ASK THE TAX PRO: AN EXCEPTION TO THE 2-YEAR OWNERSHIP AND RESIDENCE RULE

I recently received a tax question from a reader that was submitted as a comment to a totally unrelated TWTP post. 

Here is the comment -

“Hello,

My wife and I bought our current home as our primary home n Temecula, CA and closed escrow on 9/28/12. We sold a townhome which was our primary which we lived in for 7 years in Carlsbad, CA before buying our current home in Temecula, CA. I work for a company working remotely from home.

We are putting our house up for sale as of 6/20/14 and I received approval from my manager to relocate at my own expense back to Overland Park, KS, so we can be closer to my mother-in-law as she has multiple sclerosis and her son lives with her working full time and he needs help taking care of her.

If we sell our home before the 2 years is up what sort of paperwork would I need to have in case the IRS asks me about paying capital gains tax on our profit since we have lived less than 2 years in our home. I can always just have the potential buyer not close until after 9/28/14 so we have lived in our primary home for 2 years. We would make around 165K profit so we would meet the married filing joint proration criteria.

If we sell and close escrow before the 2 years is up then would I meet the over 50 miles job transfer criteria since I approached my company to relocate and/or would I need my mother-in-law to provide medical documentation show she has multiple sclerosis. I just don't want to have to pay capital gains tax which would amount to around a 40k tax bill if the IRS doesn't feel we have sufficient evidence for selling our home and moving without living in our home for 2 years.

Any info would be appreciate. Thanks.

David Allen”

First let’s address the issue of not owning and living in the home for 24 months during the 5 year period prior to sale.

Here is what we are told in IRS Publication 523 “Selling Your Home” (highlight is mine)  -

“If you fail to meet the requirements to qualify for the $250,000 or $500,000 exclusion, you may still qualify for a reduced exclusion. This applies to those who:

• Fail to meet the ownership and use tests, or

• Have used the exclusion within 2 years of selling their current home.

In both cases, to qualify for a reduced exclusion, the sale of your main home must be due to one of the following reasons.

• A change in place of employment.

• Health.

• Unforeseen circumstances.”

And

“The sale of your main home is because of health if your primary reason for the sale is:

• To obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or

• To obtain or provide medical or personal care for a qualified individual suffering from a disease, illness, or injury.

The sale of your home is not because of health if the sale merely benefits a qualified individual's general health or well-being.

For purposes of this reason, a qualified individual includes, in addition to the individuals listed earlier under Qualified individual , any of the following family members of these individuals.

• Parent, grandparent, stepmother, stepfather.

• Child, grandchild, stepchild, adopted child, eligible foster child.

• Brother, sister, stepbrother, stepsister, half-brother, half-sister.

• Mother-in-law, father-in-law, brother-in-law, sister-in-law, son-in-law, or daughter-in-law.

• Uncle, aunt, nephew, niece, or cousin.

Example.

In 2012, Chase and Lauren, spouses, bought a house that they used as their main home. Lauren's father has a chronic disease and is unable to care for himself. In 2013, Chase and Lauren sold their home in order to move into Lauren's father's house to provide care for him. Because the primary reason for the sale of their home was to provide care for Lauren's father, Chase and Lauren are entitled to a reduced maximum exclusion.”

You can exclude a portion of your gain if you are selling your home and lived there less than 2 years and you meet one of the three exceptions.  The $500,000 maximum exclusion is pro-rated based on the period of residence.

The website of legal publisher NOLO has this to say in “Exceptions to the Home Sale Exclusion Two Year Rule” from Stephen Fishman, J.D -

“Health problems are a valid excuse if a doctor recommends that you move for health reasons—for example, you have asthma and your doctor tells you that living in Arizona would be better for you than Maine. The health problems can belong to you, your spouse, any co-owner of the property, any other person who uses your home as his or her principal residence, or a close family member of any person in the prior categories—for example, a child or parent. Thus, for example, you can move if you need to be closer to an ill parent. If you want to use the health exception, be sure to get a letter from your doctor stating that the move is for health reasons and what they are. Keep the letter with your tax files.”

The safest way to secure the exception to the 2-year rule is to obtain an IRS Private Letter Ruling – but this is truly very expensive.  Before selling the home I would get a letter from the mother’s doctor stating her medical condition and her need for personal care.  I would also get a letter from the brother stating that he is unable to provide continual care because of his full-time employment.  These letters do not to be attached to the 2014 tax return, but should be available in case of an inquiry.

If the sale of the home closes prior to 9/28/2014, the couple can still report the sale on the 2014 Schedule D and claim the Section 121 exclusion.  A statement should to be attached to the return explaining why the period of ownership and residence is less than 2 years and including the calculation of the reduced maximum exclusion amount.

As for the question of deducting moving expenses (not specifically asked, but alluded to in the reference to the “over 50 miles job transfer criteria”) – since the move from California to Kansas is not at all job-related none of the moving expenses are deductible.

IRS Publication 521 “Moving Expenses” says -

“You can deduct your moving expenses if you meet all three of the following requirements.

•Your move is closely related to the start of work.

•You meet the distance test.

•You meet the time test.”

While the distance and, I expect, the time tests will be met, the move is personally motivated and has nothing whatsoever to do with DA’s employment.  He works out of his home.  He is not moving to start a new job or because his company is relocating.  He is moving to be able to take care of a qualified family member.  .   

I hope this post satisfactorily answers the questions posed by Mr. Allen.  Does anyone out there have any additional comments or suggestions, or disagree with anything I have said?

TTFN

ASK THE TAX PRO - NY NONRESIDENT TAX

I recently received a question about NY non-resident taxation via a comment to an older post.

“Hello,

I was wondering if I was to work from home 5 days a week for a company with a NYC address would I still be liable for NY taxes?

Thanks.”

As with any question involving taxes the answer is “it depends”.  It depends on the specific facts and circumstances of your situation.

You do not indicate whether or not you are an employee or the company with the NYC address or if you are an “independent contractor”.  I assume we are talking here about “telecommuting”. 

In May of 2006 the New York Department of Taxation and Finance addressed this issue for employees in TSB-M-06(5)I “New York Tax Treatment of Nonresidents and Part-Year Residents Application of the Convenience of the Employer Test to Telecommuters and Others”.  If you are an employee I suggest you download and read in full this TSB Memo.

Nonresident employees of New York employers do not have to pay New York state income tax on days worked physically outside of New York State.  The allocation is made on Schedule A of Form IT-203-B (Allocation of Wage and Salary Income to New York State).  The instructions for this Schedule provide that (highlight is mine):

“Work days are days on which you were required to perform the usual duties of your job. Any allowance for days worked outside New York State must be based upon the performance of services which, because of necessity (not convenience) of the employer, obligate the employee to out-of-state duties in the service of his employer. Such duties are those which, by their very nature, cannot be performed at the employer’s place of business.

Applying the above principles to the allocation formula, normal work days spent at home are considered days worked in New York State.”

The TSB Memo notes (highlights are mine) -

“Under this rule, days worked at home are considered New York work days only if the employee’s assigned or primary work location is at an established office or other bona fide place of business of the employer (hereinafter, a bona fide employer office) in New York State.”

For tax years beginning on or after January 1, 2006, it is the Tax Department’s position that in the case of a taxpayer whose assigned or primary office is in New York State, any normal work day spent at the home office will be treated as a day worked outside the state if the taxpayer’s home office is a bona fide employer office.

A combination of several factors are taken into account to determine if a taxpayer’s home office is a “bona fide employer office”.  For example - 

·      If some of the core duties of employment are performed at the home office, then the home office will meet this factor. For example, the core duties of a stock broker include the purchase and sale of stock. Accordingly, if the stock broker executes stock purchases and sales from the home office, this would constitute performing some of the core duties at the home office. However, if the stock broker merely reads business publications on the weekend, this would not constitute performing any core duties at the home office.

·      If an important part of the employee’s duties include physically meeting with clients, patients or customers in the normal course of the employer’s trade or business, and those meetings are performed on a regular and continuous basis at the home office, then the home office will meet this factor.

·      If the employer requires the employee to work from his or her home office as a condition of employment, the home office will meet this factor. For example, if a written employment contract states the employee must work from home to perform specific duties for the employer, then the home office will meet this factor.

·      If the employer does not provide the employee with designated office space or other regular work accommodations at one of its regular places of business, then the home office will meet this factor.

If you are a “self-employed” independent contractor, and your main place of business is your home, which is not located in New York, and the NY-based company is one of your clients or customers, and you do the work for this client or customer exclusively at your home office I would say you do not have to pay NY state income tax on the fees paid by this company.

Does anyone disagree?

FYI - NJ residents who regularly work as an employee at an office in New York do not have to pay NY state income tax on regular working days when you attend a job-related conference, convention, seminar, or other training activity, or visit a client, in another state.  For example, you attend a training session in Connecticut, or spend two days at a client or customer’s office in New Jersey. 

By allocating your days outside of NY you will probably pay less net combined state income tax, because the tax rate is higher in NY than NJ on most levels.  You would allocate out these days on Schedule A of Form IT-203-B. 

TTFN

OOPS!

I inadvertently deleted a comment that had been posted to IT AIN’T NECESSARILY SO that, while it had absolutely nothing to do with my post, posed a good question.  I apologize for the deletion – and will herein respond to the question.  

The reader asked –

“If you have to amend several years of taxes, will this lead to an audit?”

In almost 40 years of preparing 1040s I have never seen a Form 1040X (an amended return) audited - or even questioned.

I think one of the reasons is that, in addition to providing a detailed explanation of the changes made on the 1040X, often actual documentation of the changes is attached to the amended return (which I recommend).  So any potential questions are already answered.

I think it is an “urban tax myth” that filing an amended return will substantially increase one’s chance of an audit.

What I do recommend to clients who are amending several years of taxes is that they mail the oldest 1040X first (i.e. if amending 2008, 2009, and 2010 mail the 2008 Form 1040X first).  When the refund for that return is received mail out the next (i.e. 2009) Form 1040X.  And when that refund is received mail out the next (i.e. 2010).  If you are not requesting a refund, allow at least 8 weeks between the mailing of each return. 

Generally you have three (3) years from the due date of the return being amended to file a Form 1040X – although there are situations when you can, and would want to, file amendments for earlier returns.  For example, you have up to seven (7) years to amend a return to claim a loss on worthless stock.

If you find an error on a previous return, and that error affects subsequent returns or the error was repeated on subsequent returns, you should submit amended returns.  Do not be afraid that you will be automatically audited.  If your amendment is legitimate, and you are one of the truly rare “amenders” who are actually questioned, you should have nothing to worry about if you have proper documentation for the change(s). 

As I have said in the past, while an audit is not something you would want, if your return is properly and correctly prepared, and you have documentation for your income, deductions and credits, there is no cause for fear and concern.  In such a case the audit is just an inconvenience.  You should not make tax decisions based solely on the possibility of being audited.    

TTFN

ASK THE TAX PRO - EXCESS TAX CREDITS

Here is a question I got via email from a long-time friend and client.

Q. This may be a stupid question, but I just want to be sure. Between the $1,700 tax credit for the hybrid I will receive, as long as it is delivered by 9/30/08, and the sales tax credit of about $2,900 I will exceed my total tax liability for the year. In addition, because of my medical expenses, and I am having dental work done now also, property taxes, new home equity interest, and the usual I will have lots of deductions. If I exceed my tax liability will I still receive the balance of the tax credits as a refund? If not, I could always cash in some more bonds.

A. There is no such thing as a stupid tax question – only stupid taxpayers (who don’t consult a competent tax professional)! The question actually brings up an excellent tax-planning point.

First of all, the “sales tax credit of about $2,900” to which he refers is not actually a credit (a credit is a dollar-for-dollar reduction of tax liability). He is talking about the “above the line” tax deduction for sales or excise taxes paid on the purchase of a new automobile. His Adjusted Gross Income (AGI), and not his tax liability, will be reduced by $2,900. He also mentions excessive medical expenses, so the $2,900 “above the line” deduction will increase his allowable medical deductions by $218!

He is basically asking if the $1,700 energy tax credit for purchasing a hybrid car reduces his tax liability to below “0” will he be able to receive a refund of the unused credit. The answer is no.

Most tax credits are not “refundable”. Only the Earned Income Credit, BO’s new Making Work Pay Credit, a portion of the new American Opportunity Credit for tuition and fees, and possibly the Child Tax Credit are “refundable”. By “refundable” I mean they are treated as additional withholding and can be applied against “other” taxes, such as the self-employment tax and the penalty for early withdrawal from a pension account, and ultimately added to the taxpayer’s refund.

In the case of my friend – he is single with no children, recently retired (late 2008) - though not receiving Social Security or Railroad Retirement - and will be reporting some nominal net earnings from self-employment for 2009. The only “refundable” credit to which he will be entitled is the Making Work Pay credit, which is based on 6.2% of his self-employment income. The MWP credit can be applied against his self-employment tax for the year.

However with reduced income due to retirement and excessive deductions due to special situations it is very possible that the $1,700 hybrid credit will exceed his federal income tax liability. In such a case the excess hybrid credit would be lost.

In this particular case the taxpayer has a large “inventory” of US Series E savings bonds, both purchased and inherited, that are still earning interest. He plans to cash in a certain amount each year, determined by tax planning, to supplement his income until Social Security kicks in. He has already cashed in the bonds scheduled for 2009.

What we will do is prepare a “preliminary” 2009 tax return in late November or early December as part of regular year-end tax planning. If at that time we determine, based on year-to-date information, that his tax liability before the hybrid credit will be less than $1,700 he will cash in enough additional savings bonds to generate the amount of taxable interest income needed to use up the excess credit. By doing this the additional savings bond interest will be totally tax free (US savings bond interest is already tax free on the NJ-1040)!

FYI, my friend and client uses the Savings Bond Wizard software available online to properly “inventory” his bonds so that he knows how much interest each bond will accrue for the year.

TTFN

ASK THE TAX PRO - MISSED CAPITAL LOSS

Q. We had a $20,000+ capital loss in 2004 that was not claimed on our 2004 Form 1040. Can we still claim this loss?

A. Generally you have three (3) years from the due date of the return to file an amended return to get an additional refund.

The 2004 Form 1040 would have been due on April 15, 2005. So you would have until April 15, 2008 to amend your 2004 return. At this point in time 2004 and 2005 are considered “closed” years and cannot be amended to claim the loss deduction and get a check from Sam.

However, according to TC Memo 1983-318, a taxpayer can claim a capital loss carryover deduction in open years for a loss that occurred in a closed year but was not claimed in that year. You must, of course, adjust the carryforward for any losses that would have been used up in the closed years.

The maximum net capital loss deduction allowed is $3,000 per year. You would begin with tax year 2004. If you had no other capital gains or losses in 2004 you would reduce the loss by the $3,000 that would have been allowed and carry $17,000 forward to 2005. If the original 2004 Form 1040 had shown a net capital gain of $5,000 the $20,000 would first be used to wipe out the gains and only $12,000 would be carried forward to 2005.

The procedure is repeated for tax year 2005. If there are no gains or losses reported $3,000 is deducted from the carryforward from 2004 and the balance is brought forward to tax year 2006. You can file an amended 2006 Form 1040 to claim the loss carryforward deduction.

If the 2005 return reported a net $5,000 loss the 2004 carryover would be added to the $2,000 unused 2005 loss and the total carried over to 2006.

If there were no other gains or losses reported in either 2004 or 2005 the capital loss carryforward deduction on the amended 2006 Schedule D would be $14,000 – the forgotten $20,000 loss less $3,000 each year for 2004 and 2005.

TTFN

ASK THE TAX PRO – WHERE DOES THE MONEY GO?

Earlier this month I received the below question from Murray, submitted as a comment to my post ASK THE TAX PRO - UNUSED FLEXIBLE SPENDING ACCOUNT CONTRIBUTIONS.

It is as good a question as any with which to begin the return of ASK THE TAX PRO Wednesday.

Q. Where does the money go? To the employer? To the government? Or does it just evaporate?

A. The question relates to the unused portion of moneys set aside in an employer-sponsored “Flexible Spending Account” or FSA.

An FSA is a “use it or lose it account”. The employee-participant “forfeits” any unused monies set aside. If he/she sets aside $5,000 for the year, but only submits $4,000 in qualifying expenses, the unused $1,000 is lost. The employee is $1,000 “out of pocket” – although, as I point out in my post, this is not a tax-deductible loss.

A plan year is generally a calendar year. Originally expenses had to be submitted by December 31st to be included. However under new rules for Flexible Spending Accounts you have 2½ months of the following year to submit expenses against FSA monies contributed for the year – if your plan so permits. So participants would be able to submit expenses up until March 15th of 2009 to be applied to monies set aside in calendar/plan year 2008.

So, as you ask, where does any unused FSA money go?

Obviously the money does not just evaporate. And it does not go to the government. Ultimately the money goes back to the employer.

I do not know the specific mechanics of what happens to forfeited FSA monies, as I have never had, or wanted, any direct experience with the administration of an FSA. I would expect that initially the unused money remains in the actual “plan” – and can be used to offset plan losses that can arise from employees whose employment is terminated with a “negative” FSA cash balance.

It is my understanding that FSA contributions are generally made evenly throughout the year via payroll deduction - but expenses can be “reimbursed” as they are submitted, up to the total amount that has been set aside. So it is possible that an employee who has set aside $5,000 can submit $4,000 in dental expenses incurred in February, although only $833 in actual employee payments have been made. If the employee leaves the company at the end of June, with only $2,500 in total payments, he/she does not have to repay $1,500. {Please correct me if I am wrong}.

However, the bottom line answer to the question is that, as said above, ultimately the unused FSA contributions go back to the employer.

TTFN

ASK THE TAX PRO – AMENDING YOUR RETURN FROM SEPARATE TO JOINT

This question was first posed in a comment to my post on "Amending Your Return".
.

Q. My mother just found out that her 2007 e-file was rejected due to her name change in the same year (marriage). She filed "married, separately" but now wants to change it to filing jointly. What should she do, and what numbers should she include on the 1040x since she has no "original" tax return but he does?

A. First of all – I hope she has changed her name with the Social Security Administration. If not – she should do so immediately. Click here.

Now on to the Form 1040X. You cannot change from Married Filing Joint to Married Filing Separately after the initial April filing deadline has passed – but you can change from separate to joint. According to the 1040X instructions (the highlight is mine) –

“If you and your spouse are changing from separate returns to a joint return, follow these steps.

1. Enter in Column A the amounts from your return as originally filed or as previously adjusted (either by you or the IRS) {the information from the separate tax return of your step-father would go here – rdf}.

2. Combine the amounts from your spouse’s return as originally filed or as previously adjusted with any other changes you or your spouse are making to determine the amounts to enter in Column B. If your spouse did not file an original return, include your spouse’s income, deductions, credits, other taxes, etc., to determine the amounts to enter in Column B” {here is where your mother’s 2007 information would go – rdf}.

You would combine the amounts in Columns A and B and enter the totals in Column C. Column C should show income, deductions and credits as they would have appeared if they had originally filed a joint return.

Both your mother and step-father must sign the Form 1040X.

I would recommend they retain a tax professional to prepare the amended return.

FYI - This will be my last ASK THE TAX PRO post until May. Please do not submit any questions to be answered here until after the tax season. Any questions received will be stored away in "inventory" unread until May 2009!

TTFN

ASK THE TAX PRO - UNUSED FLEXIBLE SPENDING ACCOUNT CONTRIBUTIONS

Q. What happens to money left behind in the FSA? I lost track of time and left $1000 behind in my FSA account. Ok, so I lose and it's a forfeit. Any chance I can deduct the monies left behind?

A. You cannot claim a “loss” or miscellaneous itemized deduction for unused, or forfeited, FSA monies.

The monies you contributed to your FSA, including the $1,000 that was forfeited, have already been deducted on your tax return. The total amount of wages that are paid into a Flexible Spending Account reduces the taxable federal wages reported in Box 1 of your Form W-2.

If you contributed $5,000 of your wages to the FSA then your “take home pay” and your federal taxable wages (and possibly state taxable wages) are reduced by $5,000. If your gross wages are $100,000 the W-2 will show $95,000. If you only submitted $4,000 in expenses then you have indeed suffered an economic loss of $1,000 – but it is income that was not taxed.

All is not lost. Under the new rules for Flexible Spending Accounts you have until March 15th of 2009 to submit expenses against FSA monies contributed for tax year 2008 – if your plan so permits. This applies to both medical expense and dependent care FSAs.

.

So there is still time to use the $1,000 balance in your 2008 account!

.
TTFN

AN ASK THE TAX PRO QUICKIE

It is Christmas Eve, and as is my annual holiday custom I will be typing W-2s!

Since it is Wednesday here is a quickie ASK THE TAX PRO -

.
Q. I've been following your blog for some time now, but never had a question to ask that I couldn't find an answer to online. Right now I have a really puzzling one that I can't seem to find an answer for anywhere on the internet.

I understand that a person's ability to contribute to a Roth IRA may be partially or fully restricted due to income limits. I recently read about a Fidelity Retirement Rewards American Express Card that contributes 2% “cash-back” into a Fidelity IRA account for you. Their fine print says that it is up to the cardholder to ensure that they comply with all legal regulations.

Because the contribution is coming from American Express or Fidelity, rather than directly from me, does that mean that those contributions would be allowable in full regardless of income?

A. The IRA contributions are NOT coming from American Express or from Fidelity - they are coming from you!

American Express will pay you a "cash-back" bonus. Instead of sending you a check for the bonus they will directly deposit the bonus into an IRA account in your name at Fidelity.

You still must personally satisfy the AGI income limitations in order to be able to contribute to a ROTH account. If you cannot have a ROTH because of your AGI the "cash-back" bonus would have to be deposited to a "traditional" IRA, and the normal rules would apply to determine if the contributions would be deductible.

TTFN

ASK THE TAX PRO - PER DIEMS FOR OWNER-EMPLOYEES

Q. I have an S Corp (100% ownership) with about 40 employees including my spouse and myself. I also own a “C” Corp. We do IT consulting for different clients and visit the clients at their sites.

My employees claim per diem travel expenses based on the GSA per diem rates for lodging and meals if they travel more than 100 miles to our client sites from their home base.

I also travel to client sites and in some cases it is more than 100 miles from my home base. I was told by my CPA that as per IRS rules I, as the owner of the S Corp, will not be able to claim per diem.

In my case, I am not only the owner of the S Corp but I am also a consultant who helps clients whose location may be more than 100 miles from my home base.

Can I claim travel per diem expenses for lodging and meals based on the GSA allowance through the S Corp? Is the owner allowed to take per diem via the C Corp if the S Corp option is not possible?

A. An employer can pay to an employee a per diem allowance for expenses incurred by the employee for travel away from home by using one of the following methods –

* The federal per diem rate for meals, incidentals and lodging.

* The standard meal allowance (federal rate for meals and incidentals).

* The high-low rate,

Under IRS Rev Proc 2007-63, self-employed taxpayers filing a Schedule C and employees who are not covered by an employer reimbursement plan cannot use the per diem method that includes lodging. To claim a deduction for lodging expenses these taxpayers must substantiate the actual cost. The can use the standard meal allowance or incidental expense only per diem.

Similarly, corporate employers cannot use the per diem that includes lodging for owner-employees with more than 10% ownership, based on direct or indirect ownership.

Employers can reimburse employees tax free under an "accountable plan", and claim a deduction for travel expense, only if the employee is “away from home overnight” and the rules for a “temporary assignment” apply. An overnight stay is required.

If an employee is required to stay at a hotel or motel overnight in the course of a business assignment the employer can reimburse the employee tax-free for meals and lodging under an “accountable” plan, and a deduction is allowed for such an expense.

The employer can use the GSA per diem rate for meals and lodging to reimburse the employee in lieu of requiring the employee to substantiate the actual out-of-pocket expenses.

However if the employee owns 10% or more of the stock of the corporation, either directly or indirectly, the deduction for lodging is limited to the actual out-of-pocket expense.

If the actual cost of the hotel room is $100.00 and the allowable GSA per diem lodging allowance is $115.00, the employer can reimburse a non-10% employee, and claim a deduction for, $115.00 for lodging. However the employer can only deduct $100.00 if the employee in question is an owner-employee with a more than 10% ownership.

In your case as 100% owner you can deduct lodging while away from home overnight on business, but your tax deduction is limited to the actual expense for lodging. The Rev Proc does not differentiate between an “S” or “C” corporation. You can, however, deduct the GSA per diem standard meal allowance amount for meals and incidental expenses incurred while away from home overnight.

The use of 100 miles away from home base as criteria has absolutely nothing to do with the ability of an employer to reimburse an employee for business travel. The requirement for an overnight stay still exists.

If an employee travels to a business location, including the office of a client, during the day and returns to his home in the evening (i.e. there is no overnight stay), regardless of the number of miles traveled, no deduction is allowed for lodging. In such a case meals will only be deductible if the specific meal qualifies under the general rules for deducting business meals and entertainment.

If you pay an employee, owner or not, an additional flat per diem amount for traveling 100+ miles from home base and no overnight stay is involved that amount is considered to be additional taxable compensation subject to all payroll taxes and included as wages on the Form W-2.

TTFN

ASK THE TAX PRO - CHARITABLE CONTRIBUTIONS

Q. Just wondering -- if we buy candy, 50/50 raffles, etc. from co-workers/friends/family for the benefit of schools or scouts, are we allowed to deduct the expenses on our tax return? (Sometimes, each order amounts to $40 or so.) If yes, should we pay by check each time?

.
A. When giving me a list of charitable contributions for the year many clients will include the cost of raffle tickets, including 50-50s, purchased for the benefit of a church or school. Regardless of who is selling them (i.e. church or charity) 50-50 raffle tickets, or any kind of raffle tickets, are not charitable contributions - they are gambling. To repeat - raffle tickets are not deductible as contributions.

If you are reporting taxable gambling winnings on Line 21 of your Form 1040 - from whatever source (i.e. casinos, racetrack, lottery, raffle, etc) - the cost of raffle tickets are deductible as a gambling expense (to the extent of the winnings reported) as a miscellaneous deduction (deductible in full – not subject to 2% of AGI exclusion) if (and only if) you itemize on Schedule A.

The only possible instance in which you could claim a charitable deduction for a raffle ticket is if you purchased a ticket and then donated the ticket itself back to the charity so they could sell it again. In such a situation you would not have any chance of winning the item(s) being raffled.

For the most part the purchase of candy, cookies, etc from a church or charity (most common example being Girl Scout Cookies) is not deductible as a charitable contribution. You are not making a contribution - you are buying something of value for a fair market price.

.

The only exception would be if, for example, the normal market value of a box of cookies is $3.00 and the charity is selling them for $10.00. In this case $7.00 would possibly be deductible. But in most cases the cookies and candy are being sold for pretty much what you would pay in the store - so no tax deduction.

TTFN

ASK THE TAX PRO - POINTS

Q. My HUD statement only says "Loan Origination Fee - % - bank name amount". It does not say "points" anywhere, but it was computed as 1.25 points of the loan. So, does it qualify for a full deduction or an amortized one?

A. Your question is kind if like – “My car is blue. How many miles to the gallon should it get?” You do not provide sufficient information to give an answer.

For me to properly answer your question you must tell me if the mortgage is for the purchase of your principal residence or for a vacation or rental property. If it is a refinanced mortgage is it on your personal residence and is any additional monies taken out used to substantially improve the residence?

First off, the word “points” will rarely if ever appear on the Settlement Statement for the purchase or refinance of real estate. This item is most often referred to as “Loan Origination Fee” or “Loan Discount” or “Commitment Fee” and is reported on Lines 801 or 802 of the statement. This number will be a % (1%, 1.25%, 2.5%, 3%, etc) of the “Principal amount of new loan” indicated on Line 202.

In order to deduct in full the total amount of the “Loan Origination Fee” indicated on your Settlement Statement the mortgage on which the points are charged must be used to buy, build or substantially improve your principal residence, and be secured by that residence.

In addition, in order to deduct the points in full in the year of purchase the amount of money paid at closing, including any seller-paid points and the initial down payment or deposit, must at least equal the amount of points charged. The points on a $300,000 mortgage are $6,000. You had initially given a $1,000 deposit and paid $25,000 at closing. The $6,000 is deductible in full on your Schedule A.

While the points paid in such situations qualify for a full deduction, you can also elect to amortize the points over the life of the mortgage. Why would you want to do this? Consider the following example.

.
John and Jane Q Taxpayer close on the purchase of a principal residence in November of 2007. The total amount of points paid at closing is $2,500 and the interest paid on the mortgage for 2007 is also $2,500. The real estate tax adjustment on the Closing Statement is $458. This is the first principal residence for both of them – prior to the purchase J+J had rented an apartment. Their deductible state and local income taxes and charitable contributions add up to $4,142. Their itemized deductions for 2007 total $9,600. The 2007 standard deduction for a married couple for is $10,700. So they are not able to itemize on their 2007 Form 1040. They can elect to amortize the points paid on the purchase over the life of the mortgage loan so they will be able to get a tax benefit for the points in future years.

Points paid on the refinance of your principal residence or the initial purchase or refinance of a vacation home or a rental or investment property must be amortized over the life of the mortgage. However, if you refinance a mortgage on your principal residence in order to get additional money to “substantially improve” that residence you can deduct in full the points paid on the funds used for the improvements. A substantial improvement is one that adds value to the home or prolongs its useful life.

TTFN

ASK THE TAX PRO - A VERY INTERESTING QUESTION

Q. Can you cash a check from the collection plate in church?

A. That is not a tax question. But I know what you are getting at, you sly dog - and that is cheating!

.

I remember reading many years ago of a church member who approached the pastor with a concern. It seems that the cash from the Sunday collection plate was placed in a safe in the church office overnight and not deposited until Monday. The member was concerned about leaving large sums of money in what was not a very sturdy safe overnight, as the church was not in the best of neighborhoods.

.

The church member had a retail business and needed cash in all denominations for the register. He came up with an idea that would benefit both the church and himself (you bet it would benefit himself). Each Sunday after the service he would give the pastor a check for the bulk of the cash in the collection plate and take the cash for use in his retail store. The pastor thought this was a wonderful idea and took him up on it.

.
Each week the member would write a check, payable to the church and not to “cash” (he told the pastor a check payable to the church could not be cashed by a thief, while one made out to “cash” could) for a nice round figure ($200.00 and never $203.75 - this was easier for his own bookkeeping he said) to cover the bulk of the cash in the plate.

.
When it came time to prepare his taxes he claimed as a charitable contribution the sum of all the checks he had written to the church during the year, which included his normal pledge and holiday donations as well as the weekly checks he wrote to the church for the cash in the plate!

.
I don’t remember how this person had been caught – only that his “scam” had indeed been uncovered by the IRS in audit.

.
Needless to say this is pre-meditated tax fraud, and anyone who does this is subject to all the various and sundry criminal penalties and fines that go with tax fraud.

.
I hope I have answered your question!

TTFN

ASK THE TAX PRO - INHERITED IRA

Q. Is the 5 year rule for the distribution of inherited traditional IRAs still in effect or must the IRA be distributed either in a lump sum or over the beneficiaries' life time? Thanks!

.
A. The rules for how quickly an inherited IRA must be withdrawn depends on whether the original owner died before or after the “Required Beginning Date” (RBD) for taking “Required Minimum Distributions” (RMD), and whether the account had a designated beneficiary.

.
The RBD for an IRA is April 1st of the year following the year in which the original account owner turned 70½. It does not matter if the owner had taken distributions from the IRA prior to his/her RBD.

.

In the case of a non-spouse beneficiary, if the deceased went on to his/her final audit before the Required Beginning Date (for example the deceased was age 67) then the withdrawals are taken over the beneficiary’s life expectancy. If the deceased had begun taking annual RMDs prior to death then the withdrawals are taken over the longer of the beneficiary’s life expectancy or the remaining life expectancy of the deceased.

.
If there is no named beneficiary on the account the monies must be distributed under the 5-Year Rule (the entire account balance must be distributed by the end of the calendar year 5 years after death) if the original owner passed before reaching his/her RBD. If the owner died after beginning to receive RMDs, the withdrawals can be taken over the remaining life expectancy of the deceased.

.
The IRS has special tables for calculating RMDs based on “life expectancy”. The RMD is just than – a required minimum distribution. You can always take out more than the required minimum.

.
The beneficiary can also elect to receive a “lump-sum” distribution, or he/she can chose to have the monies distributed under the 5-Year Rule.

.
Confusing, isn’t it? The bottom line is – it appears that all three options are available to you.

TTFN

ASK THE TAX PRO - SECOND HOME OVERSEAS

Q. Last year we bought a small house (second home) overseas and financed it through the seller. The year end statement from the seller shows the total paid (principal and interest) but interest is not shown separately. Also, the seller does not have a social security number or employer identification number because he is not a US resident or citizen. So, I have two questions:

1- In order to deduct interest can I just calculate the interest portion based on 30 year mortgage amortization tables or should I get a separate statement from the seller? And,

2- What should I do about the social security number? I imagine IRS would also like to see some kind of social security or identification number in order to allow interest payment deductions.

.
A. I have two answers.

.
1- You can certainly calculate the interest deduction using a standard amortization schedule. There are several calculators available online. For example HSH Associates Financial Publishers website has an entire page of excellent mortgage and financial calculators. Be advised that the loan must be secured by the property to qualify as a mortgage.

.
2- According to IRS Publication 936 (Home Mortgage Interest Deduction) - “If you paid home mortgage interest to the person from whom you bought your home, show that person's name, address, and taxpayer identification number (TIN) on the dotted lines next to line 11” on Schedule A. You can try to enter the information without a TIN, writing “foreign individual – no TIN”.

.

However Pub 936 further states “The seller must give you this number and you must give the seller your TIN” and “Failure to meet any of these requirements may result in a $50 penalty for each failure”.

.

The number for the mortgage holder does not have to be a Social Security number. It can also be “an individual taxpayer identification number (issued by the Internal Revenue Service)”. To be safe you should ask that the sellers apply for a TIN using a IRS Form W-7 (Application for IRS Individual Taxpayer Identification Number).

TTFN

ASK THE TAX PRO - JOINT PROPERTY + SEPARATE FILING

Today I am off to visit my folks at Assisted Living. Tuesday through Thursday I will be in Atlantic City attending a year-end tax update seminar. While I am gone I have devoted the whole week of posts to ASK THE TAX PRO.

Q. A married couple living apart for all of the year jointly owns the home occupied by the spouse. The spouse pays, from the spouse’s separate checking account, the property taxes. Can the spouse deduct all of this real estate tax when filing under "married filing separately" status?

A. When filing separately each spouse can deduct only those expenses that he/she has actually paid, and for which he/she is legally responsible. Expenses paid from separate funds (i.e. the wife’s separate checking account) are considered to be paid by that spouse, while expenses paid from joint funds (a joint checking account) are considered to be paid equally by each spouse unless they can prove otherwise.

Real estate taxes can only be deducted by the owner of the property. In the case of a jointly-held property, where both names are on the deed, each spouse can deduct the amount of interest that he/she has actually paid. If one spouse has paid all of the real estate taxes from his/her separate checking account then that spouse can claim the real estate taxes.

Similarly, mortgage interest is only deductible by a person who is legally liable for that mortgage. For a mortgage on jointly-held property, where both names are on the mortgage, each spouse can deduct the amount of interest that he/she has actually paid. Again, if all mortgage payments have been made by one spouse from that spouse’s separate checking account then that spouse can claim all the mortgage interest on his/her Schedule A.

I must point out that if a taxpayer is filing as Married Filing Separately and his/her spouse itemizes deductions on Schedule A then he/she must also itemize. In such a situation both spouses must itemize, even if the total deductions of one spouse are less than the allowable Standard Deduction.

I once again refer you to my THE WANDERING TAX PRO posts “JOINT OR SEPARATE? THAT IS THE QUESTION! - PART ONE” and “JOINT OR SEPARATE? THAT IS THE QUESTION! - PART TWO”.

TTFN

ASK THE TAX PRO – TRAVEL TO DIFFERENT JOB SITES

Q. I have a question. I work for a college and I am only on the main campus one day per week. The other 4 days I am traveling to other campuses. I do not receive a reimbursement for this. I have been told that I can deduct it from my taxes. What amount is deductible - the entire mileage (to and from) for those 4 days, or the difference between the mileage each day and the normal mileage that I use on the one day?

.
A. First of all as an employee receiving a W-2, which I assume you are, in order to deduct business mileage, or any other unreimbursed “employee business expenses”, you must be able to itemize on Schedule A. If you claim the standard deduction you are out of luck – there is no “above-the-line” deduction for such expenses.

Second, if you do itemize the total of all of your “miscellaneous” deductions (employee business expenses, investment expenses and tax preparation fees) must be more than 2% of your Adjusted Gross Income (AGI) for you to receive any tax benefit. If your AGI is $60,000 you must have more than $1,200 in these types of expenses. If your total deductible unreimbursed employee business, investment and tax preparation expenses are only $1,100 you are out of luck.

The cost of commuting from your home to a regular place of work and back is not deductible. What is deductible is driving between different regular places of work, whether for two or more employers or to multiple job locations or clients for the same employer.

In your case each of the various campuses is a regular place of work. So going from home to the first campus of the day is non-deductible commuting. However if you travel from home to your base office on the main campus first, and then go from the main campus to another campus, the miles from the main campus to the second campus and, if applicable, back to the main campus are deductible.

If you go from home to Campus A, then to Campus B, then to Campus C, then back to Campus A and then home all in one day the driving from Campus A to B and C and back to A is deductible. If you go from home to Campus A, from Campus A to Campus B, and then back home the miles from Campus A to Campus B are deductible.

But if on Monday you go from home to Campus A and back, and on Tuesday you go from home to Campus B and back, and so on, visiting one different campus each day, then it is all commuting and none of it is deductible.

Also, if from home to Campus A, your main office, is 5 miles and from home to Campus B is 8 miles, and you go from home to Campus B and back on Tuesday, you do not deduct 3 miles (8 miles – 5 miles = 3 miles). You deduct 0 miles.

However, if you work for University A, visiting various campuses of that University during the week, and you travel some 250 miles to University B in another state for a special project that will last a month, then your travel from home to University B is deductible. This is because you are traveling to a “temporary” business location (temporary = the assignment will last less than 12 months) that is outside of the area of your tax home.

You can deduct 50.5 cents per mile from January to June and 58.5 cents per mile for July to December for 2008 for business driving – plus any tolls paid in the course of deductible travel. Under certain circumstances you also have the option of deducting a percentage of the actual cost of operating your car, including depreciation.

TTFN

ASK THE TAX PRO – HOME OFFICE FOR MILEAGE VS HOME OFFICE FOR DEDUCTION

Q. I'm a personal tax pro who's having an ongoing discussion with our corporate CPA. She argues that there is a difference in a office which happens to be in the home being "qualified" for the purposes of taking mileage (principal and only place of business, but not exclusive use), and being "qualified" for the purposes of taking Office in the Home deductions (principal place of business and exclusively used).

.

I'm interpreting IRS Pub 587 (2007), page 3 " Your home office will qualify as your principal place of business if you meet the following requirements. You use it exclusively and regularly...." in showing that exclusive use is a necessary characteristic of "principal place of business".

.

Who's right?

A. A very interesting question. For once I agree that the CPA may be correct in his/her thinking!

I must point out that this is my personal interpretation.

IRS Publication 463, which deals with issues of deductible mileage, states –

“If you have an office in your home that qualifies as a principal place of business, you can deduct your daily transportation costs between your home and another work location in the same trade or business.”

Pub 463 does not state that in order to deduct mileage between a home office and another work location the office in your home must qualify for the home office deduction.

IRS Publication 587, which deals with the home office issue, states –

“To qualify to deduct expenses for business use of your home, you must use part of your home:

* Exclusively and regularly as your principal place of business (defined later)”

The publication then goes on to describe the three (3) individual tests for “exclusive use”, “regular use”, and “principal place of business” as three separate considerations.

In makes the following statement regarding the “principal place of business” test –

“Under the principal place of business test, your home must be your principal place of business for that trade or business. To determine whether your home is your principal place of business, you must consider:

* The relative importance of the activities performed at each place where you conduct business, and

* The amount of time spent at each place where you conduct business.”

Pub 587 also says, “Your home office will qualify as your principal place of business if you meet the following requirements.

* You use it exclusively and regularly for administrative or management activities of your trade or business.

* You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.”

I take this to be an alternative test for “principal place of business”, and not as a strict definition of “principal place of business”. The instructions seem to say that if these two conditions are met than you will automatically have a “principal place of business”, but not, in my opinion, that these two conditions must be met in order to have a “principal place of business”.

I recall attending a tax conference years ago with a seminar that addressed this issue. If memory serves me the seminar instructors indicated back then that a home office did not need to qualify for a tax deduction (i.e. exclusive use) in order for one to be able to deduct mileage from the home office to another business location, as long as the home office was the “principal place of business”.

.

So I would say that you do not necessarily need to be able to deduct a home office in order to be able to deduct the miles from the home office to another business location.

.
I would be interested in hearing what my fellow tax bloggers have to say on this issue.

TTFN

ASK THE TAX PRO - THE ESTIMATED TAX SAFE HARBOR RULE

Now is a good time to review the topic that is raised in this ASK THE TAX PRO question -

Q. We have medical insurance, but in spite of that the costs of my wife's cancer treatments and real estate depreciation deductions resulted in a net loss on our 2006 1040 form. So we ended up not owing any taxes for 2006. We had paid $5000.00 in estimated amounts for 2006, so we applied these 2006 estimated payments to our taxes due in 2007.

.
We have submitted an automatic extension for our 2007 taxes.

.
During 2007, we received a payment from previously sold property, so we will probably owe something over $10,000. Our 2006 tax liability was under $150,000.00 and we have already paid in over 100% of our 2006 tax liability.

.
We conclude that we will not be liable for a penalty for underpayment of estimated tax.

A. Your conclusion is correct.

Because your 2006 federal income tax liability was “0” and you had $5,000 from 2006 applied to 2007 you will not be penalized for “underpayment of estimated tax” for 2007 if you waited until October 15, 2008 to file your 1040 and pay the $5,000 anticipated balance due.

You are covered under what we call the “safe harbor” rule. As long as you had 100% of your prior year tax liability paid in either via withholding or estimated tax you will not be penalized. The alternative is to have 90% of the current year liability paid in.

If your 2007 tax liability was $5,000 and your 2008 tax liability will turn out to be $100,000, as long as you have at least $5,000 withheld during 2008 you can put aside the remaining $95,000 in an interest-bearing account and wait until you file your 2008 return in April of 2009 to send it to “Sam”.

In the case of estimated tax payments the penalty is determined on a quarterly basis. With the above example you would have to pay $1,250 per quarter in estimated tax, for a total of $5,000, to satisfy the safe harbor rule. If you paid the entire $5,000 as your 3rd quarter payment you would be penalized for the first two quarters.

Withholding is automatically treated as being paid evenly throughout the calendar year, regardless of when the money is actually withheld and remitted to “Sam”. You could have no federal tax withheld for the first 11 months of the year and have the entire $5,000 withheld in December and you would avoid the penalty under safe harbor.

Here is a good tip for this time of the year. First pull out your 2007 tax returns. Now get your most recent pay-stub(s) for all your employers and determine the total amount of income tax that has been withheld for the year. Add in any withholding from other sources – pensions, etc. Now compare the total amount withheld-to-date for 2008 to the total tax liability on Line 63 of your 2007 Form 1040 (or Line 37 of a 2007 Form 1040A).

If the 2008 number is already at least as much as the total tax liability for 2007 you are ok. If the 2007 liability is greater, based on your current year pay-stubs estimate the amount of income tax that will be withheld during the rest of 2008. Now see how it compares to the 2007 liability. If you come up short you can have your employer withhold an additional amount from the rest of your 2008 pay checks to cover the shortage. Be aware that it will probably take a week or two for your employer to properly process the additional withholding request – so calculate accordingly.

Make the withholding comparisons for state as well as federal income tax. Most states have a similar “safe harbor” rule.

Of course if you expect your taxable income to be substantially lower for 2008 than it was in 2007 there is no need to meet the “safe harbor” requirement.

If your 2007 Adjusted Gross Income (AGI) is more than $150,000 you must have 110% of the total 2007 tax liability paid in during 2008 to be covered by the safe harbor rule.

TTFN

ASK THE TAX PRO - MARRIAGE AND FORM W-4

Before I begin today’s post I just want to say – THANK GOD IT’S OVER! The historic campaign seemed to go on forever. Congratulations to President-Elect Barack Obama.

And now – today’s question -

Q. My finance and I will be married this fall. Can we change our W-4’s to show Married and have less money taken out now?

.
A. Yes you can.

.
However you may not want to have less money withheld. On the contrary - you may want to have more withheld as you may be victims of the dreaded (almost as much as the AMT) “marriage penalty”. If you both work you will not pay any less tax – you will pay either the same or more!

.
As your status will be “married” on December 31st (the last day of the year) you must file your Form 1040 for the entire year as married – either joint or separate.

.
I tell two-income married couples that at least the spouse with the lower income should claim “Married- But Withheld at the Lower Single Rate- 0”.

.
If other aspects of your situation will change in the fall, such as the purchase of a home that generates real estate tax and mortgage interest deductions, they may help to wipe out some or all of the additional tax from the marriage penalty. However, if you will be purchasing the home late in the year (i.e. the fall) you may not have enough deductions for the year to be able to itemize.

.
My advice to you is to not change your withholding statuses for 2008. Keep your W-4s at Single. This way you will not find yourself in shock next February. You can evaluate your situation after you file your 2008 tax returns and make changes to your W-4s for 2009 if appropriate.

.
When preparing your 2008 Form 1040 you may want to consider filing separately. As I advise any clients and readers faced with options – you should calculate the federal and state tax liability filing both joint and separately and compare the results. Check out my posts JOINT OR SEPARATE? THAT IS THE QUESTION! - PART ONE and TWO.

TTFN