The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the "pass-through deduction" or the "qualified business income deduction." Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final.

The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the "pass-through deduction" or the "qualified business income deduction." Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final.

Code Sec. 199A allows business owners to deduct up to 20 percent of their qualified business income (QBI) from sole proprietorships, partnerships, trusts, and S corporations. The deduction is one of the most high-profile pieces of the Tax Cuts and Jobs Act ( P.L. 115-97).

In addition to providing general definitions and computational rules, the new guidance helps clarify several concepts that were of special interest to many taxpayers.

Trade or Business

The proposed regulations incorporate the Code Sec. 162 rules for determining what constitutes a trade or business. A taxpayer may have more than one trade or business, but a single trade or business generally cannot be conducted through more than one entity.

Taxpayers cannot use the grouping rules of the passive activity provisions of Code Sec. 469 to group multiple activities into a single business. However, a taxpayer may aggregate trades or businesses if:

• each trade or business is itself a trade or business;
• the same person or group owns a majority interest in each business to be aggregated;
• none of the aggregated trades or businesses can be a specified service trade or business; and
• the trades or businesses meet at least two of three factors which demonstrate that they are in fact part of a larger, integrated trade or business.

Specified Service Business

Income from a specified service business generally cannot be qualified business income, although this exclusion is phased in for lower-income taxpayers.

A new de minimis exception allows some business to escape being designated as a specified service trade or business (SSTB). A business qualifies for this de minimis exception if:

• gross receipts do not exceed $25 million, and less than 10 percent is attributable to services; or
• gross receipts exceed $25 million, and less than five percent is attributable to services.

The regulations largely adopt existing rules for what activities constitute a service. However, a business receives income because of an employee/owner’s reputation or skill only when the business is engaged in:

• endorsing products or services;
• licensing the use of an individual’s image, name, trademark, etc.; or
• receiving appearance fees.

In addition, the regulations try to limit attempts to spin-off parts of a service business into independent qualified businesses. Thus, a business that provides 80 percent or more of its property or services to a related service business is part of that service business. Similarly, the portion of property or services that a business provides to a related service business is treated as a service business. Businesses are related if they have at least 50-percent common ownership.

Wages/Capital Limit

A higher-income taxpayer’s qualified business income may be reduced by the wages/capital limit. This limit is based on the taxpayer’s share of the business’s:

• W-2 wages that are allocable to QBI; and
• unadjusted basis in qualified property immediately after acquisition.

The proposed regulations and Notice 2018-64, I.R.B. 2018-34, provide detailed rules for determining the business’s W-2 wages. These rules generally follow the rules that applied to the Code Sec. 199 domestic production activities deduction.

The proposed regulations also address unadjusted basis immediately after acquisition (UBIA). The regulations largely adopt the existing capitalization rules for determining unadjusted basis. However, "immediately after acquisition" is the date the business places the property in service. Thus, UBIA is generally the cost of the property as of the date the business places it in service.

Other Rules

The proposed regulations also address several other issues, including:

• definitions;
• basic computations;
• loss carryovers;
• Puerto Rico businesses;
• coordination with other Code Sections;
• penalties;
• special basis rules;
• previously suspended losses and net operating losses;
• other exclusions from qualified business income;
• allocations of items that are not attributable to a single trade or business;
• anti-abuse rules;
• application to trusts and estates; and
• special rules for the related deduction for agricultural cooperatives.

Effective Dates

Taxpayers may generally rely on the proposed regulations and Notice 2018-64 until they are issued as final. The regulations and proposed revenue procedure will be effective for tax years ending after they are published as final. However:

• several proposed anti-abuse rules are proposed to apply to tax years ending after December 22, 2017;
• anti-abuse rules that apply specifically to the use of trusts are proposed to apply to tax years ending after August 9, 2018; and
• if a qualified business’s tax year begins before January 1, 2018, and ends after December 31, 2017, the taxpayer’s items are treated as having been incurred in the taxpayer’s tax year during which business’s tax year ends.

Comments Requested

The IRS requests comments on all aspects of the proposed regulations. Comments may be mailed or hand-delivered to the IRS, or submitted electronically at www.regulations.gov (indicate IRS and REG-107892-18). Comments and requests for a public hearing must be received by September 24, 2018.

The IRS also requests comments on the proposed revenue procedure for calculating W-2 wages, especially with respect to amounts paid for services in Puerto Rico. Comments may be mailed or hand-delivered to the IRS, or submitted electronically to Notice.comments@irscounsel.treas.gov, with “ Notice 2018-64” in the subject line. These comments must also be received by September 24, 2018.

The IRS’s proposed pass-through deduction regulations are generating mixed reactions on Capitol Hill. The 184-page proposed regulations, REG-107892-18, aim to clarify certain complexities of the new, yet temporary, Code Sec. 199A deduction of up to 20 percent of income for pass-through entities. The new deduction was enacted through 2025 under the Tax Cuts and Jobs Act (TCJA), ( P.L. 115-97). The pass-through deduction has remained one of the most controversial provisions of last year’s tax reform.

The IRS’s proposed pass-through deduction regulations are generating mixed reactions on Capitol Hill. The 184-page proposed regulations, REG-107892-18, aim to clarify certain complexities of the new, yet temporary, Code Sec. 199A deduction of up to 20 percent of income for pass-through entities. The new deduction was enacted through 2025 under the Tax Cuts and Jobs Act (TCJA), ( P.L. 115-97). The pass-through deduction has remained one of the most controversial provisions of last year’s tax reform.

A legislative package that would make permanent the pass-through deduction, as well as other individual tax cuts, is expected to move though the House this fall. However, the House’s legislative efforts are not expected, at this time, to pass muster in the more narrowly GOP-controlled Senate.

Criticism

Several Democratic lawmakers and tax policy experts have already started to weigh in on the proposed regulations, which were released on August 8 while Congress remained in its annual August recess. Democrats have criticized the new deduction for primarily benefiting the wealthy. Meanwhile, several tax policy experts have taken to Twitter to note that the deduction is overly complex and administratively burdensome.

Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., has reportedly said that the proposed regulations "confirm that the fortunate few win," under the new tax law. "Tax planners are already scouring through the nearly 200 pages of regulations in search of new ways to keep wealthy clients from paying their fair share."

Compliance Burdens

The pass-through deduction could add 25 million hours to taxpayers’ annual reporting burden, according to the proposed regulations. Additionally, the IRS has estimated that gross reporting annualized costs to taxpayers will total approximately $1.3 billion over 10 years.

Furthermore, the IRS has estimated that the compliance burden will vary between taxpayers, averaging between 30 minutes and 20 hours. The administrative burden on smaller pass-through entities is anticipated to be on the lower end of the estimate, according to the IRS.

Comment. Ryan Kelly, partner at Alston & Bird LLP, told Wolters Kluwer on August 13 that the IRS’s 25 million-hour estimate, whether accurate or not, suggests that there will be a significant increase in administrative compliance costs. "There is a real cost to tax compliance in lost time and productivity for taxpayers," Kelly said. However, Kelly predicted that taxpayers’ Code Sec. 199A compliance burden will eventually decrease. "Time will reveal the extent of taxpayers’ administrative burden to comply; however, it is likely that as time goes on the taxpayers’ compliance burden will fall as taxpayers, tax practitioners, and the Service all become more familiar with section 199A and how it is intended to operate."
Meanwhile, the chairs of the House and Senate tax writing committees have both praised Treasury and the IRS for quickly releasing the much anticipated regulations. Additionally, several tax policy experts have also praised the proposed regulations for alleviating confusion, as well as taxpayer anxiety, about ambiguous provisions of the law.

"This first-ever 20 percent deduction for small businesses allows our local job creators to keep more of their money so they can hire, invest, and grow in their communities," House Ways and Means Committee Chairman Kevin Brady, R-Tex., said in a statement. "These proposed regulations are intended to provide certainty and flexibility for Main Street businesses in this historic new small business deduction."

Improvements to the proposed regulations are expected in the coming months as stakeholders submit comments. A public hearing at IRS headquarters in Washington, D.C., has been scheduled for October 16. "Evolution of tax regulations is generally never a pretty process, but it is a necessary process that in this case will hopefully happen sooner rather than later," Kelly told Wolters Kluwer.

The House’s top tax writer has unveiled Republicans’ "Tax Reform 2.0" framework. The framework outlines three key focus areas:.

The House’s top tax writer has unveiled Republicans’ "Tax Reform 2.0" framework. The framework outlines three key focus areas:

• making permanent the individual and small business tax cuts enacted under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97);
• promoting family savings by streamlining retirement savings accounts and creating a new Universal Savings Account; and
• spurring business innovation by allowing new businesses to write off more initial start-up costs.

Tax Reform 2.0

The GOP’s tax reform "phase two" framework—otherwise known as "Tax Cuts 2.0"—was released by House Ways and Means Committee Chairman Kevin Brady, R-Tex. on July 24. The outline is expected to be used for GOP "listening sessions" to be held among lawmakers.

Brady has said that making permanent the TCJA’s individual and small business tax cuts, enacted last December temporarily through 2025, will be the "centerpiece" of the next tax reform package. Further, Brady told reporters on July 24 that he anticipates Tax Reform 2.0 to move forward as three separate tax bills. A House vote on the package is expected sometime in September.

Preliminary Analysis

Republicans’ Tax Reform 2.0 framework is a "good start," according to a July 24 report released by the independent, yet widely-considered conservative-leaning, think tank Tax Foundation. The report praised the framework’s proposal to streamline retirement savings accounts and make permanent the TCJA’s individual tax cuts. Additionally, the Tax Foundation estimates that making permanent the individual tax cuts set to expire in 2026 would grow the U.S. economy by 2.2 percent while reducing federal revenue by $165 billion annually on a static basis.

Democrats Disagree

However, several Democratic lawmakers began issuing statements criticizing the Tax Reform 2.0 framework shortly after its release. Democrats have remained united in their disapproval of the TCJA, criticizing last year’s tax code overhaul for primarily benefiting the wealthy and corporations.

"Republicans’ first tax bill exposed the party’s real priorities: big corporations and people at the top," House Ways and Means Committee ranking member Richard Neal, D-Mass., said in a July 24 statement. "This new framework is more of the same – it rewards the well-off and well-connected, fails to reinstate the state and local tax deduction, and leaves the middle class behind."

Corporate Tax Cuts

The Tax Reform 2.0 framework did not include a proposal to further reduce the corporate tax rate. President Trump has called for lowering the corporate tax rate to 20 percent. The corporate tax rate was lowered from 35 to 21 percent last December under the TCJA. Brady previously told reporters that House Republicans and the White House are continuing discussions on the idea.

Tax Reform 3.0, 4.0

"Tax Reform 2.0 is a new commitment to improve the tax code each and every year for American families and local businesses," the framework says. Congress will examine the tax code each year to identify areas of needed improvement, according to the outline. Additionally, Brady has said he hopes to see a Tax Reform 3.0, 4.0, and so on.

Senate

At this time, the Tax Reform 2.0 package is not expected to clear the Senate in its entirety. It is thought on Capitol Hill that Democrats may support measures that focus on retirement and education savings and business innovation. However, several lawmakers view it as unlikely that Democrats would support a bill that makes permanent the individual tax cuts under the TCJA.

Brady has reportedly said that extending TCJA’s individual provisions would increase the deficit by $600 billion over 10 years but would be offset, at least in part, by beneficial economic factors. Several Senate Democrats and Republicans have said they would not vote for extending or creating tax cuts that increase the federal deficit.

The IRS faces numerous challenges, most of which are attributable to funding cuts, the National Taxpayer Advocate Nina Olson told a Senate panel on July 26. "The IRS needs adequate funding to do its job effectively," Olson told lawmakers.

The IRS faces numerous challenges, most of which are attributable to funding cuts, the National Taxpayer Advocate Nina Olson told a Senate panel on July 26. "The IRS needs adequate funding to do its job effectively," Olson told lawmakers.

IRS Funding

Olson, while testifying at a Senate Finance Committee (SFC) Taxation and IRS Oversight Subcommittee hearing, placed blame on both congressional appropriations and IRS management for the Service’s challenges. "While some of the IRS’s struggles can be addressed by better management, much of the IRS’s challenges are attributable to funding cuts," Olson said.

The IRS has simultaneously seen an increased workload and budget reduction of 20 percent when accounting for inflation between fiscal years 2010 and 2018, according to Olson. "Because of these reductions, the IRS does not have enough employees to answer the phones, to conduct outreach and education, or to provide basic taxpayer service," she added.

Further, Olson noted that the IRS answered only 29 percent of telephone calls received on the Accounts Management lines during this year’s filing season. Additionally, IRS compliance and enforcement efforts have also struggled, Olson said, adding that the audit rate is at its lowest level in "memory."

Likewise, Phyllis Jo Kubey, testifying on behalf of the National Association of Enrolled Agents, IRS Advisory Council, remarked on decreased IRS funding. "The agency is handicapped by budgeting that is not only insufficient to meet its large and growing portfolio, but also inefficiently structured," Kubey told lawmakers.

IRS Reform

The SFC subcommittee hearing came just days after the 20-year anniversary of the IRS Restructuring and Reform Act of 1998. The House and Senate are currently working toward approving bipartisan legislation that would significantly reform the IRS for the first time in 20 years.

SFC Taxation and IRS Oversight Subcommittee Chairman Rob Portman, R-Ohio, and Sen. Ben Cardin, D-Md., unveiled on July 26 the bipartisan Protecting Taxpayers Bill. The measure aims to reform a number of IRS functions and administrative practices, according to a joint press release issued the same day.

"It has been 20 years since the last significant IRS reform, and it is time to update the agency once again," Portman said in the press release. Similarly, Cardin praised the bill for including needed updates to modernize the IRS. "Americans of all income levels deserve a responsive, effective IRS, and the updates contained in this bipartisan bill will help keep the IRS on that path," Cardin said.

Additionally, SFC Chairman Orrin G. Hatch, R-Utah, and ranking member Ron Wyden, D-Ore., recently introduced the bipartisan Taxpayer First Bill ( Sen. 3246). The measure would also reform certain administrative practices at the IRS.

To that end, the House approved its bipartisan IRS reform package, the Taxpayer First Bill ( HR 5444) last April. The House package contains several proposals, which would, among other things:

• establish a single point of contact for tax-related identity theft victims;
• expand the use of Low-Income Taxpayer Clinics (LITCs); and
• require electronic filing for certain tax-exempt organizations

Path Forward

Hatch previously told Wolters Kluwer that the House’s IRS reform proposals are a "welcomed step forward." Additionally, Hatch told Wolters Kluwer that he will work with his "colleagues in Congress to find a path forward that reflects both the House and Senate views."

Senate Finance Committee (SFC) Republicans are clarifying congressional intent of certain tax reform provisions. In an August 16 letter, GOP Senate tax writers called on Treasury and the IRS to issue tax reform guidance consistent with the clarifications.

Senate Finance Committee (SFC) Republicans are clarifying congressional intent of certain tax reform provisions. In an August 16 letter, GOP Senate tax writers called on Treasury and the IRS to issue tax reform guidance consistent with the clarifications.

The letter, addressed to Treasury Secretary Steven Mnuchin and Acting IRS Commissioner David Kautter, identifies three sections of the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) needing clarification:

• Section 13204 – qualified improvement property expensing;
• Section 13302 – net operating losses (NOLs) deduction; and
• Section 13307 – sexual misconduct settlement deduction.

Real Property Depreciation

Congressional intent for Section 13204 under the TCJA was to provide a 15-year modified accelerated cost recovery system (MACRS) recovery period for qualified improvement property, the lawmakers wrote. Additionally, the letter states that the new law should also provide a 20-year alternative deprecation system (ADS) recovery period for qualified improvement property.

NOLs

The TCJA contains a typographical error in Section 13302. The law should state that the NOL carryforward and carryback modifications are effective for NOLs arising in tax years beginning after December 31, 2017, the lawmakers noted. Currently, the legislative text states the effective date is for tax years ending after December 31, 2017.

Attorney’s Fees

Generally, section 13307 of the TCJA denies a deduction for attorney’s fees related to a settlement or payment stemming from a sexual harassment/abuse nondisclosure agreement (NDA). Congressional intent was that attorney’s fees would not be subject to the rule prohibiting the deduction, the letter states.

Technical Corrections

SFC Republicans intend to introduce a technical corrections bill addressing other needed clarifications of the TCJA, the letter notes. The intended technical corrections bill is not expected to be a part of Republican "Tax Reform 2.0" efforts.

"While this letter focuses on these three important provisions, we are continuing a thorough review…to identify other instances in which the language as enacted may require regulatory guidance or technical corrections to reflect the intent of the Congress. After this review, we intend to introduce technical corrections legislation to address any items identified in the on-going review."

Taxpayers and practitioners need clarity on certain S corporation issues by next tax filing season, the American Institute of CPAs (AICPA) has said. In an August 13 letter sent to Treasury and the IRS, the AICPA requested immediate guidance on certain S corporation provisions under the Tax Cuts and Jobs Act (TCJA) (P.L. 115-97).

Taxpayers and practitioners need clarity on certain S corporation issues by next tax filing season, the American Institute of CPAs (AICPA) has said. In an August 13 letter sent to Treasury and the IRS, the AICPA requested immediate guidance on certain S corporation provisions under the Tax Cuts and Jobs Act (TCJA) (P.L. 115-97).

S Corporations

S corporations elect to pass corporate income, losses, deductions, and credits through to shareholders for federal tax purposes. Thus, S corporations are considered a pass-through entity. This election allows S corporations to avoid double taxation on the corporate income, according to the IRS.

"Taxpayers and practitioners need clarity on S corporation issues in order to comply with their 2018 tax obligations and to make informed decisions regarding cash-flow, entity structure, and tax planning issues," Annette Nellen wrote in the letter on behalf of the AICPA. Generally, the letter noted the following three areas for which guidance is needed:

• application of the new laws on loss carryforwards;
• clarification of certain provisions relating to the post-termination transition period (PTTP) and the eligible terminated S corporation period (ETSC Period); and
• treatment of deferred foreign income upon transition to participation exemption system of taxation for S corporation trust shareholders.

Earlier this year, the AICPA also called for guidance on the Code Sec. 199A new pass-through deduction.

A top House tax writer has confirmed that House Republicans and the Trump administration are working on a second phase of tax reform this year. House Ways and Means Committee Chairman Kevin Brady, R-Tex., said in an interview that the Trump administration and House Republicans "think more can be done."

A top House tax writer has confirmed that House Republicans and the Trump administration are working on a second phase of tax reform this year. House Ways and Means Committee Chairman Kevin Brady, R-Tex., said in an interview that the Trump administration and House Republicans "think more can be done."

A Ways and Means spokesperson told Wolters Kluwer on March 15 that "there are opportunities in making individual tax cuts permanent, increasing innovation, [and] encouraging household savings."Confirmation that House GOP tax writers are mulling additional tax changes to the tax code comes just days after President Trump announced that he and House Republicans are very serious about working on a “phase-two” of tax reform. Trump quipped that Brady is the "king of tax cuts."

Individual Tax Cuts
Among expected changes, in particular, the temporary individual tax cuts enacted under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) could be made permanent, a Ways and Means spokesperson told Wolters Kluwer. For budgetary reasons, the cuts to individual tax rates and benefits were not made permanent under the new law. "While the tax cuts for families were long-term, they are not yet permanent, so we’re going to address issues like that," Brady said.

Criticism
Democratic lawmakers remain largely united in their criticisms of the TCJA. House Minority Leader Nancy Pelosi, D-Calif., criticized the new tax law in a March 15 news conference for "giving 83 percent of the benefits to the top 1 percent, ultimately raising taxes for 86 million middle-class families while contending that it's a middle-class tax cut."

To that end, across the U.S. Capitol, Senate Minority Leader Charles E. Schumer has said Democrats would be reluctant to work with Republicans in making any fixes to the new tax law unless Republicans would be willing to address Democrats’ concerns with the law, as well. "We don't have much of an inclination, unless they want to open up other parts of the tax bill that we think need changes, to just help them clean up the mess they made," Schumer said.

Looking Forward
"Mainstream optimism is at record levels, our economy is really gaining momentum and booming in a big way," Brady said. "We’re always looking to improve the tax code," he said, adding that lawmakers are currently considering new ideas for tax reform. "We think there are some good ones." Lawmakers will not combine additional tax reform measures with technical corrections to the existing TCJA, according to Brady, emphasizing that any significant changes to come will be new ideas.

The IRS has responded to criticism from the Treasury Inspector General for Tax Administration and the National Taxpayer Advocate, among others, that resolution of identity theft accounts takes too long by increasing its measures to flag suspicious tax returns, prevent issuance of fraudulent tax refunds, and to expedite identity theft case processing. As a result, the IRS's resolution time has experienced a moderate improvement from an average of 312 days, as TIGTA reported in September 2013, to an average of 278 days as reported in March 2015. (The 278-day average was based on a statistically valid sampling of 100 cases resolved between August 1, 2011, and July 31, 2012.) The IRS has recently stated that its resolution time dropped to 120 days for cases received in filing season 2013.

The IRS has responded to criticism from the Treasury Inspector General for Tax Administration and the National Taxpayer Advocate, among others, that resolution of identity theft accounts takes too long by increasing its measures to flag suspicious tax returns, prevent issuance of fraudulent tax refunds, and to expedite identity theft case processing. As a result, the IRS's resolution time has experienced a moderate improvement from an average of 312 days, as TIGTA reported in September 2013, to an average of 278 days as reported in March 2015. (The 278-day average was based on a statistically valid sampling of 100 cases resolved between August 1, 2011, and July 31, 2012.) The IRS has recently stated that its resolution time dropped to 120 days for cases received in filing season 2013.

Even with a wait time of 120 days, taxpayers who find themselves victims of tax refund identity theft likely find the road to resolution a frustrating and time consuming process. This article seeks to explain the various pulleys and levers at play when communicating with the IRS about an identity theft case.

Initiating an ID theft case

A taxpayer may become aware that he or she is a victim of tax-related identity theft when the IRS rejects their tax return because someone has already filed a return using the taxpayer's name and/or social security number. A taxpayer may also receive correspondence directly from the IRS that informs them, prior to filing, that someone has filed a suspicious return under their information. In other cases, a taxpayer may have had his or her identity information compromised and wishes to alert the IRS as to the possibility that he or she may be targeted by an identity thief.

For all such cases, the IRS has created Form 14039, Identity Theft Affidavit. Taxpayers who are actual or potential victims of tax-related identity theft may complete and submit the Affidavit to ensure that the IRS flags the tax account for review of any suspicious activity. Taxpayers who have been victimized are asked to provide a short explanation of the problem and how they became aware of it.

The Identity Theft Affidavit may also be submitted by taxpayers that have not yet become victims of tax-related identity theft, but who have experienced the misuse of their personal identity information to obtain credit or who have lost a purse or wallet or had one stolen, who suspect they have been targeted by a phishing or phone scam, etc. The form asks these taxpayers to briefly describe the identity theft violation, the event of concern, and to include the relevant dates.

Once the Form 14039 has been completed and submitted, the taxpayer should expect to receive a Notice CP01S from the IRS by mail. The Notice CP01S simply acknowledges that the IRS has received the taxpayer's Identity Theft Affidavit and reminds the taxpayer to continue to file all federal tax returns.

IDVerify.irs.gov

The IRS has implemented a pre-screening procedure for suspicious tax returns. Rather than halt the refund process entirely, which can prevent a refund claimed on a legitimately filed return, the IRS has provided taxpayers with the opportunity to verify their identity.

Now when the IRS receives a suspicious return, it will send a Letter 5071C or Notice CP01B to the taxpayer requesting him or her to either visit idverify.irs.gov or call the toll-free number listed on the header of the letter (1-800-830-5084) within 30 days. When the taxpayer does this, the taxpayer will encounter a series of questions asking for personal information. If the taxpayer fails to respond to the verification request or responds and answers a question incorrectly the IRS will flag the return as fraudulent and follow the prescribed procedures for resolving identity theft cases.

Resolving the case

After a tax return has been flagged with the special identity theft processing code, the IRS will assign the case to a tax assistor. TIGTA reported that the IRS assigns each case priority based first on its age and then by case type—for example, with cases nearing the statute of limitations placed first, followed by cases claiming disaster relief, and then identity theft cases. However, TIGTA has reported that cases are frequently reassigned to multiple tax assistors, and there are often long lag times where no work is accomplished toward resolution. National Taxpayer Advocate Nina Olson also noted in her recent "Identity Theft Case Review Report" on a statistical analysis of 409 identity theft cases closed in June 2014 that a significant number of cases experience a period of inactivity averaging 78 days.

After resolution

The IRS has also created the Identity Protection Personal Identification Number (IP PIN) project, which is meant to prevent taxpayers from being victimized by identity thieves a second time after the IRS has resolved their cases and closed them. The IP PIN is a unique six-digit code that taxpayers must entered on their tax return instead

The IRS assigns an IP PIN to a taxpayer by sending him or her a Notice CP01A. Generally this Notice is issued in December in preparation for the upcoming filing season. The taxpayer then enters it into the appropriate box of his or her federal tax return (i.e. Forms 1040, 1040A, 1040EZ or 1040 PR/SS). On paper returns, this box is located on the second page, near the signature line. When e-filing, the tax software or tax return preparer will indicate where the taxpayer should enter the IP PIN, social security number or taxpayer identification number (TIN) at time they file their tax return. The IP PIN is only good for one tax year.

Taxpayers who have been assigned an IP PIN, but who have lost or misplaced it cannot electronically file their tax returns until they have located it. Previously such taxpayers had no way to retrieve their IP PIN and had to file on paper. Beginning on January 14, 2015, however, taxpayers who had lost their IP PINs were able to retrieve them by accessing their online accounts and providing the IRS with specific personal information and answer a series of questions to verify identity.

Latest breach

The IRS announced on May 26th that 100,000 taxpayers became victims of a new identity theft scheme discovered in mid-May 2015. Identity theft criminals used stolen personal identification information to access the IRS's online "Get Transcript" application and illegally download these taxpayers' tax transcripts. The IRS is concerned that the criminals intend to use taxpayers' past-year return information to file false tax returns claiming tax items and refunds that look legitimate and that do not trigger the IRS's filters for finding suspicious returns. 

Within this latest breach of security, identity thieves had attempted to download a total of 200,000 transcripts, but had only been successful half of the time, according to an announcement by IRS Commissioner John Koskinen. Because the IRS has yet to see how many taxpayers were actually victimized, the IRS may not provide IP PINs to all of these 200,000 taxpayers. However, the 100,000 taxpayers whose tax transcripts were downloaded will receive free credit monitoring services at the IRS's expense, Koskinen stated.

Sometimes in a rush to file your income tax return, you may unintentionally overlook some income that had to be reported, or a deduction that you should or should not have taken.  Now what?  The solution is usually straightforward: you should file what is called an amended return.

Taxable income is measured on an annual basis so you cannot generally wait on correcting a mistake by “making up the difference” on the return that you file next year.  You need to make the correction(s) directly on a revised return for the same tax year.  Form 1040X, Amended U.S. Individual Income Tax Return, is used to amend any individual income tax return.  Income tax returns other than individual income tax returns or returns filed on Form 1120, U.S. Corporation Income Tax Return, or Form 1120-A, U.S. Corporation Short Form Income Tax Return, are amended by filing the same form originally used to file the return.  Partnerships may use Form 1065X.  Amended returns should clearly be marked as such.  Some return forms such as Form 1041, U.S. Income Tax Return for Estates and Trusts, contain a box to be checked if it is being filed as an amended return.  For returns other than income tax returns, Form 843, Claim for Refund and Request for Abatement, is used to claim a refund.

To amend a non-income tax return other than to claim a refund, the same form originally used to file the return generally should be used.  Estate tax returns cannot be amended after they are due.  However, supplemental information may be filed that can change the amount of estate tax due from the amount shown on the return.

When to file an amended return.  A taxpayer must file an amended return and pay the additional tax due if the taxpayer omitted an item of income or incorrectly claimed a deduction for a tax year for which the limitation period is still open.  A tax year ordinarily remains open for three years from the filing of a return.  The three-year period starts running the day after the return is filed.  A return that is filed early is treated as filed on the due date of the return.  The limitations period on assessment for which a return remains open does not start over if an amended return is filed. 

If you realize that you made a mistake on your return that is not in IRS’s favor, it is best to correct it through filing an amended return as soon as possible.  If the IRS starts to audit you and finds the mistake first before you file your amended return, it can assess penalties on the original amount and treat you as if you had not come forward voluntarily on your own.

Special disaster loss option.  Not all amended returns are filed to correct a mistake.  One in particular –claiming a disaster loss—may be filed to effectively accelerate a casualty-loss deduction.  A taxpayer may elect to deduct a disaster loss in the year of occurrence or the immediately preceding year.  To qualify for the election, the loss must occur in a federally-declared disaster area.  The election is made on a return (if you have not filed your return yet for the preceding tax year), an amended return or a refund claim.  The amount of the deduction is determined using the casualty loss limitations.

The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

Dependency deduction

You are allowed one dependency exemption deduction for each person you claim as a qualifying dependent on your federal income tax return. The deduction amount for the 2010 tax year is $3,650. If someone else may claim you as a dependent on their return, however, then you cannot claim a personal exemption (also $3,650) for yourself on your return. Additionally, your standard deduction will be limited.

Only one taxpayer may claim the dependency exemption per qualifying dependent in a tax year. Therefore, you and your spouse (or former spouse in a divorce situation) cannot both claim an exemption for the same dependent, such as your son or daughter, when you are filing separate returns.

Who qualifies as a dependent?

The term "dependent" includes a qualifying child or a qualifying relative. There are a number of tests to determine who qualifies as a dependent child or relative, and who may claim the deduction. These include age, relationship, residency, return filing status, and financial support tests.

The rules regarding who is a qualifying child (not a qualifying relative, which is discussed below), and for whom you may claim a dependency deduction on your 2010 return, generally are as follows:

-- The child is a U.S. citizen, or national, or a resident of the U.S., Canada, or Mexico;

-- The child is your child (including adopted or step-children), grandchildren, great-grandchildren, brothers, sisters (including step-brothers, and -sisters), half-siblings, nieces, and nephews;

 -- The child has lived with you a majority of nights during the year, whether or not he or she is related to you;

 -- The child receives less than $3,650 of gross income (unless the dependent is your child and either (1) is under age 19, (2) is a full-time student under age 24 before the end of the year), or (3) any age if permanently and totally disabled;

 -- The child receives more than one-half of his or her support from you; and

 -- The child does not file a joint tax return (unless solely to obtain a tax refund).

Qualifying relatives

The rules for claiming a qualifying relative as a dependent on your income tax return are slightly different from the rules for claiming a dependent child. Certain tests must also be met, including a gross income and support test, and a relationship test, among others. Generally, to claim a "qualifying relative" as your dependent:

-- The individual cannot be your qualifying child or the qualifying child of any other taxpayer; -- The individual's gross income for the year is less than $3,650; -- You provide more than one-half of the individual's total support for the year; -- The individual either (1) lives with you all year as a member of your household or (2) does not live with you but is your brother or sister (include step and half-siblings), mother or father, grandparent or other direct ancestor, stepparent, niece, nephew, aunt, or uncle, or inlaws. Foster parents are excluded.

Although age is a factor when claiming a qualifying child, a qualifying relative can be any age.

Special rules for divorced and separated parents

Certain rules apply when parents are divorced or separated and want to claim the dependency exemption. Under these rules, generally the "custodial" parent may claim the dependency deduction. The custodial parent is generally the parent with whom the child resides for the greater number of nights during the year.

However, if certain conditions are met, the noncustodial parent may claim the dependency exemption. The noncustodial parent can generally claim the deduction if:

-- The custodial parent gives up the tax deduction by signing a written release (on Form 8332 or a similar statement) that he or she will not claim the child as a dependent on his or her tax return. The noncustodial parent must attach the statement to his or her tax return; or

-- There is a multiple support agreement (Form 2120, Multiple Support Declaration) in effect signed by the other parent agreeing not to claim the dependency deduction for the year.

Correctly calculating your estimated tax payments and/or withholding is even more important as the year end approaches. Accurate calculations are especially important as third and fourth quarter payments become due, and your income and expenses for the rest of the year can be more accurately projected.

Estimated tax payments

You are required to pay estimated tax if you receive income from which tax is not withheld, including income from self-employment, dividends and interest, capital gains and losses, rental income, and alimony, and your tax is expected to be $1,000 or more (after subtracting credits and withholding). Generally, individuals who do not pay at least 90 percent of their tax through withholding must estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability throughout the year.

Higher-income taxpayers. For higher-income taxpayers whose adjusted gross income (AGI) shown on the preceding year's tax return exceeds $150,000 ($75,000 for married individuals filing separately), the required annual payment is the lesser of 90 percent of the tax for the current year, or 110 percent of the tax shown on the return for the preceding tax year.

Estimated tax payments are due quarterly. For most individuals, the due dates for the 2010 tax year are: April 15, June 15, and September 15 of 2010, and January 15, 2011. Failing to pay enough estimated tax on each installment date may result in a penalty for underpayment of estimated tax, even if you are due a refund. Therefore, properly calculating your payments is vital to avoid the penalties, including calculating adjustments needed in remaining quarters (including as soon as September 15, 2010 for the third quarter).

Third quarter payments are around the corner – September 15, 2010 – for the period June 1 through August 31. Fourth quarter payments will be due January 15, 2011 for the period September 1, 2010 through December 31, 2010. If your total estimated payments and withholding add up to less than 90 percent of what you owe, you may face an underpayment penalty.

Withholding

With the third and fourth quarter payments becoming due, ensure you are properly withholding and paying enough in estimated tax. Look at your projected year-end tax payments as compared with your expected tax liability to determine if your estimated tax payments need some tweaking. If your payments are expected to be less than 90 percent of current-year tax, you will generally need to increase your withholding or make estimated tax payments.

You may want to file a new W-4 with your employer adjusting your withholding to withhold more from your final paychecks for the year if you are currently underwithholding. This will help avoid being subject to a penalty when you file your return.

Adjusting estimated tax payments

A change in your business's income, deductions, credits, and exemptions may also make it necessary to refigure your estimated payments for the remainder of the year. To avoid either a penalty from the IRS or overpaying the IRS interest-free, consider increasing or decreasing the amount of your remaining estimated payments.

If, during the quarter, you learn that a change in your business's anticipated income, deductions, credits, exemptions, or other adjustments will either increase or decrease your business's tax liability, and therefore affecting your required annual payment for the remainder of the year, you should adjust your remaining quarterly payments accordingly.

Taxpayers who do not meet the requirements for the home sale exclusion may still qualify for a partial home sale exclusion if they are able to prove that the sale was a result of an unforeseen circumstance. Recent rulings indicate that the IRS is flexible in qualifying occurrences as unforeseen events and allowing a partial home sale exclusion.

Generally, single taxpayers may exclude from gross income up to $250,000 of gain on sale or exchange of a principal residence and married taxpayers filing jointly may exclude up to $500,000. The exclusion can only be used once every two years.

To qualify for this exclusion, taxpayers must own and use the property as their principal residence for periods totaling two out of five years before sale. The five-year period can be suspended for up to 10 years for absences due to service in the military or the foreign service.

Partial exclusions are available when the ownership and use test or two-year test is not met but the taxpayer sells due to change of employment, health or unforeseen circumstances. Without these mitigating circumstances, all gain on the sale of a residence before the two years are up is taxed.

The IRS offers several "safe harbors," that is, events that will be considered to be unforeseen circumstances. These include the involuntary conversion of the taxpayer's residence, casualty to the residence caused by natural or man-made disasters or terrorism, death of a qualified individual, unemployment, divorce or legal separation, and multiple births from the same pregnancy.

If a taxpayer does not qualify for any of the safe harbors, the IRS can determine if a sale is the result of unforeseen circumstances by applying a facts and circumstances test. Some of the factors looked at by the IRS are proximity in time of sale and claimed unforeseen event, suitability of the property as the taxpayer's principal residence materially changes, whether the taxpayer's financial ability to maintain the property is materially impaired, whether the taxpayer used the property as a personal residence and whether the unforeseen circumstances were foreseeable when the taxpayer bought and used the property as a personal residence.

Recently, the IRS has decided that several non-safe harbor events were unforeseen circumstances. These include sales because of fear of criminal retaliation, the adoption of a child, a neighbor assaulting the homeowners and threatening their child, and a move to an assisted living facility followed by a move to a hospice.

If you think you may be eligible for a reduced home sale exclusion because of an unforeseen circumstance, give our office a call.

When it comes to legal separation or divorce, there are many complex situations to address. A divorcing couple faces many important decisions and issues regarding alimony, child support, and the fair division of property. While most courts and judges will not factor in the impact of taxes on a potential property settlement or cash payments, it is important to realize how the value of assets transferred can be materially affected by the tax implications.

When it comes to legal separation or divorce, there are many complex situations to address. A divorcing couple faces many important decisions and issues regarding alimony, child support, and the fair division of property. While most courts and judges will not factor in the impact of taxes on a potential property settlement or cash payments, it is important to realize how the value of assets transferred can be materially affected by the tax implications.

One of the most argued points between separating couples regarding taxes is who gets to claim the children as dependents on their tax return, since joint filing is no longer an option. The reason this part of tax law is so important to divorcing parents is that the federal and state exemptions allowed for dependents offer a significant savings to the custodial parent, and there are also substantial child and educational credits that can be taken. The right to claim a child as a dependent from birth through college can be worth over $30,000 in tax savings.

The law states that one parent must be chosen as the head of the household, and that parent may legally claim the dependents on his or her return.

Example: If a couple was divorced or legally separated by December 31 of the last tax year, the law allows the tax exemptions to go to the parent who had physical custody of the children for the greater part of the year (the custodial parent), and that parent would be considered the head of the household. However, if the separation occurs in the last six months of the year and there hasn't yet been a legal divorce or separation by the year's end, the exemptions will go to the parent that has been providing the most financial support to the children, regardless of which parent had custody.

A non-custodial parent can only claim the dependents if the custodial parent releases the right to the exemptions and credits. This needs to be done legally by signing tax Form 8332, Release of Claim to Exemption. However, even if the non-custodial parent is not claiming the children, he or she still has the right to deduct things like medical expenses.

Child support payments are not deductible or taxable. Merely labeling payments as child support is not enough -- various requirements must be met.

Alimony is another controversial area for separated or divorced couples, mostly because the payer of the alimony wants to deduct as much of that expense as possible, while the recipient wants to avoid paying as much tax on that income as he or she can. On a yearly tax return, the recipient of alimony is required to claim that money as taxable income, while the payer can deduct the payment, even if he or she chooses not to itemize.

Because alimony plays such a large part in a divorced couple's taxes, the government has specifically outlined what can and can not be considered as an alimony expense. The government says that an alimony payment is one that is required by a divorce or separation decree, is paid by cash, check or money order, and is not already designated as child support. The payer and recipient must not be filing a joint return, and the spouses can not be living in the same house. And the payment cannot be part of a non-cash property settlement or be designated to keep up the payer's property.

There are also complicated recapture rules that may need to be addressed in certain tax situations. When alimony must be recaptured, the payer must report as income part of what was deducted as alimony within the first two payment years.

Many aspects of property settlements are too numerous and detailed to discuss at length, but separating couples should be aware that, when it comes to property distributions, basis should be considered very carefully when negotiating for specific assets.

Example: Let's say you get the house and the spouse gets the stock. The actual split up and distribution is tax-free. However, let's say the house was bought last year for $300,000 and has $100,000 of equity. The stock was bought 20 years ago, is also worth $100,000, but was bought for $10,000. Selling the house would generate no tax in this case and you would get to keep the full $100,000 equity. Selling the $100,000 of stock will generate about $25,000 to $30,000 of federal and state taxes, leaving the other spouse with a net of $70,000. While there may be no taxes to pay for several years if both parties plan to hold the assets for some time, the above example still illustrates an inequitable division of assets due to non-consideration of the underlying basis of the properties distributed.

Under a recent tax law, a spouse who acquires a partial interest in a house through a divorce settlement can move out and still exempt up to $250,000 of any taxable gain. This still holds true if he or she has not lived in the home for two of the last five years, the book states. It also applies to the spouse staying in the home. However, the divorce decree must clearly state that the home will be sold later and the proceeds will be split.

Complications and tax traps can also occur when a jointly owned business is transferred to one spouse in connection with a divorce. Professional tax assistance at the earliest stages of divorce are recommended in situations where a closely held business interest is involved.

When a couple splits up, the courts have the authority to divide a retirement plan (whether it's an account or an accrued benefit) between the spouses. If the retirement money is in an IRA account, the individuals need to draw up a written agreement to transfer the IRA balance from one spouse to the other. However, if one spouse is the trustee of a qualified retirement plan, he or she must comply with a Qualified Domestic Relations Order to divide the accrued benefit. Each spouse will then be taxed on the money they receive from this plan, unless it is transferred directly to an IRA, in which case there will be no withholding or income tax liability until the money is withdrawn.

Extreme caution should be exercised when there are company pension and profit-sharing benefits, Keogh plan benefits, and/or IRAs to split up. Unless done appropriately, the split up of these plans will be taxable to the spouse transferring the plan to the other.

When a couple prepays taxes by either withholding wages or paying estimated taxes throughout the year, the withholding will be credited to the spouse who earned the underlying income. In community property states, the withholding will be credited equally when spouses each report half of their income. When a joint refund is issued after a couple has separated or divorced, the couple should consult a tax advisor to determine how the refund should be divided. There is a formula that can be used to determine this amount, but it is wisest to use a qualified individual to make sure it is properly applied.

To the dismay of most divorcing couples, the massive legal bills most end up paying are not deductible at tax time because they are considered personal nondeductible expenses. On the other hand, if a part of that bill was allocated to tax advice, to securing alimony, or to the protection of business income, those expenses can be deducted when itemizing. However, their total -- combined with other miscellaneous itemized deductions -- must be greater than 2% of the taxpayer's adjusted gross income to qualify.

Divorce planning and the related tax implications can completely change the character of the divorcing couple's negotiations. As many divorce attorneys are not always aware of these tax implications, it is always a good idea to have a qualified tax professional be involved in the dissolution process and planning from the very early stages. If you are in the process of divorce or are considering divorce or legal separation, please contact the office for a consultation and additional guidance.