY 2012.

There is, however, another dangerous facet of identity theft that costs the government, taxpayers, and businesses millions of dollars each year. That is business identity theft, which like its consumer counterpart involves the theft or impersonation of a business's identity. To add insult to injury, business identity theft can have crippling federal tax consequences. The following article summarizes the problem of business taxpayer identity theft, the methods employed by thieves, and the means by which you can protect your business.

Business v. individual identity theft

Businesses generally deal with larger transactions, have larger account balances and credit lines than individual taxpayers, and can set up and accept merchant credit card payments with numerous banks. Business information regarding tax identification numbers, profit margins and revenues, officers, and even officer salaries are often public and easily accessed. At the same time remedies and enforcement tend to focus more on individual identity theft. Thus, business identity theft can be more lucrative and arguably less dangerous to engage in than individual taxpayer identity theft.

Methods used

Only some of the many business identity theft schemes relate to tax. Nevertheless, such schemes can be devastating for businesses, resulting in massive employment tax liabilities for fictitious wages or huge deficiencies in reported income. Identity thieves can use a business's employer identification number (EIN) to initiate merchant card payment schemes, file false tax returns, and even generate hundreds of fake Form W-2s in furtherance of more individual taxpayer identity theft.

How they do it

Business identity theft can require less effort than individual identity theft because less information is required to establish a business or open a line of credit than is required of individuals. In general, the thief needs to obtain the business's EIN, which is easy to acquire. Common sources for an EIN include:

Filings made to the Securities and Exchange Commission (SEC) such as the Form 10-K, which includes the EIN on its first page;
Public databases that enable users to search for business entities sometimes also display the employer's EIN;
Websites specifically designed to search for EINs, such as EINFinder.com;
Business websites sometimes openly display the EIN; and
Forms W-2, W-9, or 1099.

Once a thief has the EIN, he or she may file reports with various state Secretaries of State to change registered business addresses, registered agents' names, or even appoint new officers. In some cases the thief will apply for a line of credit using this new information. Since the official Secretary of State records display the changed information, potential creditors will not be alerted to the fraud. In one case, however, criminals changed the names of a business's officers by filing with the Secretary of State's office and then sold the whole business to a third party. In the end, however, once an identity thief has established a business name, EIN, and address information, he or she has all the basic tools necessary to perpetrate business identity theft.

Best practices

Businesses should review their banks' policies and recommendations regarding fraud protection. They should know what security measures are being offered and, if commercially reasonable, take them. In a recent U.S. district court case from Missouri, the court found that a bank was not liable for a fraudulent $440,000 wire transfer because it had offered the business a commercially reasonable security procedure, and the business had rejected it. The decision cited Uniform Commercial Code Article 4A-202(b), as adopted by the Missouri Code. Many other states have also adopted the UCC, meaning victimized businesses might find themselves without recourse against their banks in the event of a large fraudulent wire transfer.

Other easy preventative measures that businesses can take include monitoring their financial accounts on a daily basis. They should follow up immediately on any suspicious activity. Businesses should also enroll in email alerts so that they would immediately be apprised of any change in your account name, address, or other information.

A business should also monitor the information on its business registration frequently, whether or not the business is active or inactive. Often businesses that close do not go through the formal dissolution process, which terminates all of the corporate authority. They instead let the charter be forfeited by the Secretary of State. These forfeited charters may be easily reinstated and hijacked by identity thieves.

After fraud occurs

If it is too late, and a fraudulent transaction has occurred in your business's name, take immediate action by contacting your bank, creditors, check verification companies, and credit reporting companies. Report the crime to your local law enforcement authorities and your state's secretary of state business division. Finally, whenever possible, memorialize all correspondence in writing and keep it in your records.

If you'd like more information on how you can take steps to safeguard your personal or business "identity" through safeguarding your tax and other financial accounts, please contact this office.

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Gain or loss is not recognized when property held for productive use in a trade or business or for investment is exchanged for like-kind property. Instead, the taxpayer's basis and holding period in the property transferred carries over to the property acquired in the exchange. Deferring taxable gain, always a good strategy, makes more sense than ever after the recent rise in tax rates for many taxpayers under the American Taxpayer Relief Act of 2012. In particular, Code Section 1031 like-kind exchanges deserve a close second look by many businesses and investors.

Flexibility

More than two properties can be exchanged and more than two parties can participate in a transaction that qualifies for non-recognition treatment. Intermediaries may be used to purchase other property before completing like-kind exchange. Taxpayers can participate in acquisition of other property and qualify for like-kind treatment if there is no actual or constructive receipt of cash proceeds from sale of their property.
It is not required that the properties be given up and received on the same day. However, if the exchange of properties is not simultaneous, the property to be received must be identified within 45 days after the date the relinquished property is transferred. In addition, the identified property must be received within 180 days after the date of transfer or the due date for the return for the tax year in which the transfer occurred, whichever date is earlier.

Certain limitations

Property not qualifying for this treatment includes inventory, securities, foreign real estate and foreign personal property. In an otherwise qualifying exchange, the receipt of boot, in the form of cash, relief from liability, or other non-qualifying property, results in the recognition of realized gain or loss to the extent of the boot received. However, gain so recognized can be postponed if the installment sale rules apply. Depreciation recapture may also result from a like-kind exchange. Losses are not recognized on the acquisition of like-kind property. To recognize a loss, the transaction must be arranged so that the non-recognition provision does not apply.

Literal conformity to the requirements of the non-recognition provisions may not be sufficient to prevent recognition of gain. The substance of the transaction must also satisfy the underlying purpose of the statute. Continuity of investment purpose continues to be emphasized as the primary rationale for non-recognition in a like-kind exchange.

Latest success story

IRS Chief Counsel just this past month approved a taxpayer's exchange of properties as tax-free under Code Sec. 1031 even though the taxpayer used proceeds from the sale of relinquished property to pay down its liabilities. In CCA 201325011, Chief Counsel determined that such use did not trigger constructive receipt. Although taking a look at this winning arrangement may get a bit technical, it is worthwhile if only to provide another example of how like-kind exchange transactions can help your business's tax expenses.

The arrangement. The taxpayer rents equipment to customers. The taxpayer has implemented a like-kind exchange (LKE) program to defer gain from the sales of its rental equipment. The taxpayer has engaged in multiple exchanges under a Master Exchange Agreement (MEA) with a qualified intermediary (QI). Under the MEA, the taxpayer transfers relinquished property to the QI. The QI transfers the relinquished property and acquires replacement property, which it transfers to the taxpayer.

The taxpayer maintains two lines of credit, which are used to purchase replacement property. The taxpayer also uses the lines of credit for general business operations. The lines of credit are secured by the taxpayer's rental properties, accounts receivable, and new equipment sold to customers. The full value of the rental property secures the entire balance on the lines of credit.

The QI must deposit sales proceeds from relinquished property into a joint taxpayer/QI account, and must use the proceeds to pay down the line-of-credit balances. The QI does not use proceeds from the account receivables or the new equipment sales to pay down the lines of credit. The taxpayer then uses borrowed funds to acquire replacement property and complete its exchange. The taxpayer finances the acquisition with new debt in an amount that equals or exceeds the debt that encumbered the relinquished property. Under the MEA, the taxpayer does not have the right to receive, pledge, borrow or otherwise use the money held by the QI.

Chief Counsel's analysis. The IRS field attorney argued that the debt pay-down arrangement gives the taxpayer actual or constructive receipt of the proceeds from the relinquished property before the deadline for the taxpayer to obtain replacement property. IRS Chief Counsel's Office, however, disagreed. It concluded that the taxpayer was not in constructive receipt of the proceeds received for the relinquished property. This conclusion was not affected by the use of the debt to purchase replacement property and for general business operations, or the QI's use of the proceeds to pay down the lines of credit.
If a taxpayer receives, in part, non-like-kind property, the taxpayer must recognize gain (boot) for the amount of this property. The assumption of a liability, or the transfer of property subject to a liability, is treated as boot. If the relinquished property and the replacement property are both subject to a liability (such as a mortgage), the liabilities are netted and the difference is boot to the party being relieved of the larger mortgage.

Chief Counsel concluded that the taxpayer's transaction was permitted by the regulations where the taxpayer is relieved of debt on the transfer of relinquished property and incurs debt on the acquisition of the replacement property. Under the boot netting rules, there is no gain to the taxpayer.

If you would like further information on how like-kind exchanges might work within your business operations, please do not hesitate to contact our offices.

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For many individuals, volunteering for a charitable organization is a very emotionally rewarding experience. In some cases, your volunteer activities may also qualify for certain federal tax breaks. Although individuals cannot deduct the value of their labor on behalf of a charitable organization, they may be eligible for other tax-related benefits.

Before claiming any charity-related tax benefit, whether for a donation or volunteer activity, you must determine if the charity is a "qualified organization." Under the tax rules, most charitable organizations, other than churches, must apply to the IRS to become a qualified organization. If you are uncertain about an organization's status as a qualified organization, you can ask the charity. The IRS has a toll-free number (1-877-829-5500) for questions from taxpayers about charities and also maintains an online tool at www.irs.gov/charities.

Time or services

An individual may spend 10, 20, 30 or more hours a week volunteering for a charitable organization. Precisely because the individual is a volunteer, he or she receives no remuneration for his or her time or services and cannot deduct the value of his or her time or services spent on activities for the charitable organization. Unpaid volunteer work is not tax deductible.

Vehicle expenses

Vehicle expenses associated with volunteer activity should not be overlooked. For example, many individuals use their personal vehicles to transport others to medical treatment or to deliver food to shut-ins. Taxpayers can deduct as a charitable contribution qualified unreimbursed out-of-pocket expenses, such as the cost of gas and oil, directly related to the use of their vehicle in giving services to a charitable organization. However, certain expenses, such as registration fees, or the costs of tires or insurance, are not deductible. Alternatively, taxpayers can use a standard mileage rate of 14 cents per mile to calculate the amount of their contribution. Do not confuse the charitable mileage rate, which is set by statute, with business mileage rate (56.5 cents per mile for 2013), which generally changes from year to year. Parking fees and tolls are deductible whether the taxpayer uses the actual expense method or the standard mileage rate.

Uniforms

Some volunteers are required to wear a uniform, such as a jacket that identifies the wearer as a volunteer for the charitable organization, while engaged in activity for the charity. In this case, the tax rules generally allow taxpayers to deduct the cost and upkeep of uniforms that are not suitable for everyday use and that the taxpayer must wear while performing donated services for a charitable organization.

Hosting a foreign student

Qualifying expenses for a foreign student who lives in the taxpayer's home as part of a program of the organization to provide educational opportunities for the student may be deductible. The student must not be a relative, such as a child or stepchild, or dependent of the taxpayer and also must be a full-time student in secondary school or any lower grade at a school in the U.S. Among the expenses that may be deductible are the costs of food and certain transportation spent on behalf of the student. The cost of lodging is not deductible. If you are planning to host a foreign-exchange student, please contact our office and we can explore the possible tax benefits.

Travel

Volunteers may be asked to travel on behalf of the charitable organization, for example, to attend a convention or meeting. Generally, qualified unreimbursed expenses may be deductible subject to complicated rules. Very broadly speaking, there must not be a significant element of personal pleasure, recreation, or vacation in the travel. Special rules apply if the charitable organization pays a daily travel allowance to the volunteer. There are also special rules for attendance at a church meeting or convention and the capacity in which the volunteer attends the church meeting or convention. If you plan to travel as part of your volunteer activity for a charitable organization, please contact our office and we can review your plans in greater detail.

If you have any questions, please contact our office.

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Vacation homes offer owners tax breaks similar-but not identical-to those for primary residences. Vacation homes also offer owners the opportunity to earn tax-advantaged and even tax-free income. This combination of current income and tax breaks, combined with the potential for long-term appreciation, can make a second home an attractive investment.

Homeowners can deduct mortgage interest they pay on up to $1 million of "acquisition indebtedness" incurred to buy their primary residence and one additional residence. If their total mortgage indebtedness exceeds $1 million, they can still deduct the interest they pay on their first $1 million. If one mortgage carries a substantially higher rate than the second, it makes sense to deduct the higher interest first to maximize deductions.

Vacation homeowners don't need to buy an actual house (or even a condominium) to take advantage of second-home mortgage interest deductions. They can deduct interest they pay on a loan secured by a timeshare, yacht, or motorhome so long as it includes sleeping, cooking, and toilet facilities.

Gains from selling a vacation home are generally taxed as short-term or long-term capital gains. While gain on the sale of a principal residence can be excludable, gain on the sale of a vacation home is not. Recent rules limit the amount of prior gain on a vacation residence that can be sheltered if a vacation home is converted into a primary residence.

Vacation home rentals. Many vacation home owners rent vacation homes to draw income and help finance the cost of owning the home. These rentals are taxed under one of three sets of rules depending on how long the homeowner rents the property.

Income from rentals totaling not more than 14 days per year is nontaxable.
Income from rentals totaling more than 14 days per year is taxable and is generally reported on Schedule E (Form 1040), Supplemental Income and Loss. Homeowners who rent their properties for more than 14 days can deduct a portion of their mortgage interest, property taxes, maintenance, utilities, and other expenses to offset that income. That deduction depends on how many days they use the residence personally versus how many days they rent it.
Owners who use their home personally for less than 14 days and less than 10% of the total rental days can treat the property as true "rental" property if certain rules are followed.

If you are considering the purchase of a vacation home, our offices can help compute your true, "after-tax" cost of ownership in determining whether such a purchase makes sense.

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Vacation homes offer owners many tax breaks similar to those for primary residences. Vacation homes also offer owners the opportunity to earn tax-advantaged and even tax-free income from a certain level of rental income. The value of vacation homes are also on the rise again, offering an investment side to ownership that can ultimately be realized at a beneficial long-term capital gains rate.

Homeowners can deduct mortgage interest they pay on up to $1 million of "acquisition indebtedness" incurred to buy their primary residence and one additional residence. If their total mortgage indebtedness exceeds $1 million, they can still deduct the interest they pay on their first $1 million. If one mortgage carries a substantially higher rate than the second, it makes sense to deduct the higher interest first to maximize deductions.

Vacation homeowners don't need to buy an actual house (or even a condominium) to take advantage of second-home mortgage interest deductions. They can deduct interest they pay on a loan secured by a timeshare, yacht, or motor home so long as it includes sleeping, cooking, and toilet facilities.

Capital gain on vacation properties. Gains from selling a vacation home are generally taxed as long-term capital gains on Schedule D. As with a primary residence, basis includes the property's contract price (including any mortgage assumed or taken "subject to"), nondeductible closing costs (title insurance and fees, surveys and recording fees, transfer taxes, etc.), and improvements. "Adjusted proceeds" include the property's sale price, minus expenses of sale (real estate commissions, title fees, etc.). The maximum tax on capital gain is now 20 percent, with an additional 3.8 percent net investment tax depending upon income level. There's no separate exclusion that applies when selling a vacation home as there is up to $500,000 for a primary residence.

Vacation home rentals. Many vacation home owners rent those homes to draw income and help finance the cost of owning the home. These rentals are taxed under one of three sets of rules depending on how long the homeowner rents the property.

Income from rentals totaling not more than 14 days per year is nontaxable.
Income from rentals totaling more than 14 days per year is taxable and is generally reported on Schedule E of Form 1040. Homeowners who rent their properties for more than 14 days can deduct a portion of their mortgage interest, property taxes, maintenance, utilities, and other expenses to offset that income. That deduction depends on how many days they use the residence personally versus how many days they rent it.
Owners who use their home personally for less than 14 days and less than 10% of the total rental days can treat the property as true "rental" property, which entitled them to a greater number of deductions.

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President Obama recently said that he wants a tax reform/deficit reduction package by August and lawmakers have many proposals to consider. The President has introduced a $3.77 trillion budget for fiscal year (FY) 2014 with a host of tax reform proposals, the House and Senate Budget Committees have approved competing deficit reduction and tax reform blueprints, other committees are exploring ideas for tax reform, and private groups, most notably authors of the Simpson-Bowles Plan, are also making proposals. Whatever proposals are adopted, the outcome is sure to impact your tax strategy and planning.

All of the proposals have one common goal: reduce the federal government's approximate $16 trillion federal budget deficit. To reduce the budget deficit, many of the plans propose to cut spending and raise revenues. Lawmakers and the White House also want to replace sequestration (across-the-board spending cuts for many federal agencies) for FY 2014 and beyond. Replacing sequestration will require spending cuts, new revenue or a combination of both. Let's take a look at how some of the tax proposals would affect individuals, businesses and others.

Individuals

The American Taxpayer Relief Act of 2012 (ATRA), signed into law on January 2, 2013, set the individual tax rates at 10, 15, 25, 28, 33, 35 and 39.6 percent for 2013 and beyond. The House GOP budget blueprint would consolidate the current seven individual income tax rate brackets into two rates. The lower rate would be 10 percent with the goal of a top rate of 25 percent. The Simpson-Bowles plan also calls for lower rates but does not specify the amounts; however, lower rates would be contingent on eliminating certain tax credits and deductions, possibly some popular ones such as the home mortgage interest deduction. President Obama has not proposed any changes to the current individual income tax rates.

President Obama has, however, proposed a minimum 30 percent tax on individuals with incomes over $1 million (full phase in at $2 million). This was known as the "Buffett Rule" (now called the Fair Share Tax). President Obama would also limit the tax rate at which higher income individuals can reduce their tax liability to a maximum of 28 percent. This limit would apply to all itemized deductions; foreign excluded income; tax-exempt interest; employer sponsored health insurance; retirement contributions; and selected above-the-line deductions. Another proposal would limit contributions and accruals on tax-favored retirement accounts, including IRAs, qualified plans, tax-sheltered annuities, and deferred compensation plans.

The budget blueprint put forward by Senate Democrats makes similar proposals. The Senate plan would impose across-the-board limits on itemized deductions claimed by the top two percent of income earners, by capping the rate at which itemized deductions and other tax preferences reduce tax liability, a percentage of income cap, or a specific dollar cap. The Senate plan also proposes to change, without giving details, unspecified itemized deductions into tax credits.

Not surprisingly, the House plan, written by the GOP, does not include these proposals. Along with consolidating the individual tax rates, the House blueprint would repeal the 3.8 percent net investment income (NII) surtax and the 0.9 percent Additional Medicare Tax, both of which took effect in 2013. The House plan also calls for repealing the alternative minimum tax (AMT). The House plan also calls for tax simplification but does not give details.

Another proposal endorsed by the President but which will be a difficult sale in Congress is to increase the federal estate tax. ATRA "permanently" extended the estate tax at a maximum rate of 35 percent with a $5 million exclusion (indexed for inflation). President Obama wants to raise the maximum rate to 45 percent with a $3.5 million exclusion (not indexed for inflation) after 2017.

Businesses

Reducing the U.S. corporate tax rate is a common goal of many of the tax reform proposals but they take different approaches. President Obama has said he would support lowering the corporate tax rate in exchange for businesses giving up unspecified tax preferences. These could include tax incentives for fossil fuels, the Code Sec. 199 deduction and more. The House blueprint would reduce the top corporate tax rate to 25 percent, paid for by tax savings elsewhere. The Simpson-Bowles plan also calls for a reduction in the corporate tax rate, contingent on businesses relinquishing unspecific tax preferences.

President Obama and the House and Senate budgets also propose a number of incentives to encourage business spending and job creation. These include:

Enhanced small business expensing (Obama and House but at different amounts);
Permanent research tax credit (Obama, House and Senate);
Temporary tax credit for increasing payrolls (Obama); and
Special incentives for manufacturing in the U.S. (Obama).

Another key difference among the competing proposals: the House budget plan would repeal the Patient Protection and Affordable Care Act, including all of its business tax-related provisions, such as employer-shared responsibility provisions, the medical device excise tax, and more. The Senate approved a non-binding resolution to repeal the medical device tax but is not expected to go along with repeal of the entire Affordable Care Act.

Internet sales tax

In May, the Senate is expected to approve the Marketplace Fairness Act (H.R. 743). The bill gives states the authority to compel online merchants, no matter where they are located, to collect sales tax at the time of a transaction. However, states would be able to compel collection of sales tax only after they have simplified their sales tax laws, such as by adopting the Streamlined Sales and Use Tax Agreement. The bill has the support of President Obama. However, the bill may not pass in the House, where many lawmakers view it as a tax increase.

Discussion drafts

The two Congressional tax writing committees – House Ways and Means and Senate Finance – are engaged in discussions among their members over tax reform. Ways and Means has produced three detailed discussion drafts exploring possible approaches to reforming the taxation of financial products, the taxation of small businesses and moving the U.S. to a territorial system of taxation. Ways and Means Chair Dave Camp, R-Mich., has promised to introduce tax reform legislation this year. Senate Finance has also produced four discussion drafts, less detailed than the House drafts, on simplifying the Tax Code, business taxation and education, and infrastructure, energy and natural resources. Senate Finance Committee Chair Max Baucus, D-Mont., has pledged his commitment to seeing tax reform through before his retirement, which he announced would start at the end of 2014.

Looking ahead

Tax reform coupled with deficit reduction is starting to gain momentum. Whether this will lead to legislation this summer or before year-end is unclear. As long as the key players continue their discussions, there is the chance of tax reform.

Our office will keep you posted of developments. Please contact our office if you have any questions about the tax reform proposals we have reviewed.

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Questions over the operation of the new 3.8 percent Medicare tax on net investment income (the NII Tax) continue to be placed on the IRS's doorstep as it tries to better explain the operation of the new tax. Proposed "reliance regulations" issued at the end in 2012 (NPRM REG-130507-11) "are insufficient in many respects," tax experts complain, as the IRS struggles to turn its earlier guidance into final rules.

A public hearing on the existing regulations, held at IRS headquarters in Washington, D.C., in early April 2013, only confirmed how the application of the NII Tax to certain categories of income—particularly income arising from "passive activities"—is challenging even the experts. Nevertheless, taxpayers are not getting a reprieve from the immediate application of this new tax. The 3.8 percent Medicare surtax on net investment income (NII) became effective January 1, 2013. Current confusion over exactly how the 3.8 percent operates can impact on tax strategies that should be put into motion in 2013. Any misinterpretation can also bear on 2013 estimated tax that may be due to cover any 3.8 percent NII Tax liability.

NII Tax Thresholds

For tax years beginning after December 31, 2012, the NII surtax on individuals equals 3.8 percent of the lesser of: net investment income for the tax year, or the excess, if any, of:

the individual's modified adjusted gross income (MAGI) for the tax year, over
the threshold amount.

The threshold amount in turn is equal to:

$250,000 in the case of a taxpayer making a joint return or a surviving spouse,
$125,000 in the case of a married taxpayer filing a separate return, and
$200,000 in any other case.

Trusts and estates are also subject to the NII surtax, to the extent of the lesser of: (i) undistributed net investment income, or (ii) the excess of adjusted gross income over the dollar amount at which the highest tax bracket begins (which, for 2013, is $11,950).

Net Investment Income

The primary confusion over application of the 3.8 percent NII Tax revolves around finding a precise definition of "net investment income" as enacted by Congress. To appreciate the complexity of the task, just look at the applicable Internal Revenue Code provision. Code Sec. 1411(c)(1) defines net investment income as the sum of:

Category (i) income: Gross income from interest, dividends, annuities, royalties, and rents, other than such income which is derived in the ordinary course of a trade or business not described in Code Sec. 1411(c)(2);
Category (ii) income: Other gross income derived from a trade or business described in Code Sec. 1411(c)(2); and
Category (iii) income: Net gain attributable to the disposition of property, other than property held in a trade or business not described in Code Sec. 1411(c)(2); over

Deductions properly allocable to such gross income or net gain.

A Code Sec. 1411(c)(2) trade or business includes a passive activity under Code Sec. 469 with respect to the taxpayer or trading in financial instruments or commodities.

Comment. Code Sec 1411 effectively creates a new tax and a new tax base, on top of the income tax, alternative minimum tax, self-employment tax and payroll taxes. Nevertheless the Preamble to the proposed regs states that, except as otherwise provided, the income tax rules should apply to Code Sec. 1411 unless good cause otherwise exists. Practitioners have asked the IRS that the final regulations give greater reassurance of this general rule.

Complexity

The IRS has stated that the principal purpose of Code Sec. 1411 is "to impose a tax on unearned income or investments of certain individuals, estates, and trusts." Unfortunately, Code Sec. 1411 is not so direct and simple, with its three categories of income (that is, (i), (ii) and (iii), above), complicating matters, albeit in an effort to close every door to those who try to "game the system."

Application of the 3.8 percent NII Tax to capital gains and dividends from a personal stock portfolio is clear under this rule of thumb. But clarity breaks down when a "trade or business" is thrown into the mix and the concept of "passive activity" is added to it.

If gain or other income is the result of an active business activity, it generally escapes NII Tax. However, when the "active" business is a passive activity (for example, a rental business), it may be deemed to generate income that is subject to the NII Tax. Furthermore, when a passive activity is not merely incidental to a business however otherwise active that business should be, the NII Tax also becomes an issue.

Passive Activity

Any revised or additional rules from the IRS on the application of the NII Tax on passive activities should be made more user friendly to the broad middle range of taxpayers and their advisors, one expert at the hearing recommended. The IRS should err on the side of explaining things clearly and simply, even at the expense of not covering every possible nuance of interpretation.

At the same time, however, other experts are asking for more detail, at least in the way of clarification. For example, the IRS has stated that passive activity for NII Tax purposes should be applied within a narrower scope than the passive activity loss rules under Code 469. Those Code Sec. 469 rules restrict "passive losses" from reducing income that is not "passive income." Experts want the IRS to explain exactly what they mean by a "narrower scope."

Self-Rental Activities/Grouping

The self-rental recharacterization rule under Code Sec. 469 affects taxpayers who rent property to a trade or business in which they materially participate. Concern has been expressed over the possibility of interpreting net investment income under Code Sec. 1411 to include rental income from a self-rental activity grouped with a trade or business activity in which the taxpayer materially participates.

The material participation and trade or business requirements should be tested on the grouped activity as a whole rather than on a component basis, one expert in particular stressed at the hearing. If that test is passed, he argued, the trade or business income and rental income from the grouped activity should be excluded from the reach of the NII Tax. For example, the owners of self-rental properties should not have that rent considered as separate from their overall business activity and subject to the net investment tax simply because properties are held in a separate LLC to avoid tort liability.

Regrouping deadline

The proposed regulations permit businesses subject to the NII Tax to elect to regroup their activities for passive-loss purposes in 2013 or 2014. This regrouping election allows taxpayers with a fresh start to accommodate the new NII surtax. Without permitting regroupings, taxpayers would be bound by their original grouping decisions, some of which may have been made as many as 20 years ago, only for purpose of Code Sec. 469 passive loss rules and not the NII Tax. Some small business representatives are also concerned that, because of the complexity of the rules, the final regulations should extend the deadline for a regrouping election through 2015.

Application of the net investment income tax is particularly difficult to get a handle on in a variety of situations. Unfortunately, however, at 3.8 percent, it is costly enough not to be ignored.

If you have any questions about how the NII Tax may apply to your business, rental operations, or overall investment strategy, please do not hesitate to call our office.

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Under the Patient Protection and Affordable Care Act (PPACA), small employers can claim a credit for providing health insurance for employees and their families. Health insurance includes not only basic medical and hospital care, but dental or vision, long-term care, and coverage for specific diseases or illness. Self-funded plans do not qualify; the insurance must be provided through a third party.

For 2010-2013, for-profit employers can claim a credit of 35 percent of the employer's nonelective contributions, increasing to 50 percent for 2014 and 2015. Nonprofit employers can claim a credit of 25 percent through 2013, and 35 percent for the two succeeding years. Beginning in 2012, the credit for nonprofit employers is limited to the payroll taxes paid by the employer.

Small employers

Employers can claim the full credit if their full-time equivalent (FTE) employees are 10 or less, and their average annual wages per employee are $25,000 or less. FTEs are determined by figuring total hours of service for all employees and dividing the total by 2,080.

The credit is phased out for employers with 11 to 25 employees or with average wages between $25,000 and $50,000. The credit percentage is reduced 6.67 percent per "excess" employee (over 10) and four percent for each $1,000 of average wages in excess of $25,000.

To determine the amount of the credit, employers must add up the total premiums they paid on behalf of their employees during the year, subject to the state average premium limit. This total is then multiplied by the applicable percentage (25 or 35 percent for 2013, minus any phase-out). The credit is then reduced for FTEs in excess of 10, and for average annual wages (in units of $1,000) over $25,000. The result is the total credit that the employer can claim.

Other requirements

Under current law, employers must pay at least 50 percent of the insurance costs and must pay a uniform percentage for all employees. The credit is reduced if the employer premiums exceed the state's average premium for small group markets.

In its proposed fiscal year 2014 budget, the Obama administration would modify or eliminate some of these requirements. The credit phase-out would apply to employers with 21-50 employees, rather than 11-25. The phase-out rate would also be more gradual. Furthermore, the administration would eliminate the requirement that employers make a uniform contribution for each employee, and would eliminate the limit for state average premiums.

Reports indicate that the small business health insurance credit is being underutilized, with many businesses leaving this tax money on the table without claiming it or arranging their affairs to do so.

If you have any questions about how you might be able to position your business to claim this credit or claim a larger credit, do not hesitate to call this office for an update.

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A return or a payment that is mailed to the IRS is timely filed or paid if it is delivered on or before its due date. A return with a U.S. postmark, which is delivered after its due date, is timely filed if the date of the postmark is no later than the due date, the return was properly addressed, and the return had proper postage. The timely mailing/timely filing rule also applies when a taxpayer receives a filing extension. If an envelope has a post office postmark and a non-post office postmark, the latter is disregarded and the post office postmark determines the filing date.

Comment. The timely filing, timely mailing rule requires that the return be postmarked within the prescribed filing period. Thus, an individual return postmarked April 16 and received on April 20 is considered filed on April 20.

Private carriers. A return delivered by a designated private carrier is timely if the carrier marks or records the return no later than the due date of the return. However, a return delivered by means other than the U.S. mail or a designated private carrier must be delivered to the appropriate IRS office on or before its due date to be timely.

The IRS can designate a private carrier if the carrier: is available to the general public; is as timely and reliable as U.S. first class mail; records the date on which the package was given to it for delivery; and satisfies other conditions. The IRS has identified DHL Express, Federal Express, and United Parcel Service as designated carriers.

No postmarks; other postmarks. If there is no postmark, the taxpayer may establish the mailing date by extrinsic evidence. A return in an envelope with a foreign postmark or private meter machine postmark is timely filed if the postmark is on or before the due date of the return and the return is received no later than if it had been postmarked by the postal service on the last day for filing the return.

Registered, certified. A receipt showing that a return was sent by registered or certified mail is proof that the return was delivered to the place that it was addressed. Returns sent by registered mail are deemed to be postmarked on the date of registration. Returns sent by certified mail are deemed to be postmarked on the date stamped on the receipt, under the timely mailed, timely filed rule. However, if a taxpayer mails a return certified but does not obtain a certified receipt, the postmark on the envelope determines the filing date.

Comment. A taxpayer mailing a return on or near its due date should use registered or certified mail with a postmarked receipt. Documents sent in this manner are automatically timely filed.

Electronic. An electronically-filed return with a timely electronic postmark is timely filed, provided that the return is filed in the manner prescribed for electronic returns. An electronic postmark is a record of the date and time, in the taxpayer's time zone, that an authorized electronic return transmitter receives the e-filed document on its host system.

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An LLC (limited liability company) is not a federal tax entity. LLCs are organized under state law. LLCs are not specifically mentioned in the Tax Code, and there are no special IRS regulations governing the taxation of LLCs comparable to the regulations for C corporations, S corporations, and partnerships. Instead, LLCs make an election to be taxed as a particular entity (or to be disregarded for tax purposes) by following the check-the-box business entity classification regulations. The election is filed on Form 8832, Entity Classification Election. The IRS will assign an entity classification by default if no election is made. A taxpayer who doesn't mind the IRS default entity classification does not necessarily need to file Form 8832.

"Check-the-Box" Election

An LLC with more than one member can elect tax status as:

Partnership
Corporation
S corporation (accomplished by electing to be taxed as a corporation, then filing an S corporation election)

An LLC with only one member can elect tax status as:

Disregarded entity
Corporation
S corporation (accomplished by electing to be taxed as a corporation, then filing an S corporation election)

The IRS will assign the following classifications if no entity election is filed for an LLC (the default rules):

any business entity that is not a corporation is classified as a partnership
any entity that is wholly-owned by a single person will be disregarded as an entity separate from its owner (taxed as a sole proprietorship).

Typically, an LLC with more than one member will elect to be taxed as a partnership, whereas a single-member LLC will elect to be disregarded and taxed as a sole proprietorship.

If you have any questions relating to LLCs, their benefits, drawbacks, or their treatment under the Tax Code, please contact our offices.

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The limitation on itemized deductions (also known as the Pease limitation after the member of Congress who sponsored the original legislation) is reinstated by the American Taxpayer Relief Act (ATRA) for tax years beginning after December 31, 2012. The reinstated Pease limitation is intended to reduce or eliminate the itemized deductions of higher income taxpayers to raise revenue.

Background

The Pease limitation dates to 1990. At that time, Congress was looking to raise revenue without increasing the income tax rates and lawmakers created the Pease limitation. The Pease limitation effectively limits the benefit of itemized deductions claimed by higher income individuals. Itemized deductions that would otherwise be allowed are reduced by the lesser of three percent of adjusted gross income (AGI) that exceeds a threshold amount or 80 percent of the total amount of otherwise allowable itemized deductions.

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). The 2001 law gradually eliminated the Pease limitation for the years 2006 through 2010. In 2010, Congress extended repeal of the Pease limitation through 2012. Last year, repeal was again up for a vote in Congress. Many lawmakers wanted to extend repeal of the Pease limitation for one or two more years (or make repeal permanent) but ATRA instead reinstated the Pease limitation for 2013 and subsequent years.

Reinstated Pease limitation

ATRA provides that the amount of a taxpayer's otherwise allowable itemized deductions is reduced or eliminated if the taxpayer's AGI exceeds "applicable threshold amounts." The applicable threshold amounts for application of the Pease limitation in 2013 are $300,000 in the case of married couples filing a joint return or surviving spouse; $275,000 in the case of head of household; $250,000 in the case of an unmarried individual who is not a surviving spouse or head of household; and $150,000 in the case of a married couple filing separately. After 2013, the applicable threshold amounts are adjusted for inflation.

Congress selected these applicable threshold amounts to limit application of the Pease limitation to higher income taxpayers. A taxpayer's AGI must exceed the applicable threshold amount for the Pease limitation to apply.

Certain other rules apply. For purposes of the 80 percent limitation, itemized deductions do not include certain deductions: the deductions for qualified medical expenses, interest expenses, casualty or theft losses, and allowable wagering losses. Additionally, limitations on itemized deductions are applied first and then the otherwise allowable total amount of itemized deductions is reduced. These include the two percent floor for miscellaneous itemized deductions.

Let's take a look at an example:

Inez, age 30, and Tyler, age 31, are married, have no children and file a joint federal income tax return for 2013. Their AGI for 2013 is $350,000. Inez and Tyler have the following amounts to report as itemized deductions on their 2013 return:

Contributions to charitable organizations:

$4,000.00

State and local real property taxes:

$11,000.00

Medical expenses (in excess of the 10 percent AGI floor for 2013):

$2,000.00

Because their AGI exceeds the applicable threshold of $300,000 for a married couple filing a joint return, the amount of their otherwise allowable itemized deductions ($17,000) must be reduced. The first possible reduction is three percent of the excess of their AGI over the applicable threshold amount (($350,000 − $300,000) x 0.03) which is $1,500. The second possible reduction is 80 percent of the amount of itemized deductions (excluding medical expenses) ($15,000 x 0.80) which is $12,000. The lesser of these two amounts is $1,500. Inez and Tyler must reduce their otherwise allowable deductions to $15,500 ($17,000 − $1,500).

If you have any questions about the reinstated Pease limitation, please contact our office.

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When starting a business or changing an existing one there are several types of business entities to choose from, each of which offers its own advantages and disadvantages. Depending on the size of your business, one form may be more suitable than another. For example, a software firm consisting of one principal founder and several part time contractors and employees would be more suited to a sole proprietorship than a corporate or partnership form. But where there are multiple business members, the decision can become more complicated. One form of business that has become increasingly popular is called a limited liability company, or LLC.

The LLC combines several favorable characteristics of a traditional partnership, in which all members are entitled to participate in the management and operation of the business, with those of a corporation, in which the owners, directors, and shareholders are generally shielded from liability for the corporation's debts. The means that in an LLC, just as in a corporation, the personal assets of the business owners' would generally be protected if the business failed, lost a lawsuit, or faced some other catastrophe. Members are only liable to the extent of their capital contribution to the business. In addition, members can fully participate in the management of the business without endangering their limited liability status.

When filing season begins, the profits (or losses) from the LLC pass through to its members, who pay tax on any income when filing their individual returns. In other words, income from the LLC is taxed at the individual tax rates. Income from corporations, on the other hand is taxed twice, once at the corporate entity level and again when distributed to shareholders. Because of this, more tax savings often results if a business formed as an LLC rather than a corporation.

Taxpayers should note, however, that Congress recently increased the top marginal individual income tax rate to 39.6 percent, has placed a .09 percent additional Medicare tax on wages over $200,000 (single taxpayers), and has imposed a 3.8 percent net investment income tax on higher-income taxpayers. At the same time, there is strong talk among members of both political parties of lowering the corporate rate from the current 35 percent to something around 28 or 25 percent to make the United States more competitive with foreign nations. If this happens, many highly profitable LLC businesses may need to rethink their situation and consider switching to a corporate form.

Forming an LLC involves many requirements, but the benefits can be substantial. Please call our offices if you have any questions.

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A business with a significant amount of receivables should evaluate whether some of them may be written off as business bad debts. A business taxpayer may deduct business bad debts if the receivable becomes partially or completely worthless during the tax year.

In general, most business taxpayers must use the specific charge-off method to account for bad debts. The deduction in any case is limited to the taxpayer's adjusted basis in the receivable.

The deduction allowed for bad debts is an ordinary deduction, which can serve to offset regular business income dollar for dollar. If the taxpayer holds a security, which is a capital asset, and the security becomes worthless during the tax year, the tax law only allows a deduction for a capital loss. However, notes receivable obtained in the ordinary course of business are not capital assets. Therefore, if such notes become partially or completely worthless during the tax year, the taxpayer may claim an ordinary deduction for bad debts.

For a taxpayer to sustain a bad debt deduction, the debt must be bona fide. The IRS looks carefully at a bad debt of a family member.

To be entitled to a business debt write off, the taxpayer must also make a reasonable attempt to collect the debt. However, in a nod to reality, the IRS does not request the taxpayer to turn the debt over to a collection agency or file a lawsuit in an attempt to collect the debt if doing so has little probability of success.

Deadlines for claiming a write off for any past business bad debt must be watched. Taxpayers have until the later of (1) seven years from the date they timely filed their tax return or (2) two years from the time they paid the tax, to claim a refund for a deduction for a wholly worthless debt not deducted on the original return.

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Often, timing is everything or so the adage goes. From medicine to sports and cooking, timing can make all the difference in the outcome. What about with taxes? What are your chances of being audited? Does timing play a factor in raising or decreasing your risk of being audited by the IRS? For example, does the time when you file your income tax return affect the IRS's decision to audit you? Some individuals think filing early will decrease their risk of an audit, while others file at the very-last minute, believing this will reduce their chance of being audited. And some taxpayers don't think timing matters at all.

What your return says is key

If it's not the time of filing, what really increases your audit potential? The information on your return, your income bracket and profession--not when you file--are the most significant factors that increase your chances of being audited. The higher your income the more attractive your return becomes to the IRS. And if you're self-employed and/or work in a profession that generates mostly cash income, you are also more likely to draw IRS attention.

Further, you may pique the IRS's interest and trigger an audit if:

You claim a large amount of itemized deductions or an unusually large amount of deductions or losses in relation to your income;
You have questionable business deductions;
You are a higher-income taxpayer;
You claim tax shelter investment losses;
Information on your return doesn't match up with information on your 1099 or W-2 forms received from your employer or investment house;
You have a history of being audited;
You are a partner or shareholder of a corporation that is being audited;
You are self-employed or you are a business or profession currently on the IRS's "hit list" for being targeted for audit, such as Schedule C (Form 1040) filers);
You are primarily a cash-income earner (i.e. you work in a profession that is traditionally a cash-income business)
You claim the earned income tax credit;
You report rental property losses; or
An informant has contacted the IRS asserting you haven't complied with the tax laws.

DIF score

Most audits are generated by a computer program that creates a DIF score (Discriminate Information Function) for your return. The DIF score is used by the IRS to select returns with the highest likelihood of generating additional taxes, interest and penalties for collection by the IRS. It is computed by comparing certain tax items such as income, expenses and deductions reported on your return with national DIF averages for taxpayers in similar tax brackets.

E-filed returns. There is a perception that e-filed returns have a higher audit risk, but there is no proof to support it. All data on hand-written returns end up in a computer file at the IRS anyway; through a combination of a scanning and a hand input procedure that takes place soon after the return is received by the Service Center. Computer cross-matching of tax return data against information returns (W-2s, 1099s, etc.) takes place no matter when or how you file.

Early or late returns. Some individuals believe that since the pool of filed returns is small at the beginning of the filing season, they have a greater chance of being audited. There is no evidence that filing your tax return early increases your risk of being audited. In fact, if you expect a refund from the IRS you should file early so that you receive your refund sooner. Additionally, there is no evidence of an increased risk of audit if you file late on a valid extension. The statute of limitations on audits is generally three years, measured from the due date of the return (April 18 for individuals this year, but typically April 15) whether filed on that date or earlier, or from the date received by the IRS if filed after April 18.

Amended returns. Since all amended returns are visually inspected, there may be a higher risk of being examined. Therefore, weigh the risk carefully before filing an amended return. Amended returns are usually associated with the original return. The Service Center can decide to accept the claim or, if not, send the claim and the original return to the field for examination.

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