The penalties are severe.  The penalty for failing to file the information return is $10,000 per failure and increases by $10,000 for each 30 day period following notification from the Treasury.  There is a 90 day grace period following notification before additional $10,000 penalties accrue which are capped at $50,000.  The penalty may be waived for reasonable cause.  In addition, there’s a 40% accuracy penalty for underpayment of tax pertaining to an undisclosed foreign financial understatement.  The statute of limitations is extended to six years for the omission of gross income in excess of $5,000 attributable to the foreign financial asset and does not even begin to run in the case of non-disclosure. 

Another provision imposes burdensome requirements on foreign institutions wishing to do business in the U.S.  Beginning in 2013, there are new withholding obligations and reporting requirements on accounts held by U.S. persons.  The foreign financial institutions will be required to do due diligence to ascertain if they have U.S. person account holders and if they do, to report the identifying number of the U.S. account holder, the account number, the account balance and the gross deposits and withdrawals with respect to these accounts.  If an account holder refuses to comply with requests for this information, dubbed “recalcitrant account holders”, the foreign financial institution must deduct 30% of withholding from their payments.  This Act will not affect people who invest with foreign institutions who have no U.S. connection.  The laws are cracking down on taxpayers using offshore accounts to evade taxes.  For those who chose not to comply, this provision of FACTA may now prompt them to.  If they don’t, though, the third party financial institutions may soon be doing it for them.

Jennie Ward, J.D., LL.M

The timing of our conversation was pertinent since members of both houses had introduced a bill called the Foreign Account Tax Compliance Act of 2009 (“FACTA”) in October 2009 which was drafted to target individuals who hide assets overseas and evade U.S. tax laws.  FACTA became law in March of this year when it was incorporated into the HIRE Act passed by Congress.  The Act is composed of five parts, two of which will be discussed in Part 2 of my blog.

Jennie Ward, J.D., LL.M

Section 1256 was updated with the recently passed financial reform package to except interest rate swaps, currency swaps, basis swaps, interest rate caps, interest rate floors, commodity swaps, equity swaps, equity index swaps, and credit default swaps from the definition of a section 1256 contract.

Generally for tax purposes, gain and loss recognition does not occur until an event, such as a sale, triggers such recognition.  However, the gains and losses from Section 1256 contracts are “marked-to-market”, meaning that any contract held at the end of the tax year is assumed to have been sold for its current fair market value as of that date and the resulting unrealized gain or loss is recognized.  Once a contract actually is sold, any difference between the actual gain or loss realized on the sale and any amounts of unrealized gain or loss that have previously been recognized is picked up in the year of sale. 

Since these contracts are considered to be sold every year, the holding period of the underlying asset does not determine whether or not the gain or loss is short term or long term, rather all gains and losses on these contracts are considered to be 60% long term and 40% short term.   

Typically, taxpayer’s are allowed to recognize up to $3,000 of net capital loss in a year and carry forward the excess indefinitely.  While this is also true for net Section 1256 contracts losses, a special election can be made that allows these losses to be carried back three years to offset any net Section 1256 gains. 

Amanda Brown

Why is this important?

Employees may exclude from gross income the value of employer-provided health coverage under an accident or health plan. The exclusion applies to coverage for personal injuries or sickness for employees (including retirees), their spouses and their dependents. In addition, any reimbursements under an accident or health plan for medical care expenses for employees (including retirees), their spouses, and their dependents generally are excluded from gross income. For this purpose, a “child” means an individual who is the taxpayer’s son, daughter, stepson, stepdaughter or eligible foster child (i.e., an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction).

Under the old law, one of the requirements for a child to be a qualifying child of a taxpayer (therefore eligible for the exclusion) was that the child had to be under age 19 (or under age 24 in the case of a full-time student, or no age limit for individuals who are totally and permanently disabled at any time during the calendar year).   Therefore, only employees who had children that met this requirement could exclude the value of employer-provided health coverage under an accident or health plan from their income.  If your child didn’t meet these requirements, any medical or health costs you paid for them would not be reimbursable (tax free) under your employers accident or health plan.  Or, if you were self employed, the cost of those expenses paid for the child would not be deductible. 

The above rules also apply to more-than-2% S corporation shareholders. 

Jeremy Smith, CPA

When filing separately, some credits and deductions are not allowed.  These include earned income credit, credit for the elderly or disabled, child care credit and adoption credit (unless spouses lived apart for the last six months of the year), education credits, student loan interest deduction, tuition and fees deduction, and savings bond interest exclusion.  Additionally, if filing separately, both spouses must agree to claim the standard deduction or itemize deductions.  Therefore, if one spouse itemizes, the other must also itemize, even if the standard deduction is a greater deduction for that spouse.  Other disadvantages of filing separately include a higher percentage of taxable social security benefits, IRA limitations, capital and passive loss limitations, and phaseout of the AMT exemption.

On the other hand, there are some advantages to filing separately rather than jointly.  When signing a joint return, both spouses are liable for what is reported on the return and paying any tax due.  Alternatively, when filing separately, each spouse is only responsible for reporting and paying the tax on his or her own items.   Generally, tax brackets and standard deductions of married filing separately returns are half that of married filing jointly.  Therefore, if both spouses have a similar amount of income, the tax liability should be about the same in either case.  However, filing separately can result in less income tax in some situations.  If one spouse has deductions that are limited based on an adjusted gross income floor, such as medical expenses, casualty loss, or employee business expenses, filing separately could result in lower tax.  This is because these expenses would only be based on the adjusted gross income of that spouse.

There may be other factors that come into play when deciding your filing status.  It is best to consult your tax advisor so he or she can compute the tax liability under both circumstances.

Jill Helm, CPA

Under JGTRRA, capital gains that were taxed at 10% (8% for securities held longer than five years) became subject to a 0% rate for years from 2008-2010. The 20%/18% rate was reduced to 15%. These lower rates applied to both regular tax and alternative minimum tax. Qualified dividends were allowed to be taxed at the net capital gains rates, which were 15% for most taxpayers.

Without new legislation from Congress, those lower tax rates will expire. Capital gains will be taxed at 10%/8% or 20%/18% again, and qualified dividends will be taxed at ordinary income rates.

Taxpayers should pay close attention to the news for word of any laws expected to be passed by Congress to address this matter. They should also prepare a contingency plan that assumes that the higher rates will go into effect on January 1, 2011. Those people who plan to sell securities in the next 12 months ought to seriously consider selling before the end of the year. It might be prudent for some investors to reduce the amount of dividend-paying stocks that they own. It is worth having a conversation with a financial advisor to discuss the makeup of one’s portfolio. Do not wait until it is too late to consider how this change in the tax law can impact your financial situation.

Brandon Harbeke

In contrast to the above, IRS audit hours for small companies (less than 10 million is assets) increased by 30 percent and the hours spent auditing midsize companies (between $10 and $250 million) have jumped 13 percent.  One argument for increasing audits of smaller companies are studies that show an ever increasing “tax gap” between what amount of income and resulting taxes should have been calculated and what is actually reported and paid.  But you have to question the wisdom of doing so at the expense of letting larger companies escape the audit roulette and the resulting decrease in taxes collected in audit.  The pullback in audits of large companies have declined even as the number of returns filed in this category have grown.

Dale Jensen, CPA

First of all, does the residence qualify as your “main” home?  And secondly, will the sale result in a gain or a loss? 

You cannot deduct a loss from the sale of your main home, and generally, you are eligible to exclude all or part of the gain from the sale of your main home if you owned and used it as your main home for a period totaling at least 2 years out of the 5 years prior to its sale.  The ownership test generally requires that you own the home directly, not through an entity.  For example, you wouldn’t qualify for the ownership test if the home was owned by a limited partnership or an irrevocable trust.  But you would qualify for the ownership test if the home was owned by a single-member LLC that is disregarded for tax purposes or by a grantor trust and you are the grantor of the trust.

If you have a loss on the sale of your main home and you received a Form 1099-S from the sale, report the sale on your Form 1040, Schedule D, even though the loss is not deductible.

If you have a gain from the sale of your main home and you meet the ownership and use tests described above, you may be able to exclude up to $250,000 of the gain from your income or $500,000 on a joint return, in most cases.  This exclusion may be claimed each time that you sell your main home, but generally no more often than once every 2 years.

If you do not meet the ownership and use tests to qualify for the $250,000 or $500,000 exclusion, you may still qualify for a reduced maximum exclusion.  But you must have sold your home for a specific reason such as serious health issue, a change in your place of employment, certain unforeseen circumstance such as divorce or legal separation, natural or man-made disaster resulting in a casualty to your home, or an involuntary conversion of your home.

You do not report the sale of your main home on your tax return unless you have a gain and part of the gain is taxable.  If you do have a taxable gain, report it on Form 1040, Schedule D.

If you have more than one home, you can exclude gain only from the sale of your main home.  You must pay tax on the gain from selling any other home.  If you have 2 homes and live in both of them, your main home is ordinarily the one you live in most of the time, but other factors may be relevant in determining which is your main home such as your place of employment, the main home of your family members, the address you use on your income tax returns, on your driver’s license, and on your auto and voter registration, your mailing address for bills and correspondence, the location of your bank, and the location of your religious organizations and recreational clubs.

Pamela Wheeler, EA

• There are two easy and convenient options for obtaining free copies of your federal tax return information — tax return transcripts and tax account transcripts.
• The IRS does not charge a fee for transcripts, which are available for the current year as well as the past three years.
• A tax return transcript shows most line items from your tax return as it was originally filed, including any accompanying forms and schedules.  It does not reflect any changes you, your representative or the IRS made after the return was filed. In many cases, a return transcript will meet the requirements of lending institutions, such as those offering mortgages and student loans.
• A tax account transcript shows any later adjustments either you or the IRS made after the tax return was filed. This transcript shows basic data – including marital status, type of return filed, adjusted gross income and taxable income.
• To request either transcript by phone, call 800-829-1040 and follow the prompts in the recorded message.
• To request a tax return transcript through the mail, individual taxpayers should complete IRS Form 4506T-EZ, Short Form Request for Individual Tax Return Transcript. Form 4506T-EZ is only for individuals who filed a Form 1040 series return. Businesses, partnerships and individuals who need transcript information from other forms or need a tax account transcript must use the Form 4506T, Request for Transcript of Tax Return.
• You should receive your tax return transcript within 10 working days from the time the IRS receives your request. Allow 30 calendar days for delivery of a tax account transcript.
• If you still need an actual copy of a previously processed tax return, it will cost $57 per tax year and take much longer.  Complete Form 4506, Request for Copy of Tax Form, and mail it to the IRS address listed on the form for your area.  Please allow 60 days for actual copies of your return.  Copies are generally available for the current year as well as the past six years.
• Visit the IRS Web site, IRS.gov, to determine which form will meet your needs. Forms 4506, 4506T and 4506T-EZ can be found at IRS.gov or by calling the IRS forms and publications order line at 800-TAX-FORM (800-829-3676).

Gerry Whipple

Final income tax return (Form 1040) – for decedent’s income from January 1 through the date of death.  If the decedent was married, the surviving spouse can file a joint return for the year of death.  If a return is not required but the decedent had withholding, prior year overpayment(s) applied or made estimated payment(s), the executor will need to file to get a refund.

Informational return (2010 only) – if the estate is over $1.3 million to allocate the allowable basis adjustments.  (See my blog on What’s the IRS’ Perspective On 2010 Estate and Gift Tax? posted 6/8/10)  This form is due April 15, 2011 with the decedent’s final 1040.  Still no word, though, on when it will be released.  Posts dated June 21, 2010 on the IRS’ website state the form “is currently under construction and a number has not yet been assigned.”  In the meantime, the executor may want to track down the basis and get certain assets appraised.  No later than 30 days after filing the information return, the executor must provide each recipient of property a written statement with their basis to avoid a $50 penalty per failure.

Estate tax return (Form 706) for decedent’s dying after 2010

Gift tax return (Form 709) – if the decedent made gifts in excess of the annual exclusion (currently 13,000).

Fiduciary income tax return (Form 1041) – The decedent’s estate and/or trust are new taxing entities beginning the day after death.  The estate consists of the probate assets and assets passing to the estate either as a named beneficiary or alternatively, where there is no named beneficiary or the named beneficiary has predeceased the decedent.  If the decedent had a revocable trust during life, the trust becomes irrevocable at death and the administrative trust comes into existence to pay debts, expenses and taxes.  If a decedent had a will and trust, the personal representative and the executor can make an election to report the income for the estate and trust on one fiduciary return.

Losing a loved one is a horrible thing to experience and dealing with their affairs post death can be stressful.  Make sure you have a competent, knowledgeable preparer to assist you with the returns and tax implications during this process.

Jennie Ward, JD, LLM