Tax situations that baffled me this year

It is becoming more difficult finding time for blogging now that the tax season is moving into high gear.

To make things more difficult, I’ve had two never-before encountered tax situations arise for two of my clients.

DROUGHT-RELATED SALE OF LIVESTOCK
One client bought a half interest in a cattle business and they formed a new Limited Liability Company. A few months afterward there was a drought and they had to sell off a large part of the herd. This caused a recovery of my client’s investment, but created a potential taxable gain. There is a provision, however, that, under certain conditions, a drought-related sale of livestock qualifies as an involuntary conversion and enables the sellers to avoid paying tax on all or part of the the gain if they reinvest in replacement livestock within a specified time. A lot of research was necessary for this situation.

CANADIAN FORM NR4 INCOME FROM ESTATE
Another client had a Canadian Form NR4 which baffled me. I finally consulted with a Canadian accountant who explained that one line represented Canadian Taxable Income and Canadian Tax withheld. Another line represented U.S. Income and U.S. tax withheld. I decided that it should go on Schedule E, page 2 as Income from a Trust or Estate, but assumed that there would be a problem since a Canadian Estate would not have a U.S. ID number. The Canadian accountant said they probably did have a U.S. ID.

Later when I was looking at the Form again, I discovered a nine-digit number just below the address of the company that issued the form—so that solved my dilemma.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Foreign Income

U S Citizens often invest in foreign securities from Canada, South Africa, Europe and other nations. Some U S citizens take overseas jobs in foreign countries. This type of income has tax implications. For example Canada withholds 15% tax from dividends paid to U S investors. You may be able to deduct this tax on line 47 of your form 1040 but you may need to complete Form 1116 in order to determine if all or what part can be deducted. If you don't deduct it on line 47 of your 1040, you can deduct it as an itemized deduction.

The following is from an IRS "Tax Tip."

INCOME FROM FOREIGN SOURCES

Many United States citizens earn money from foreign sources. These taxpayers must remember that they must report all such income on their tax return, unless it is exempt under federal law.

U.S. citizens are taxed on their worldwide income. This applies whether a person lives inside or outside the United States. The foreign income rule also applies regardless of whether or not the person receives a Form W-2, Wage and Tax Statement, or a Form 1099 (information return).

Foreign source income includes earned and unearned income, such as:

• Wages and tips
• Interest
• Dividends
• Capital Gains
• Pensions
• Rents
• Royalties

An important point to remember is that citizens living outside the U.S. may be able to exclude up to $82,400 of their 2006 foreign source income if they meet certain requirements. However, the exclusion does not apply to payments made by the U.S. government to its civilian or military employees living outside the U.S.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

NOMINEE DIVIDENDS AND INTEREST

Reporting Dividends or Interest you receive for another person.

If a corporation reports dividends in your name that actually belong to someone else, this is called dividends you received as a NOMINEE. You could also receive Interest as a nominee. In such cases, you should not pay tax on such income, but you must follow proper procedures to report the income to the person who actually receives the money from the dividends or interest.

You should prepare a Form 1099-DIV or 1099-INT and send them together with a Form 1096 transmittal to the IRS. You should also give the actual owner of the dividends Copy B of the Form 1099. On these forms, you should list yourself as the Payer and list the actual owner as the Recipient.

You should also report dividends or interest which you received as a nominee on Schedule B of your Form 1040 just as you would any other dividends or interest. You should then add all dividends or interest and put a subtotal on Schedule B a few lines below the last dividend or interest item you have entered.

Below this subtotal, enter “Nominee Distribution” and show the amount received as a nominee. Subtract the total of your nominee distributions from the subtotal. Enter the result on line 6 in the case of dividends. For interest you would subtract the nominee interest from the subtotal and enter the result on Line 2 of Schedule B.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Inherited Real Etate

INCOME FROM SALE OF INHERITED REAL ESTATE

- If you inherit a home or other real estate from a deceased relative, you may actually have a tax loss. Often the heir inherit the home of the deceased and want to dispose of it as soon as possible to avoid paying ad valorem taxes on an empty house.

When they sell it they may reduce the price for a quick sale and incur real estate commissions and other closing costs.

You should value your basis in the inherited property at its value on the date of death, which might be a greater value than you received for the property. A quick and easy way to check its value would be to look at its assessed value on the county tax rolls which are usually available on the internet. That should be a safe assumption if you choose to value it as if that were your cost.

If you think the tax assessor undervalued it, you might need to get an independent appraisal.

When you report it on your tax return, it goes on Schedule D. Instead of entering the date acquired, enter “Inherited.” For the date sold, enter the actual date title was transferred to the purchaser. Even if you sold it a week after you inherited it, you would report it as a long-term capital gain or loss.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Can you trust the IRS?

Can you trust the IRS?

I noticed something new this year on the first return I prepared for which the taxpayer wanted a check mailed to him instead of a direct deposit to his bank account. Lines 74a and 74b on page 2 of Form 1040 have a place to enter your bank routing number and account number. When I printed the tax return I noticed these lines were filled in with XXXXXXXX. At first I thought this must be a flaw in my tax software.

After making inquiries, someone suggested that it might be something the IRS asked tax software companies to add to these lines. But why? The reason suggested was that some unscrupulous IRS employees might fill in their own bank account numbers if these lines were left blank.

Has this actually happened? I don't know and the IRS isn't likely to admit that your confidential information isn't safe in their hands.

This brings some related risks to my mind.

• Don't make your check out to 'IRS" Some female employee at the IRS might change the "I" in IRS to "M" then add 'rs' and the check would then be to Mrs. XXX.
• Be cautious in selecting a tax preparer. I heard that some employee of a large tax-preparation company was caught after having using the clients' information such as credit card numbers and social security numbers in an identity theft scheme

Where there is a will, there is a way----to cheat.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

IRS-related phishing scams

IRS-related phishing scams
If the IRS doesn't get you, the scammers will (if they can).
Taxpayers to be on the lookout for bogus e-mails claiming to be from the tax IRS.

Scammers send e-mails, which are designed to trick the recipients into disclosing personal and financial information that could be used to steal the recipients’ identity and financial assets.

“The IRS does not send out unsolicited e-mails asking for personal information,” said IRS Commissioner Mark W. Everson. “Don’t be taken in by these criminals.”

The IRS has seen a recent increase in these scams. Since November, 99 different scams have been identified, with 20 of those coming in June – the most since 40 were identified in March during the height of the filing season.

Many of these schemes originate outside the United States. To date, investigations by the Treasury Inspector General for Tax Administration have identified sites hosting more than two dozen IRS-related phishing scams. These scam Web sites have been located in many different countries, including Argentina, Aruba, Australia, Austria, Canada, Chile, China, England, Germany, Indonesia, Italy, Japan, Korea, Malaysia, Mexico, Poland, Singapore and Slovakia, as well as the United States.

The current scams claim to come from the IRS, tell recipients that they are due a federal tax refund, and direct them to a Web site that appears to be a genuine IRS site. The bogus sites contain forms or interactive Web pages similar to IRS forms or Web pages but which have been modified to request detailed personal and financial information from the e-mail recipients. In addition, e-mail addresses ending with “.edu” — involving users in the education community — currently seem to be heavily targeted.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Are you missing the point(s)?

If you bought a new house in 2006, you may be overlooking some tax deductions.
Take a look at your settlement statement (HUD Form).

Lines 801 and 802, Entitled Loan Origination Fee and Loan Discount - These are points charged to either the buyer or the seller - or both. The buyer can deduct these charges as interest on Line 11 or 12 of Schedule A (itemized deductions). Even the seller-paid points are deductible by the buyer, since, theoretically, the seller has priced the house high enough to cover these expenses.

However, you should check your Form 1098 to see if the Mortgage company lists the points. If it does show them, then the points go on line 11 and you don't get to deduct the same amount twice.
If the Form 1098 does NOT list the points, then you should enter them on line 12 of Schedule A.

Some other items listed on the settlement statement that are deductible by the buyer:

• line 106 and 107 Taxes charged to the buyer to reimburse the seller for prepaid taxes
• Line 901 Interest in buyer column. (not deductible if reported on Form 1098)

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Corporartion Sole

TAX AVOIDANCE SCHEMES-Corporation Sole

A few months ago someone asked me about doing business as a Corporation Sole to minimize his tax burden. He was skeptical since it sounded too good to be true. I checked with the IRS and here is what I found:

Taxpayers should be wary of promoters offering a tax evasion scheme that misuses “Corporation Sole” laws. Promoters of the scheme misrepresent state and federal laws intended only for bona-fide churches, religious institutions and church leaders.

"This scheme shamelessly tries to take advantage of special tax benefits available to legitimate religious groups and church leaders," said IRS Commissioner Mark W. Everson. "Unscrupulous tax promoters always look for ways to game the system and prey on unsuspecting victims. Taxpayers should be on the look-out for these and other scams."

Scheme promoters typically exploit legitimate laws to establish sham one-person, nonprofit religious corporations. Participants in the scam apply for incorporation under the pretext of being a “bishop” or “overseer” of the phony religious organization or society. The idea promoted is that the arrangement entitles the individual to exemption from federal income taxes as an organization described in Section 501(c)(3) laws.

The scheme is currently being marketed through seminars with fees of up to $1,000 or more per person. Would-be participants purportedly are told that Corporation Sole laws provide a “legal” way to escape paying federal income taxes, child support and other personal debts by hiding assets in a tax exempt entity.

While fraudulent Corporation Sole filings have happened sporadically for many years, the IRS has recently seen signs the scam could be starting to spread with multiple cases seen recently in states such as Utah and Washington. The IRS is concerned about this increase and is taking steps to pursue Corporation Sole promoters and participants.

Used as intended, Corporation Sole statutes enable religious leaders — typically bishops or parsons — to be incorporated for the purpose of insuring the continuation of ownership of property dedicated to the benefit of a legitimate religious organization. Generally, creditors of a Corporation Sole may not look to the assets of the individual holding the office nor may the creditors of the individual look to the assets held by the Corporation Sole. Currently, 16 states permit Corporation Sole incorporations. The IRS suggests that individuals considering becoming involved in any kind of tax avoidance arrangement obtain expert advice from a competent tax advisor not involved in selling the arrangement. Do not rely on legal opinions obtained or provided by the arrangement’s promoter. Start by asking the following questions:

• Is the arrangement designed to hide income or assets?
• Is the arrangement designed to evade income taxes?

Answering “yes,” or even “maybe,” to either of these questions should raise red flags for taxpayers.

Tax guidelines for churches and religious institutions can be found in Publication 1828, “Tax Guide for Churches and Religious Organizations”.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Missing Form 1099

MISSING A FORM 1099?

If you receive certain types of income, you may get a Form 1099 for use with your federal tax return. Form 1099 is an information return provided by the payer of the income. You should receive your Form 1099-series information returns by January 31, 2007. The payer deadline to mail Form 1099-series is January 31, 2007.

If you have not received an expected Form 1099 within a few days after that, contact the payer, to secure the missing information. If you still do not receive the form by February 15th, call the IRS for assistance at 800-829-1040.

In some cases, you may obtain the information that would be on the Form 1099 from other sources. For example, your bank may put a summary of the interest paid during the year on the December or January statement for your savings or checking account. If you are able to get the accurate information needed to complete your tax return, you do not have to wait for the Form 1099 to arrive.

Form 1099-series is not a required attachment to your return, except when you receive a Form 1099-R, or Form 1099-INT that shows federal income tax withheld. You will not usually attach a 1099-series form to your return, except when you receive a Form 1099-R that shows income tax withheld. You should keep a copy of all the 1099s that you receive with your tax records for the year. There are several different forms in this series, including:

• Form 1099–B, Proceeds From Broker and Barter Exchange Transactions
  
• Form 1099–DIV, Dividends and Distributions
  
• Form 1099–INT, Interest Income
  
• Form 1099–MISC, Miscellaneous Income
  
• Form 1099–OID, Original Issue Discount
  
• Form 1099–R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
  
• Form SSA–1099, Social Security Benefit Statement

If you file your return and later receive a Form 1099 for income that you did not fully include on that return, you should report the income and take credit for any federal income tax withheld by filing Form 1040X, Amended U.S. Individual Income Tax Return. Form 1040X and instructions are available on the IRS Web site at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

• Form 1040X, Amended U.S. Individual Income Tax Return (PDF 123K)
• Instructions for Form 1040X (PDF 43K)
• Forms and Publications

Energy saving credits

TAX CREDIT FOR ENERGY-SAVING COSTS
-If you made your home more energy-efficient you may be entitled to a tax credit.
There are two categories that qualify for the credit:
1. Energy efficiency improvements
2. Residential energy property costs.
Energy efficiency improvements:
The first category includes
· Insulation that reduces heat loss
· Energy-saving exterior windows and doors
· Metal roofs pigmented with heat-reducing coatings.
Residential energy property costs:
The second category includes
· Qualified solar electric-generating equipment
· Solar water heating equipment
· Fuel cell equipment which converts a fuel into electricity by electrochemical means.

The energy efficiency credit is 10% of the cost subject to certain dollar limitations.
The Residential energy property costs credit is 30% of costs with dollar limitations.

The above is only intended to provide a broad general discussion of the subject. For further details--if you have made any such improvements-- you should look at Form 5696 and the related instructions at http://www.irs.gov/

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

Construction Acctg

TAXATION OF CONSTRUCTION CONTRACTS:

For construction costs you would report income and expense under either the Percentage-of-completion method or the Completed Contract method.
If you begin and complete a construction contract in the same tax year, you would report all income and expense on that year’s tax return. However if the construction period laps over two years, even if the total time is less than a year, you then use a different approach.

PERCENTAGE OF COMPLETION METHOD:
If you choose, or are required to use, the Percentage-of-completion method, you must calculate a percentage to be used in reporting income. The percent is determined by dividing the cost incurred during the year by the total estimated cost to be incurred for the entire contract. Suppose you had a contract to build something for $ 3 million. If you expect the total costs to be $2 million and have incurred $ 1 million in costs during the year, you would report half of the $ 3 million as income for the year. Your income would be $ 1.5 million and your expense would be the $ 1 million cost actually incurred and the profit would be $ 500,000 minus some overhead expense.

COMPLETED CONTRACT METHOD:
A small contractor can use the completed-contract method which seems less complicated. Under the completed contract method, you would report no income or expense until the contract was completed. You would report everything in the year it was completed.

PROGRESS PAYMENTS:
Generally a contractor receives progress payments based on percentage of completion regardless of how he reports his income. These payments would not be income. They would never exceed the total contract price, and would probably be less than the income reported if the percentage-of-completion method were used. If the completed contract method is used, any unused funds would be considered a loan from the buyer until the contract was completed.

Accounting entries to record income and expense:
Percentage-of-Completion method

• Debit Construction in Progress and Credit Cash or Accounts payable to record costs.
• Debit Cash and credit 'Progress Billings' or some similar liability account to record progress payments received.
• Debit Construction in Progress and Credit Income for profits recognized.
  
• Debit 'Progress Payments' and credit 'Construction in Progress' when the contract is completed.

Completed-Contract Method:
The first two entries would be the same.
Upon completion, you would debit a Cost of Sales account and credit Construction in Progress and would Debit Progress Billings and Credit Income. If there were a final payment not included in progress billings, you would debit Cash and Credit the final payment to Income.

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

EDUCATION-RELATED DEDUCTIONS AND CREDITS

-TUITION AND FEES - DEDUCTIONS AND CREDITS

There are several options. A professional tax-preparer can easily select the best option if his software works like mine does. I enter the amount of the education expenses and check a box to select the Hope credit and check the tax result. Then I deselect the Hope credit and check the box for the lifetime learning credit and see if that increased or decreased the tax. Finally, I check the box for the deduction and see what that does. I then select the one that reduces the tax the most. Sometimes one or more of these methods results in a zero amount due to the taxpayer’s income, the student does not qualify, or the expense does not qualify.

If you do it yourself, then you need information beyond the scope of this blog, and should download publication 970 from www.irs.gov Just type in 970 in the search box. Also, you should look at Forms and instructions for Form 1098-T, Form 8815, Form 8863. If you made an early withdrawal from an IRA look at the codes for penalty exclusions for Form 5329.

A Credit is not the same thing as a deduction.

There are several education-related tax provisions related to education expenses. Two arise frequently and can be confused with each other. One type is a credit and the other type is a deduction. A credit reduces your tax by the amount of the credit, but a deduction would only reduce your taxable income which only reduces it by a percent of the deduction.

Which should I take?

You may or may not qualify for all options .

Generally the credit is better than the deduction, but not always. There are two different credits, the Hope credit and the Lifetime learning credit. The credits have different income-related limitations than the deductions

Income limits for credits:
The credits are not available if your Adjusted Gross income (AGI) exceeds $ 110,000 on a Joint Return or $ 55,000 on other returns.

Income limits for the deductions:
Your AGI can be as high as $ 160,000 on a Joint return or $80,000 and still qualify for the deduction.

There are two different credits

The two credits are the Hope credit and the Lifetime learning credit. The Hope credit usually provides the best tax reduction, but the rules may prevent you from taking the Hope credit. The Hope credit is only available for the first two years of post-secondary education. The Lifetime learning credit does not have this limitation.

Rules That Apply to Both Credits and Qualified Education Expenses
Generally, qualified education expenses are amounts paid in
2006 for tuition and fees plus, in some cases, books, supplies and other costs as explained in Publication 970 .

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.