Changes to Form 1040 - Part II - Good news for students

A continuing discussion of the tax law changes for the 2009 Form 1040 Individual Income Tax Return.  Students (or prospective students), make sure that you check out the details on the Hope credit below!

Tax - Line 44: The amount of taxable investment a child can hve without being subject to tax at the parent's rate has increased to $1,900.  Reminder - "Kiddie Tax" now applies to all child dependents, regardless of age. 

Alternative Minimum Tax - Line 45: For 2009, the AMT exemption amounts are increased to $70,950, $46,700 and $35,475 for MFJ, Single, and MFS respectively.  This does not mean AMT will necessarily apply to taxpayers earning more than these amounts, but you must file Form 6251 to determine if AMT applies. 

Education Credits - Line 49:  Hold on to your horses!  Lots of beneficial changes here! The American Opportunity Tax Credit increases the Hope credit from $1,500 to up to $2,500 of the cost of tuition and related expenses (now including books).  The Hope credit is applied to 100% of the first $2,000 of qualifying expenses, and 25% of the next $2,000 of qualifying expenses.  The credit is now available for the first for years of post-secondary education in a degree or certificate program, and is potentially refundable.  Wow!  What a deal!

Credits from Certain Forms - Line 52: Credits available in 2009 includ the Residential Energy Efficient Property Credit (first available in 2007, then not available in 2008, and back for 2009), and Qualified Adoption Expenses.

Changes to Form 1040 - Part I

This will be a series of posts concerning how changes in tax laws are affecting the 2009 Form 1040.  Currently 2 pages long, the number of lines is getting onerous and I do not know how much longer it will be until we have a 5 page Form 1040.  This is not a comprehensive list of law changes, but a paired down list of information that may be most interesting for you as the reader. 

Personal Exemptions - Divorced couples listen up!
A noncustodial parent claiming the exemption for a child can NO LONGER rely on a divorce decree or separation agreement.  You MUST fill out Form 8332 (Release/Revocation of Release of Claim to Exemption) if the decree was executed after 2008.  The noncustodial parent must attach the form, or similar statement signed by the custodial parent. 

Children Qualifying as Dependents

• The Qualifying Child must be younger than the individual claiming the deduction, unless the child is totally disabled.
• If the parents of a child can claim the child as a dependent, but nobody does so, no one else can claim the child (such as a grandparent) unless that person's adjusted gross income is higher than the AGI of either of the parents.

Unemployment Compensation - Line 19
For tax years beginning in 2009, up to $2,400 of unemployment compensation is considered tax-free.  This is to avoid the "kick 'em when they're down" mentality of taxing people's unemployment proceeds. 

Moving Expenses - Line 26
The mileage rate for moving expenses is now 24 cents per mile. 

IRA Deductions - Line 32
The IRA contribution limit is $5,000 ($6,000 if over 50 by 12/31/09).  For 2009, participants in employer plans are allowed to contribute so long as their AGI is less than $89,000 for single filers or $109,000 for joint filers. 

Standard Deduction - Line 40
The standard deduction is $5,700, $11,400 and $8,350 for single, joint, and head of household tax returns, respectively.  A taxpayer may be able to increase his standard deduction for the amount of sales tax paid on the purchase of a NEW motor vehicle or by paying real estate taxes.  The standard deduction is no longer so standard, as it may require the attachment of the new Schedule L - Standard Deduction for Certain Filers. 

Exemptions - Line 42
The personal exemption amount for 2009 will be $3,650.  There is a phase out if adjusted gross income exceeds $166,800 (single), $125,100 (MFS), $250,200 (MFJ), or $208,500 (HH).

More to come later about tax, tax credits, and items that occur below Line 42!

Business Expenses - Substantiation

Ivette Munson v. Commissioner., U.S. Tax Court, T.C. Summary Opinion 2009-164, (Oct. 26, 2009)

Here we have another business substantiation case.  Ms. Munson, in her freelance translating service, was not entitled to deductions because the substantiation for her amended income tax return was poor.  She claimed deductions for telephone, mileage, and home office even though she was unable to show business use.

Sale of rights to wrongful death proceeds non-taxable

In a series of twelve Private Letter Rulings (which cannot be cited as precident) the IRS has ruled that the sale of settlement rights received by the survivors and/or decedents estates will be considered non-taxable.

In the case, the estates of those killed sued and received a financial award for the wrongful death and intentional infliction of emotional distress.  The estates were granted summary judgement by the palintiffs and awarded an unstated aggregate recovery of compensatory damages, interest, and putnative damages. 

The defendent appealed the summary judgement, and while on appeal, the estates/beneficiaries sold the rights to the award to an investor for an immediate cash payment.  The estates/beneficiaries looked to the IRS for guidance concening the taxability of this transaction.

The IRS looked at §104(a)(2) and Regulation §1.104-1(c) which governs that awards received on account of personal physical injury or sickness are non-taxable.  Additionally, §1605 of the Small Business Job Protection Act of 1996 expands the definition to include those pertaining to the wrongful death and emotional distress attributable to a physical injury.

In general, if you are trading the rights to a future payment, the lump-sum payment will maintain the same tax characteristics as the future payment.  In the case of a lottery winner, the trade of annuity rights for a lump-sum causes ordinary income.  This has been taken through the courts, as many lottery winners attempted to modify the tax characteristics by claiming that it shoudl be a capital gain transaction. 

Citations: PLR200942007 (Jul. 06, 2009)

October 15th Deadline

Well, I got through the October 15th deadline, so its time to get back to blogging.  My goal is to have something posted 4 times a week, so we'll be working toward getting that consistently. 

Letter Ruling - Baby Formula is not elgible medical deduction

A private letter ruling is a request by an indvidual taxpayer to rule on a very specific tax issue before the taxpayer takes action.  The PLR is considered the IRS' official position, but is non-precidential.  In other words, unless your situation is exactly the same as that laid out within the private letter ruling, you may not use it to avoid penalties should you use the letter in determining your own tax liability. 

You may request a PLR by sending a letter stating all pertinent facts to:

Ruling Request Submission

Internal Revenue Service
Attn.: CC PA:LPD:DRU
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

PLR fees range from $75 to $50,000 depending on the circumstances


In today's case, a taxpayer who received a double mastectomy and therefore was unable to breastfeed her child had to purchase infant formula to meet the baby's nutritional needs.  IRC §213 governs medical deductions, and defines a deductible medical expense as one that "is paid for the diagnosis, cure, mitigation, treatment or prevention of disease."  More specifically, later regulations limit the deduction for those expenses which are paid to treat an acute medical condition, and disallow those expenses which are paid to improve general health. 

Taxpayers have previously attempted to deduct special diet food as a medical expense and have generally lost.  In one case, the Tax Court found that the taxpayer, who suffered from Crohn's disease, failed to establish that his diet was a treatment for a condition, instead of a substitute for a normal and healthy diet.  The food he consumed was merely a substitute for food normally consumed by a healthy person, and he was not entitled to a medical deduction. 

The PLR snotes "in the instant case, taxpayer's child is a healthy baby.  The formula satisfies the baby's normal nutritional needs.  Therefore, the infant formula is properly viewed as food that the infant would normally consume."  Accordingly, the PLR does not allow for the deduction.

Aaron's Take:  In accordance with how the law is written, I agree with the IRS' determination.  For similar reasons, a person's gym membership, diet food for obese people, and over the counter drugs are not generally deductible. 

How is this case potentially deductible?  If the baby had vitamin deficiencies and needed a specific type of fortified baby formula, this situation would be different.  Although the argument can be made that the formula is only necessary because of the mother's inability to produce milk, her milk would only have satisified the baby's minimum nutritional needs, and should the deduction be allowed, I'm sure some enterprising taxpayer would try to deduct the mother's food intake because "if the mother doesn't eat, than the baby won't get the right nutrition." 

IRS Whistleblower Office Sees Jump in Reports of High-Dollar Tax Evasion

If you have knowledge about a tax evader, there are rewards for turning them in.  Under the Tax Relief and Health Care Act of 2006, you can receive between 15% and 30% of the tax, interest, and penalties recovered, if that amount exceeds $2,000,000.  Smaller cases are also subject to smaller rewards.

During the fiscal year 2008, the Whistleblower office received 476 referrals relating to nearly 1,500 taxpayers, with 64 alleging evasion of more than $100 million in tax. 

The identity of the whistleblower must be revealed to the IRS, but is kept completely confidential and is sealed in separate files.  The protection of the whistleblower is a priority for the IRS.

Aaron's Take:  Knowledge of tax evasion is a serious ethical dilemna for employees.  Additionally, a company employee may not have all of the information necessary to substantiate the claim of tax evasion (a very high bar).  The availability and protection of a whistleblower is necessary for the proper function of our voluntary tax system.  The term voluntary refers to the fact that we voluntarially file our tax returns, and it is important to direct our enforcement to those that refuse to participate in the process honestly.

IRS's newest audit target? Employment taxes!

The IRS has announced that it will be using random audits uner the National Research Program to analyze the way businesses are paying and reporting their payroll taxes.  The IRS estimates that that $54 billion of the $345 billion tax gap (difference between what is paid, and what should be paid) is made up of the underreporting of payroll taxes. 

The IRS has indicated that the new study will begin in October, and that the study will be a multi-year project inspecting over 6,000 businesses in all industries.  CCH comments that "This NRP is focusing on four broad areas; worker classification, fringe benefits, non-filers, and officer compensation." 

Aaron's Take:  We have already experienced one audit that indicated the IRS is ramping up these audits.  Employment Tax Auditors are a small overall percentage of IRS staff, and these audits will require special training.  Our experience showed an auditor that needed hand holding throughout the process, and did not have the appropriate training or confidence to be able to handle this type of audit. 

Pertaining to the four areas of focus, here is what they are looking for in english:

• Worker Classification - Employee (aka mandatory withholding) vs. Independent Contractor (most common tax evaders)
• Fringe Benefits - Personal use of employer provided auto, travel expenses (non-qualified spouses & meals), non-cash benefits, boutique insurances
• Non-filers - specifically small businesses, with huge potential for penalties.  Most bang for the buck!
• Officer Compensation - the use of S-Corporations to create minimal salaries (and thereby minimal social security taxes) with high dividends. 

Taxpayer asserts he isn't a taxpayer - Court calls him "delusional"

Michigan resident, Brian Dimercurio, attempted to de-tax himself by submitting fraudulent statements to his employer, Compuware Corp.  Mr. Dimercurio notified his employer in February of 2000 claiming he was exempt from Federal income tax and submmitted a fraudulent W-4 which claimed sufficient allowances to prevent federal withholding. 

Mr, Dimercurio affirmatively began to de-tax himself by sending a letter to his employer to "hereby withdraw my authorization for Compuware to withhold tax from my personal earnings."  The requirement for an employer to withhold tax from employees is statutatory, and is not a voluntary initiative.  You may not elect out of Federal withholding unless your personal allowances are sufficient, and you can document them as such. 

HIs argument that he was not liable (instead, he claims his Social Security Trust was) was dismissed due to the lack of legal basis to support the argument that a trust existed and was the recipient of his wages.  He was fined $6,000 for the erronious argument.  Additionally, other actions before the Sixth Circut has received comment that "This argument, which is clearly fantastic and delusional, does not deserve extensive refutation." 

Nevertheless, Mr. Dimercurio continued restating his case and the court granted summary judgement in regard to the tax, resulting in the assessment of over $57,000 of income tax for years 2001-2004.  The taxpayer pentitioned the court for a reexamination of the failure to file penalty with an increased penalty for the fraudulent nature of his argument.  The penalty assessed equals 75% of the tax due, which would bring his total bill to over $100,000. 

The IRS was able to prove, by clear and convincing evidence, that Mr. Dimercurio's actions indicate fraud and the intent to evade taxes by concealing, misleading, or otherwise preventing the collection of taxes.  Though the court does allow for certain good-faith misunderstandings of the law, they determined the the college-educated taxpayer formulated his own conclusions, failed to consult with a professional, and took agressive steps to implement the failed plan. 

The Court sustained the IRS' position, and Mr. Dimercurio will owe taxes for many years to come!

Aaron's Take:  When a court, in a formal document, refers to your ideas as "fantastic and delusional," you know you're in trouble.  Representing himself pro-se (without counsel) before a district court only adds fire to the flames of Mr. Dimercurio's obvious inability to operate within the realms of reality.  Yesterday I blogged about a guy that researched, but wasn't able to provide any documentation to the court, and was then penalized.  Mr. Dimercurio did provide documentation, but it was clearly erronious and the court still assessed a significant penalty ... a very expensive lesson indeed.

"I read it on the internet" is not an excuse!

A former employee who is studying for his masters degree sent me a great case that shows a taxpayer's attempt to escape accuracy related penalties for reasonable cause.  Thanks Ethan!

IRC§ 6662 imposes a 20% penalty for the underpayment of tax that is due to the negligence or disregard of rules and regulations.  Kenneth & Trudi Woodard represented themself before the US Tax Court concerning the applicability of these penalties for a $150,000 understatement of income resulting in $27,606 of additional taxes.  The IRS tacked on $5,521 of accuracy related penalties. 

Mr. Woodard believed that $100,000 of the income would be considered a rollover to a self-directed IRA when he withdrew the money and lent it to a mortgagee, who stole the money and eventually was convicted of fraud.  He asked the court to accept that his research on Google was substantial proof that he should not be considered negligent.  He was unable to specify any website or any articles that he read, nor did he present any evidence about his attempt to confirm the accuracy of information that he read on the intenet.

The Tax Court determined that, in light of the following information, that the taxpayer should have known better, and that his education with a Bachelor of Science in Accountancy, a M.B.A. and his lapsed license as a Certified Public Accountant should have given him a proper framework to determine what information could be relied upon as difinitive guidance.  Not only did he lose the $100,000 which was stolen from him, he now owes tax and penalty on the amount, and his wife left him!

Aaron's Take:  I am currently working on a case where the taxpayer prepared their own return, read the instructions, and has subsequently and substantially understated their income.  They attempted to prepare a tax return that was substantially more complicated than their education or experience would allow for.  We already understand that there will be a substantial amount of tax due, and that the accuracy related penalty will apply.  We will be fighting this same exact issue, and hopefully will come out more successful than Mr. Woodard.  The point?  Using a tax professional can have substantial value.  Had Mr. Woodard been able to prove that he consulted with someone with expertise, he would likely have been able to get out of the penalty. 

eainaz.blogspot.com

Couple under criminal investigation fail to quash a subpoena because they didn't state a claim

A couple, Kenneth & Deborah Hibben were denied a motion to quash the IRS's attempt to examine information held by a third-party bookkeeper*.  When a subpoena is issued, the burden of proof falls on the recipient of the subpoena to prove to the court why the subpoena should not be honored. 

The taxpayers made two arguments:

• That they were not persons that fall under the IRS's summons authority; and,
• The IRS's authority is too broad and violates the taxpayer's 4th amendment rights against unlafwul search and siezure

Both of these arguments are elementary and unrealistic.  The Treasury Secretary (or his designees) are allowed by US Code “For the purpose of … determining the liability of any person for any internal revenue tax … the Secretary authorized … [t]o summon … any person having possession, custody, or care of books of account containing entries relating to the business of the person liable for the tax.”

Secondly, it is important, when debating matters of constutionality, to review Supreme Court cases that might be relevent.  After all, the Supreme Court is the SUPREME authority when it comes to constitutionality.  Donaldson v. United States, United States v. Miller, Fisher v. United States, and Hogan v. United States are all clear in their support of the IRS's ability to retrieve documentation that may assist them in determining a proper tax liability. 

in United States v. Bsiceglia, the court acknowledged that, given our tax system's reliance on self-reporting, some persons will try to outwit the system:

Thus, § 7601 gives the Internal Revenue Service a broad mandate to investigate and audit ‘persons who may be liable’ for taxes and § 7602 provides the power to ‘examine any books, papers, records or other data which may be relevant … and to summon … any person having possession … of books of account … relevant or material to such inquiry.’ Of necessity, the investigative authority so provided is not limited to such situations in which there is probable cause, in the traditional sense, to believe that a violation of the tax law exists. United States v. Powell, 379 U.S. 48, 57 (1964). The purpose of the statutes is not to accuse, but to inquire (Emphasis added). Although such investigations unquestionably involve some invasion of privacy, they are essential to our self-reporting system, and the alternatives could well involve far less agreeable invasions of house, business, and records.

Aaron's Take: While I greatly respect encourage the taxpayer's ability to protest what they deem to unfair rules and regulations, it is best to work with a professional to determine what arguments actually make sense, and what arguments are useless drivel.  Too many taxpayers go to tax court Pro Se, ill prepared, and do nothing but waste the time of the court.  If you have a genuine concern, find an Enrolled Agent or CPA that is certified to practice before the Tax Court (USTCP) or a tax lawyer that will do more for you than take a fee.

*(Kenneth A. Hibben and Deborah A. Hibben, Petitioners v. United States of America, Respondent., U.S. District Court, S.D. Ohio, 2009-2 U.S.T.C)