IRS boosts 2008 housing cost allowances for those working abroad in high-cost areas Notice 2008-107, 2008-50 IRB

Mike Habib, EA

A new Notice effectively increases the maximum housing cost exclusion for U.S. citizens and residents working abroad in specified high-cost locations. The increases are based on geographic differences in foreign housing costs relative to U.S. housing costs.

Background. A qualified individual may elect to exclude from U.S. gross income his foreign earned income and housing cost amount. (Code Sec. 911(a)) Under Code Sec. 911(c)(1), the maximum excludable housing cost amount is calculated by way of a complex formula.

The excludable housing cost amount is the excess, if any, of (1) the individual’s allowable housing expenses for the year (i.e., the housing expense limitation) over (2) a base amount. For 2008, a taxpayer’s allowable housing expenses, assuming he is eligible for the entire year, generally can’t exceed $26,280; subtracting the base amount of $14,016 yields a generally applicable maximum housing amount exclusion of $12,264.

IRS may issue regs or other guidance providing for the adjustment of the maximum allowable housing expense limitation on the basis of geographic differences in housing costs relative to housing costs in the U.S. (Code Sec. 911(c)(2)(B))

Increases for high-cost areas. Notice 2008-107 makes adjustments for housing costs during 2008 in high-cost foreign areas. Specifically, it contains a table that (1) identifies locations within countries with high housing costs relative to U.S. housing costs, and (2) provides an adjusted annual maximum and daily housing expense limitation for a qualified individual incurring housing expenses in one or more specified high cost localities in 2008 to use (instead of the otherwise applicable annual housing expense limitation of $26,280, or the prorated daily amount) in determining his housing expenses. A qualified individual incurring housing expenses in one or more of the high cost localities identified in the table for the year 2008 may use the adjusted limit provided in the table (in lieu of $26,280 or the prorated daily amount) in determining his housing cost amount on Form 2555, Foreign Earned Income.

Illustration : A U.S. taxpayer is posted to Paris, France, for all of 2008. His maximum housing cost exclusion is $86,084 ($100,100 full year limit on housing expense in Paris minus $14,016 base amount).

Observation: Many, but not all, of the maximum housing expense limitations for specified high cost localities are higher for 2008 than they were for 2007. For example, for 2008, the maximum housing expense limitation for Tokyo, Japan, is $94,200; it was $85,700 for 2007. On the other hand, for Rio de Janeiro, Brazil, the maximum housing expense limitation remains unchanged at $35,100.

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Fact sheet explains wage compensation of S corporation officers Fact Sheet 2008-25

Mike Habib, EA

A recently released IRS fact sheet provides useful information for S corporations and their owners concerning the proper tax treatment when corporate officers perform services for the entity. Specifically, it explains the proper employment tax treatment of payments made to officers of S corporations and how 2% shareholder-employees treat company-paid health insurance premiums.

Background. S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. S shareholders report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. (Code Sec. 1366)

The Code establishes that any officer of a corporation, including S corporations, is an employee of the corporation for federal employment tax purposes. See, e.g., Code Sec. 3121(d)(1), relating to Federal Insurance Contributions Act (FICA) taxes.

Warning in fact sheet. Fact Sheet 2008-25 warns S corporations not to attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages. It goes on to stress that the fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages. The fact sheet emphasizes that courts have consistently held that S corporation officer/shareholders who provide more than minor services to their corporation and receive or are entitled to receive payment are employees whose compensation is subject to federal employment taxes (see, e.g., Nu-Look Design Inc v. Com., (2004, CA3) 93 AFTR 2d 2004-608 and Yeagle Drywall Co Inc v. Com., (2002, CA3) 90 AFTR 2d 2002-7744).

While corporate officers generally are treated as employees for employment tax purposes, there is an exception in regs. Under this exception, an officer who doesn’t perform any services or performs only minor services in his capacity as an officer, and who neither receives nor is entitled to receive any remuneration directly or indirectly, is not an employee. (Reg. § 31.3121(d)-1(b))

Reasonable salary. Fact Sheet 2008-25 notes that the instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”

The amount of the compensation can’t exceed the amount received by the shareholder either directly or indirectly. However, if the shareholder received cash or property or the right to receive cash and property, a salary amount must be determined and the level of salary must be reasonable and appropriate.

There are no specific guidelines for reasonable compensation in the Code or regs. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.

Fact Sheet 2008-25 lists these factors that courts have considered in determining reasonable compensation.

  • training and experience;
  • duties and responsibilities;
  • time and effort devoted to the business;
  • dividend history;
  • payments to non-shareholder employees;
  • timing and manner of paying bonuses to key people;
  • what comparable businesses pay for similar services;
  • compensation agreements; and
  • use of a formula to determine compensation.

Medical insurance premiums. The health and accident insurance premiums paid on behalf of a 2% S corporation shareholder-employee are deductible by the S corporation as fringe benefits and are reportable as wages for income tax withholding purposes on the shareholder-employee’s Form W-2. They are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes. Therefore, this additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder, but is not included in Boxes 3 or 5 of Form W-2.

For this purpose, a “2% shareholder” is any person who owns (or is considered as owning under the constructive ownership rules of Code Sec. 318) on any day during the S corporation’s tax year more than 2% of the outstanding stock of the corporation or stock possessing more than 2% of the total combined voting power of all stock of such corporation. (Code Sec. 1372(b))

A 2% shareholder-employee is eligible for an AGI deduction for amounts paid during the year for medical care premiums if the medical care coverage is established by the S corporation. At one time, “established by the S corporation” meant that the medical care coverage had to be in the name of the S corporation. However, in Notice 2008-1, 2008-2 IRB 251, IRS stated that if the medical coverage plan is in the name of the 2% shareholder and not in the S corporation’s name, a medical care plan can be considered to be established by the S corporation if it either paid or reimbursed the 2% shareholder for the premiums and reported the premium payment or reimbursement as wages on the 2% shareholder’s Form W-2.

Observation: Without affirmatively saying so, Notice 2008-1 effectively repudiated guidance appearing in an article on IRS’s web site in 2006. That guidance had concluded that an S corporation’s sole shareholder-employee couldn’t buy health insurance in his own name and get the above-the-line deduction for the premium expense. Such a deduction is now possible if the above requirements are met.

Payments of the health and accident insurance premiums on behalf of the shareholder may be further identified in Box 14 (Other) of the Form W-2. Schedule K-1 (Form 1120S) and Form 1099 should not be used as an alternative to the Form W-2 to report this additional compensation.

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Senators question Treasury’s liberalization of bank NOL rules

Mike Habib, EA

Senator Chuck Grassley (R-IA), ranking member of the Committee on Finance, and Senator Charles E. Schumer (D-NY), have questioned a controversial IRS Notice that changed the existing rules to allow banks to deduct the built-in losses of other banks that they acquired. Code Sec. 382 generally limits the amount of an acquired corporation’s losses that can be used by the acquiring corporation. After an ownership change, such as in a takeover, Code Sec. 382 limits the amount of a corporation’s taxable income in a post-change year that can be offset by pre-change losses. However, on September 30, IRS issued Notice 2008-83, 2008-42 IRB 905, which provided that a bank’s losses on loans or bad debts (including deductions for a reasonable addition to a reserve for bad debts) wouldn’t be treated as pre-change losses. IRS implemented this administrative action–which resulted in billions of dollars of tax savings for the banks (and lost tax revenue for the government)–on its own.

The Senators noted that the tax change paved the way for Wells Fargo’s acquisition of Wachovia earlier this month, and provided significant tax savings to other banks pursuing takeovers. Wells Fargo saved $19.4 billion; and PNC Financial, which acquired National City, saved $5.1 billion. Schumer questioned whether the tax change created an unnecessary incentive for acquisition-minded banks to pursue takeovers that further consolidated the financial industry and provided no benefit to the stability of the larger financial system, but only an opportunity for firms to shelter their earnings.

Grassley requested that Treasury Inspector General Thorson investigate the facts and circumstances surrounding Notice 2008-83 , noting possible conflicts of interest of Treasury officials, former Goldman Sachs executives, and board members in the sale of Wachovia Corporation to Wells Fargo.

Grassley stated that Notice 2008-83 , which was issued just days before Congress voted on the Emergency Economic Stabilization Act of 2008, appears to have benefited Wachovia executives and Wells Fargo. It allowed Wells Fargo to take over Wachovia despite a pending bid from Citibank by reportedly allowing it to shelter up to $74 billion in profits. It also potentially enabled Wachovia’s senior executives to qualify for parachute payments that may not have been available under the Citibank deal.

Grassley also questioned whether IRS, which was authorized by Code Sec. 382 to issue regs to implement that Code Section, had exceeded that implementing authority by attempting to change the law through Notice 2008-83.

Farmer’s Tax Guide highlights administrative and tax law changes for 2008 IRS Publication 225

Mike Habib, EA

IRS recently released Publication 225, Farmer’s Tax Guide, for use in preparing 2008 returns on its web site. It highlights several administrative and tax law changes for 2008 and 2009.

What’s new for 2008. IRS Publication 225 examines these new items for 2008.

  • Qualified principal residence debt. A taxpayer can exclude from income a canceled debt that is qualified principal residence debt. IRS Publication 225 states that this exclusion applies to debts cancelled after 2006 and before Jan. 1, 2010, which doesn’t reflect the recent extension of the exclusion through 2012 by the Emergency Economic Stabilization Act of 2008. The amount excluded from income is applied to reduce the basis of the taxpayer’s principal residence.
  • Standard mileage rate. For 2008, the standard mileage rate for each mile of business use is 50.5 cents per mile for the period Jan. 1 through June 30, 2008, and 58.5 cents per mile for the period July 1, 2008 through Dec. 31, 2008.
  • Increased Code Sec. 179 expense deduction dollar limits. The maximum amount the taxpayer can elect to deduct for most Code Sec. 179 property he places in service in 2008 is $250,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $800,000.
  • Special depreciation allowance for certain qualified property acquired after Dec. 31, 2007, and placed in service before Jan. 1, 2009. For qualifying property acquired and placed in service in 2008, a taxpayer may be able to take a depreciation deduction equal to 50% of the adjusted basis of the property. Qualifying property includes certain property with a recovery period of 20 years or less, certain computer software, water utility property, or qualified leasehold improvements.
  • Extension of increased Code Sec. 179 deduction for certain qualified GO Zone property. In addition to the increase discussed above, the higher Code Sec. 179 deduction has been extended for qualified Code Sec. 179 GO Zone property placed in service in 2008. Substantially all of the use of this property must be in specified portions of the GO Zone.
  • Additional tax relief for businesses affected by the Kansas storms and tornadoes. An increased Code Sec. 179 and a special depreciation allowance may be available for qualified Recovery Assistance property.
  • Kansas and Midwestern disaster areas. Special rules apply to casualties, thefts, and condemnations in the Kansas and Midwestern disaster areas. Specifically, temporary tax relief was enacted as a result of May 4, 2007, storms and tornadoes affecting the Kansas disaster area. The tax benefits provided by this relief include suspended limits for certain personal casualty losses and special rules for withdrawals and loans from IRAs and other qualified retirement plans. For more details on these and other tax benefits related to the Kansas disaster area, see Pub. 4492-A. Also, temporary tax relief was enacted as a result of severe storms, tornadoes, or flooding affecting Midwestern disaster areas after May 19, 2008, and before Aug. 1, 2008. As discussed in Federal Taxes Weekly Alert 10/09/2008, the tax benefits provided by this relief include:
    • … Suspended limits for certain personal casualty losses and cash contributions.
    • … An additional exemption amount if the taxpayer provided housing for a person displaced by the Midwestern storms, tornadoes, or flooding.
    • … An election to use the taxpayer’s 2007 earned income to figure his 2008 EIC and additional child tax credit.
    • … An increased charitable standard mileage rate for using the taxpayers’ vehicle for volunteer work related to the Midwestern storms, tornadoes, or flooding.
    • … Special rules for time and support tests for people who were temporarily relocated because of the Midwestern storms, tornadoes, or flooding.
    • … Special rules for withdrawals and loans from IRAs and other qualified retirement plans. Details on these and other tax benefits related to the Midwestern disaster areas will be explained in IRS Publication 4492-B.
  • Federally declared disasters. New rules apply to losses of personal use property attributable to federally declared disasters declared in tax years beginning after 2007 and that occurred before 2010. A federally declared disaster is any disaster determined by the President to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. A disaster area is the area determined to warrant such assistance. The new rules do not apply to losses in the Midwestern disaster areas. The new rules are follows:

(1) The net disaster loss (defined in (3) below) is not subject to the 10% of adjusted gross income limit. (2) A taxpayer can deduct a net disaster loss even if he does not itemize his deductions on Schedule A (Form 1040). This is done by completing Form 4684 and entering the net disaster loss on line 7 of the Standard Deduction Worksheet-Line 40 in the Form 1040 Instructions.

(3) The taxpayer’s net disaster loss is the excess of his personal casualty losses attributable to a federally declared disaster and occurring in a disaster area, over his personal casualty gains.

  • Special rules for individuals impacted by Hurricanes Katrina, Rita, and Wilma. If one claimed a casualty or theft loss deduction and in a later year he received more reimbursement than he expected, he does not recompute the tax for the year in which he claimed the deduction. Instead, he must include the reimbursement in his income for the year in which it was received, but only to the extent the original deduction reduced his tax for the earlier year. However, an exception applies if the taxpayer claimed a casualty or theft loss deduction for damage to or destruction of his main home caused by Hurricane Katrina, Rita, or Wilma, and in a later year he received a hurricane relief grant. Under this exception, the taxpayer can choose to file an amended income tax return (Form 1040X) for the tax year in which he claimed the deduction and reduce (but not below zero) the amount of the deduction by the amount of the grant. If he makes this choice, he must file Form 1040X by the later of the due date for filing his return for the tax year in which he receives the grant, or July 30, 2009.
  • Maximum net self-employment earnings. The maximum net self-employment earnings subject to the social security part (12.4%) of the self-employment tax increased to $102,000 for 2008. There is no maximum limit on earnings subject to the Medicare part.
  • Conservation Reserve Program (CRP) payments. For payments made after 2007, CRP payments are excluded from self-employment tax for individuals receiving social security benefits for retirement or disability.
  • Optional methods to figure net earnings. For tax years beginning after 2007, the amount of gross and net income from self-employment one may have when using the farm optional method or nonfarm optional method has increased. This allows electing taxpayers to secure up to four credits of social security benefits coverage. In future years, the thresholds will be indexed to maintain that level of coverage.

What’s new for 2009. IRS Publication 225 examines these new items for 2009.

  • New definition for race horses eligible for the 3-year recovery period. Any race horse (without regard to the age of the horse) placed in service after Dec. 31, 2008, is considered 3-year property for General Depreciation System (GDS) recovery purposes.
  • Expiration of GO Zone and Kansas storms and tornadoes provisions. Most GO Zone and Kansas disaster area relief provisions won’t apply to property placed in service after Dec. 31, 2008.
  • New recovery period for certain machinery and equipment. Any machinery or equipment (other than any grain bins, cotton ginning assets, fences, or other land improvements) which is used in a farming business where the original use begins with the taxpayer after Dec. 31, 2008, and is placed in service before Jan. 1, 2010, will be treated as 5-year property for GDS purposes (10-year property for purposes of the Alternative Depreciation System (ADS)).
  • Maximum net self-employment earnings. The maximum net self-employment earnings subject to the social security part of the self-employment tax increased to $106,800 for 2009. There is no maximum limit on earnings subject to the Medicare part.
  • Wage limit for social security tax. The limit on wages subject to the social security tax for 2009 is $106,800. There is no limit on wages subject to the Medicare tax.
  • New employment tax adjustment process in 2009. If a taxpayer discovers an error on a previously filed Form 943 after Dec. 31, 2008, he should make the correction using Form 943-X, Adjusted Employer’s Annual Federal Tax Return for Agricultural Employees. Currently, taxpayers make corrections to Form 943 using Form 941c that is filed once a year with Form 943. Form 943-X is a stand-alone form, meaning taxpayers can file Form 943-X when an error is discovered, rather than waiting until the end of the year to file Form 941c with Form 943. Current year adjustments will continue to be made on line 8 of Form 943.

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IT company owes nearly $1.7 million in back wages due to H-1B Visa Program violations [DOL ESA News Release, 10/30/08]:

Mike Habib, EA

An information technology (IT) company has agreed to pay $1,683,584 in back wages to 343 non-immigrant workers after a Department of Labor (DOL) investigation found that the company had violated the H-1B visa provisions of the Immigration and Nationality Act.

The H-1B program permits employers to temporarily hire foreign workers for jobs in the U.S. in professional occupations, such as computer programmers, engineers, physicians, and teachers. H-1B workers must be paid at least the same wage rate that is paid to U.S. workers who perform the same type of work, or the prevailing wage rate in the area of intended employment. From March 2005 through March 2007, employees hired by the IT company were not paid the minimum amount of wages that are required under the H-1B program.

The company also charged new H-1B workers training fees ranging from $1,000 to $2,500, which is in violation of the law.

Roundup of recent employment tax rulings

Mike Habib, EA

There have been several recent rulings issued in the employment tax area. Here is a summary:

Joint employment. A federal district court has ruled that a property management company was the joint employer of leasing consultants who worked out of the management company’s call center through three different staffing agencies. As a result, the management company owed the leasing consultants overtime under the Fair Labor Standards Act (FLSA). In issuing its ruling, the district court said that the management company maintained significant control over the working conditions of the leased employees. The district court noted that although the staffing agencies provided the management company with workers, it was the management company which determined the amount it would pay, including overtime, and the total number of hours that the employees could work. The management company provided the workspace and equipment. In addition, the management company could reject any of the agency employees it did not want at its facility. In addition, the leased employees were under the management company’s control and direction and were treated exactly like the management company’s contract employees performing the same job [Bastian v. Apartment Investment and Management Company, DC IL, Dkt No. 07 C 2069, 10/21/08].

Family Medical Leave Act. A federal district court has denied summary judgment to an employer that terminated an employee due to excess absenteeism. An absentee rate above a certain level was grounds for dismissal. The employee claimed that her rate would not have been above this level if her employer had factored her FMLA leave into the computation [Dickinson v. St. Cloud Hospital, DC MN, Dkt. No 07-3346 ADM/RLE, 10/20/08].

FICA tip credit. IRS Chief Counsel has concluded that the IRC §45B credit (also known as the FICA tip credit) may be claimed by an employer on its income tax return in the year (current tax year) that the IRS issued a notice and demand for payment of the FICA taxes from the employer, even though that was not the year (previous tax year) in which the unreported tips were received by the employee. The employee had failed to report the tips to his employer in the previous tax year. The employer in the current tax year received a notice and demand for the employer share of FICA taxes from the IRS. Chief Counsel concluded that for purposes of the credit, the tip amounts are deemed to be paid on the date on which the IRS notice and demand for the employer portion of the FICA tax is made to the employer [Chief Counsel Advice 200845052].

Trust fund recovery penalty. A federal appeals court has ruled that the president of a day care facility’s board of directors was a responsible person liable for the IRC §6672(a) trust fund penalty. Under IRC §6672(a), when an employer fails to properly pay over its payroll taxes, the IRS can seek to collect a penalty equal to 100% of the unpaid taxes from a “responsible person,” i.e., a person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility. In this ruling, the president played an active role in various aspects of the day care facility’s operation and could have ensured that it paid its taxes, but chose instead not to exert any authority over these business affairs. Further, he didn’t qualify for the protection from the penalty given voluntary board members under IRC §6672(a) [Jefferson v. U.S., CA 7, 102 AFTR 2d 2008-6572, 10/8/08].

Calculation of disability benefits. A federal appeals court has ruled that per diem payments that an employer made to an employee should have been classified as “wages” for purposes of calculating benefits under the Longshore and Harbor Workers’ Compensation Act. On June 10, 2002, Otis Pearley injured his back in the course of his employment with B&D Contracting. From June 2002 through January 2006, Pearley received $241.52 per week in temporary disability benefits from B&D. The company specifically excluded its per diem payments to Pearley in the calculation of his benefits rate. Pearley challenged the amount of these payments before a Department of Labor administrative law judge (ALJ). The ALJ concluded that B&D should have included Pearley’s per diem payments as wages for purposes of calculating his average weekly wage. Accordingly, the ALJ calculated Pearley’s average weekly wage as $761.98, with a corresponding benefits rate of $507.98. The Benefits Review Board (BRB) agreed with the ALJ’s ruling. The U.S. Court of Appeals for the Fifth Circuit has now denied any further review of the BRB decision [B&D Contracting v. Pearley, CA5, Dkt. No. 07-60495, 11/6/08].

Gambling winnings or losses?

Mike Habib, EA

As a US taxpayer, you can deduct gambling losses only if you itemize your deductions on form 1040. You can claim your gambling losses as a miscellaneous deduction on IRS Form 1040, Schedule A. However, the amount of losses you deduct can not total more than the amount of gambling income you’ve reported on your return. It’s important to keep an accurate diary or similar record of your gambling winnings and losses. To deduct your losses, you must be able to provide receipts, tickets, statements or other records that show the amount of both your winnings and losses.

The IRS provides the following guidelines for proving gambling winnings and losses:

An accurate diary or similar record regularly maintained by the taxpayer, supplemented by verifiable documentation usually is acceptable evidence for substantiation of wagering winnings and losses. In general, the diary should contain at least the following information

  • Date and type of specific wager or wagering activity
  • Name of gambling establishment
  • Address or location of gambling establishment
  • Name(s) of other person(s) present with you at gambling establishment
  • Amount(s) won or lost

Verifiable documentation includes, but is not limited to:

  • Wagering tickets
  • Canceled checks
  • Credit records
  • Bank withdrawals
  • Statements of actual winnings or payment slips provided by the gambling establishment

When possible, the diary and available documentation of the placement and settlement of a wager should be supported by such documentation as:

  • Hotel bills
  • Airline tickets
  • Gasoline credit cards
  • Affidavits or testimony from responsible gambling officials regarding the wagering activity

Refer to IRS Publication 529, Miscellaneous Deductions, for information on record keeping. For additional information, refer to IRS Publication 525, Taxable and Nontaxable Income.

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Estate not taxed on transfer of decedent’s pension to charitable beneficiary PLR 200845029

IRS has privately ruled that an estate will not be taxed on a distribution of the decedent’s pension benefits to a charitable beneficiary of the estate.

Facts. An individual, whom we’ll call, Smith, died owning an interest in a defined benefit pension plan (the Plan Interest) of which his estate (Estate) was the beneficiary. His will (Will) named Charity as a residuary beneficiary. The executor of Estate proposes to assign the benefit of the Plan Interest to Charity in partial satisfaction of Charity’s share of the residue. The Will gave the executor the power to distribute property in kind and state law further allows distributions in kind without any requirement that they be made on a pro-rata basis.

Background. Income earned by an individual before death that isn’t included on his final return because of his accounting method (usually income that has been earned or accrued but hasn’t been actually or constructively received by a cash method taxpayer) is known as income in respect of a decedent or IRD. A decedent’s IRD must be reported, for the tax year when received, by:

  • the decedent’s estate, if it acquired the right to receive the item of income from the decedent;
  • the person who, by reason of the decedent’s death, acquires the right to the income whenever this right isn’t acquired by the decedent’s estate from the decedent; or
  • the person who acquires the right from the decedent by bequest, devise or inheritance, if the amount is received after distribution by the decedent’s estate of the right to the income. (Code Sec. 691(a)(1))

A transfer of a right to receive IRD is taxable to the transferor in the year of the transfer in an amount equal to the fair market value of the right or the amount received for it, whichever is greater. For this purpose, a transfer includes a sale, exchange, or other disposition, or the satisfaction of an installment obligation at other than face value, but does not include transmission at death to the estate of the decedent or a transfer to a person pursuant to the person’s right to receive the amount by reason of the decedent’s death or by bequest, devise, or inheritance from the decedent. (Code Sec. 691(a)(2))

If the estate of a decedent or any person transmits the right to IRD to another who would be required by Code Sec. 691(a)(1) to include such income when received in his gross income, only the transferee will include such income when received in his gross income. In this situation, a transfer within the meaning of Code Sec. 691(a)(2) has not occurred. (Reg. § 1.691(a)-4(b))

Under Reg. § 1.691(a)-4(b), if a right to IRD is transferred by an estate to a specific or residuary legatee, only the specific or residuary legatee must include such income in gross income when received.

Favorable ruling. The ruling concluded that the assignment of the Plan Interest to Charity in partial satisfaction of its share of the residue of Estate won’t be a transfer within the meaning of Code Sec. 691(a)(2). Thus, only Charity will include the amounts of IRD in the Plan Interest in its gross income when the distribution or distributions from the Plan Interest are received by Charity.

Observation: Thus, while the pension benefits are included in Charity’s income, as a practical matter, since Charity is a tax-exempt entity, this means the pension benefits will escape tax.

Year-end tax planning client letter with checklist

As the end of the year approaches, it is a good time to think of planning moves that will help lower your tax bill this year and possibly the next. Factors that compound the challenge include the stock market’s swoon, the difficult economic climate we’re in right now, and the strong possibility that there will be tax changes in the works next year. In fact, there might even be another economic stimulus package carrying tax changes enacted before the end of this year.

The indisputably good news we are certain of is that Congress has acted to “patch” the AMT problem for 2008, has retroactively reinstated a number of tax breaks (such as the option to deduct state and local general sales tax instead of state and local income tax and the above-the-line deduction for higher education expenses), and has created new tax breaks that go into effect for the 2008 tax year (including a tax credit for first-time homebuyers, a nonitemizers’ deduction for state and local property tax and a nonitemizers’ deduction for certain disaster losses). For 2008, businesses enjoy tax breaks such as a beefed-up expensing option and a 50% bonus first-year depreciation write-off for most machinery and equipment placed into service this year and a reinstated research credit.

We have compiled a checklist of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax saving moves to make:

  • Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year. Don’t forget you can set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids.
  • If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2008.
  • Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, and then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.
  • Postpone income until 2009 and accelerate deductions into 2008 to lower your 2008 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2008 that are phased out over varying levels of adjusted gross income (AGI). These include IRA and Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2008. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year.
  • If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into Roth IRAs if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2008.
  • It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2009.
  • If you own an interest in a partnership or S corporation you may need to increase your basis in the entity so you can deduct a loss from it for this year.
  • Consider using a credit card to prepay expenses that can generate deductions for this year.
  • If you expect to owe state and local income taxes when you file your return next year, ask your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2008.
  • Those facing a penalty for underpayment of federal estimated tax may be able to eliminate or reduce it by increasing their withholding.
  • You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions.
  • Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2008, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. This includes the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. As a result, in some cases, deductions should be deferred rather than accelerated to keep them from being lost because of the AMT.
  • If you are thinking of making energy saving improvements to your home, such as putting in extra insulation or installing energy saving windows, postpone your move until 2009. A credit of up to $500 may be available for such improvements if made next year (but not this year).
  • Substantial tax credits are available for installing energy generating equipment (such as solar electric panels or solar hot water heaters) to your home. The credits are available whether you spend the money this year or next, but if you’re installing solar electric property, and will be spending more than $6,667, the credit will be larger for expenses made in 2009 rather than 2008.
  • If you are thinking of buying a hybrid vehicle eligible for a tax credit, check to see if it’s eligible for the credit, and, if so, purchase it before year-end.
  • You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.
  • Businesses should consider making expenditures that qualify for the up to $250,000 business property expensing option for assets bought and placed in service this year; the maximum expensing amount will drop to $133,000 for assets bought and placed in service next year (higher expensing amounts apply to certain specialized assets). Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. This bonus write-off generally won’t be available next year (some exceptions apply, such as for businesses affected by Presidentially declared disasters).
  • You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
  • If you are self-employed and haven’t done so yet, set up a self-employed retirement plan.
  • You can save gift and estate taxes by making gifts sheltered by the annual gift tax exclusion before the end of the year. You can give $12,000 in 2008 to an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next.
  • If you’re thinking of donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities; the latter may yield a bigger deduction for you.
  • If you are age 70 1/2 or older, own IRAs (or Roth IRAs), and are thinking of making a charitable gift before year-end, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer can achieve important tax savings.
  • If you are receiving Social Security benefits, there are a number of steps you can take to reduce or eliminate tax on your benefits.
  • Consider extending your subscriptions to professional journals, paying union or professional dues, enrolling in (and paying tuition for) job-related courses, etc., to bunch into 2008 miscellaneous itemized deductions subject to the 2%-of-AGI floor.
  • Depending on your particular situation, you may also want to consider deferring a debt-cancellation event until 2009, electing to deduct investment interest against capital gains, and disposing of a passive activity to allow you to deduct suspended losses.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.

How businesses are affected by tax changes in the Emergency Economic Stabilization Act of 2008

As I’m sure you’re aware, on Oct. 3, 2008, the President signed into law the Emergency Economic Stabilization Act of 2008 (P.L. 110-343). Although virtually all of the press coverage of this law has concentrated on its hotly debated $700 billion financial industry bailout plan, the legislation also contains scores of mostly beneficial tax changes for business.

Most of the new law’s tax changes for business fall into one of these categories: tax changes that apply to a wide range of businesses; special tax breaks for disaster areas; and tax changes for specialized industries (there are numerous tax breaks relating to alternative energy production, but they are highly specialized and so not covered in this letter).

Tax breaks that apply to a wide range of businesses. The major news for business is that the research tax credit has been extended through 2009. The new law also makes a number of important changes in the way the research credit is calculated, effective for tax years beginning after 2008.

Other, widely applicable tax breaks for business include the following:

  • The FUTA (Federal Unemployment Tax Act) tax rate had been scheduled to drop to 6% after 2008, but under the new law it will remain at 6.2% through 2009 and will drop to 6% for 2010 and later.
  • For property placed in service after Aug. 31, 2008, the new law permits 50% first year bonus depreciation for qualified reuse and recycling property. In general, this is machinery and equipment (not including buildings or real estate), along with associated property, including software necessary to operate the equipment, which is used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials. This break is not limited to businesses in the recycling industry.
  • A two year extension through 2009 of enhanced charitable contribution deduction rules for gifts of certain types of food inventory, and corporate gifts of book inventory or computer equipment to schools.
  • A two year extension through 2009 for the tax break that allows expensing of qualified environmental remediation expenses, namely cleanup of hazardous substances (including petroleum products) at qualified contaminated sites.
  • The deduction for energy efficient commercial building property has been extended so that it applies through 2013.
  • For purchases after 2008 and before 2015, taxpayers will be able to claim a tax credit for electric drive motor vehicles.
  • After 2008, companies will be able to give employees who commute by bicycle a $20 per month tax-free reimbursement for reasonable bicycle related expenses.

Tax breaks for businesses in disaster areas. The new law creates a new set of tax relief provisions for businesses hit by events such as storms, hurricanes, and floods anywhere in the U.S. that are declared to be federal disasters after 2007 and before 2010. These are of great importance to businesses because many federal disasters have already been declared in numerous states in 2008 and many others are likely to occur before the tax breaks sunset.

Here’s a summary of the new relief provisions:

  • Qualified disaster expenses, such as cleanup (removal of debris, demolition of structures) and repairs, may be expensed.
  • A 5-year net operating loss (NOL) carryback applies instead of the usual 2-year carryback.
  • The maximum amount of machinery and equipment that may be expensed under Section 179 is increased by up to $100,000 for qualifying assets, and the investment-based phaseout of the expensing deduction is increased by $600,000.
  • A 50% first-year bonus depreciation allowance applies to most types of machinery and equipment bought to rehabilitate or replace damaged property. A number of conditions must be met, and certain types of property are excluded (including property eligible for the more widely applicable 50% first-year bonus depreciation allowance enacted as part of the Economic Stimulus Act of 2008).

The new law also includes a number of specialized provisions for victims of a Midwest disaster area (counties in ten Midwest states declared to be a major disaster after May 19, 2008, and before Aug. 1, 2008).

Tax breaks for specialized industries. Tax breaks in the new law mainly benefiting specific industries include the following:

  • Financial institutions–may treat post-2007 losses on Fannie Mae and Freddie Mac preferred stock as ordinary losses instead of capital losses; for tax years ending after Oct. 2, 2008, the $1 million deduction cap on compensation paid to certain top officers is reduced to $500,000 if the company participates in the federal government’s “troubled assets relief program” (TARP); and the “golden parachute” deduction restrictions apply to severance payments to certain top executives of companies participating in TARP. Finally, for securities acquired after 2010 (later dates apply to some specialized securities), brokers will have to report the customer’s adjusted basis in the security sold, and whether any gain or loss is short- or long-term.
  • Farming–there’s a 5-year quick depreciation writeoff for most farm machinery and equipment placed in service after 2008 and before 2010.
  • Real estate, retailers, and restaurants–the 15-year depreciation writeoff for qualifying leasehold improvements and qualifying restaurant property has been extended through 2009. What’s more, for property placed in service after 2008 and before 2010, (a) buildings as well as building improvements may qualify for the quick writeoff for restaurant property; and (b) the 15-year depreciation writeoff also applies to qualifying retail improvement property.
  • Construction companies–the $2,000 tax credit for building energy efficient homes ($1 million for manufactured homes) has been extended to apply to homes acquired through 2009. Note that construction companies also may benefit indirectly from the extended and enhanced tax breaks for real estate, restaurants, and retailers.
  • Film and TV–the option to expense up to $15 million of qualifying film and TV productions ($20 million if produced in certain low-income areas) is extended so that it applies for productions beginning before 2010; also, the qualified domestic production activities deduction has been liberalized in several ways for this industry, effective for tax years beginning after 2007.
  • Motorsports racing–the short 7-year writeoff for land improvements and support facilities at motorsports entertainment complexes has been extended to apply for property placed in service before 2010.
  • Oil and gas–there are three significant changes: (1) the otherwise available domestic production activities deduction for companies that have oil-related income will be reduced after 2009 (a complex reduction formula will apply); (2) the rule providing that percentage depletion from marginal oil and gas wells isn’t limited to 100% of income from these properties is extended though 2009; and (3) the rules relating to foreign tax credits for the oil and gas industry have been revised for tax years beginning after 2008.
  • Mining–the tax credit for mine rescue training and the election to expense 50% of the cost of certain mine safety equipment both have been extended so that they apply through 2009.

Please keep in mind that I’ve described only the highlights of how the new law affects businesses. If you would like more details, please call me at your convenience.