Tuesday, December 22, 2009


As the end of 2009 approaches I wanted to bring to your attention some important IRS and Tax Court rulings applicable to the Form 1040 that were issued during the year.

+ Credit and Debit Card Fees

The Tax Code says that expenses paid or incurred by an individual in connection with the “determination, collection, or refund of any tax” can be deducted as a miscellaneous itemized expense on Schedule A.

The IRS recently reversed its earlier position and ruled that this deduction includes "convenience" fees, including those associated with estimated tax payments, charged when taxpayers use a credit or debit card to pay their taxes electronically can be claimed as a miscellaneous itemized expense. Of course, miscellaneous expenses are deductible only to the extent that they exceed two percent of a taxpayer's Adjusted Gross Income (AGI).

+ Energy-Saving Purchases

Section 25D of the tax code provides a tax credit for individuals who buy qualifying "residential energy efficient property". Certain energy standards must be met to qualify for the credit, which is generally equal to 30% of the purchase price.

The IRS has, in Notice 2009-41, 2009-19 IRB 933, announced that a manufacturer of property may certify to a taxpayer that the property meets these standards and that the taxpayer may rely on this certification to claim the credit. If it is later determined that the property does not meet the appropriate standards, any property purchased before that determination will remain eligible for the credit. Obviously taxpayers should retain the manufacturers’ certifications with his/her tax records me.

+ Home Mortgage Interest -

The Schedule A deduction for mortgage interest is limited to “qualified residence interest” on “acquisition debt” of $1 Million (actually $1.1 Million as per another recent IRS ruling). In CCA 200911007 the IRS ruled that the $1 Million cap applies to all owners of a single personal residence collectively and not to each owner separately. It is “per home” and not “per taxpayer”.

A home was transferred from a single owner to a joint ownership with another individual who was not the owner's spouse. The new co-owner was made jointly liable on the home's mortgage, which exceeded $1 Million, and paid a portion of the mortgage interest. The taxpayers argued that the $1 million limit should be interpreted to allow each owner to deduct the interest on up to $1 million of acquisition debt on which the individual owner is personally liable. But the IRS said that the Code states that acquisition debt is debt incurred in acquiring a qualified residence of the taxpayer, and not debt incurred in acquiring the taxpayer's portion of a qualified residence.

+ IRA Distributions

Premature distributions from an Individual Retirement Account (IRA) before age 59½ are generally subject to a 10% penalty tax. There are exceptions to the penalty, such as for distributions that are part of a series of “substantially equal periodic payments”, and distributions for qualified higher education expenses. Under the “SEPP” exception, if the series of substantially equal periodic payments is modified (reduced or increased), other than by reason of death or disability, then the 10% penalty is applied retroactively to prior distributions made before the IRA owner attained age 59½.

A taxpayer, prior to reaching age 59½, elected to receive equal IRA distributions each year amounting to $102,311. A couple of years later the taxpayer also withdrew $22,500 to pay for her son's qualified higher education expenses. The IRS contended that this additional withdrawal was a prohibited modification of the substantially equal requirement, thus triggering the retroactive penalty tax.

The Tax Court, in Benz, 132 T.C. No. 15, ruled that the taxpayer did not "modify" her substantially equal periodic payments by also withdrawing funds that qualified for the higher education exception. Distributions can qualify under more than one exception. A distribution that satisfies the exception for higher education expenses is not a violation of the substantially payment equal requirement. The Tax Code specifically provides that the amount of distributions attributable to higher education expenses does not include distributions qualifying as substantially equal periodic payments. An IRA owner only has to rely on the higher education exception to the extent that distributions exceed the substantially equal periodic payments.

+ Investment Losses

In response to the Bernard Madoff scam, the IRS issued Rev. Rul. 2009-9, 2009-14 IRB 735 to outline the tax consequences for investors who suffer losses from investing in fraudulent Ponzi-like schemes.

A loss from criminal fraud or embezzlement in a transaction entered into for profit is a theft loss claimed on Form 4684 and not a capital loss. The loss can be deducted against ordinary income without regard to the $3,000 capital loss limit. A theft loss from a transaction entered into for profit is also not subject to the 10% of Adjusted Gross Income deduction threshold that applies to theft losses of personal use properties.

A loss will be considered from a fraud or embezzlement if -

(a) the lead figure, or one of the lead figures, was indicted under state or federal law with the commission of fraud, embezzlement, or a similar crime that would meet the definition of theft,

(b) the lead figure was the subject of a state or federal criminal complaint resulting from an admission by the lead figure, or

(c) the lead figure was the subject of a state or federal criminal complaint and a receiver or trustee has been appointed to administer the assets or the assets have been frozen.

The loss is deductible in the year it is discovered. The amount of the investment theft loss deduction is the basis of the property (or the amount of money) that was lost reduced by any claim for recovery or reimbursement which has a reasonable prospect of success. When a loss deduction is reduced by the claim, recoveries on the claim in a later year are not includible in the investor's gross income unless the recovery exceeds the reduction that had been claimed.

+ Rental Losses

Rental activities are generally treated as passive activities, even if the owner is actively involved in the operations, and therefore subject to the passive loss deduction limitations. A special exception allows an active participant in a "real property trade or business" – a “real estate professional” - to deduct rental losses as long as he or she materially participates in the rental activity. A "real property trade or business" is defined as any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

The Tax Court, in Agarwal, TC Summary Op. 2009-29, ruled that an individual can qualify as a "broker" for the special exception for real property trade or business even though he or she is not classified as a broker under state law. A real estate agent or salesperson who sells property, negotiates the terms of a real estate contract, secures prospective buyers, and performs similar broker-like activities is considered a broker, and therefore a “real estate professional”, for purposes of the passive loss exception.

If you think any of the above rulings apply to you I suggest you consult your tax professional.