On July 1, President Trump signed into law a sweeping, bipartisan IRS reform bill called the Taxpayer First Act ( P.L. 116-25). This legislation aims to broadly redesign the IRS for the first time in over 20 years.

On July 1, President Trump signed into law a sweeping, bipartisan IRS reform bill called the Taxpayer First Act ( P.L. 116-25). This legislation aims to broadly redesign the IRS for the first time in over 20 years.

Reworked IRS Reform Bill

The Senate approved the Taxpayer First Act by voice vote on June 13. The measure was unanimously approved in the House on June 10.

The reworked IRS reform bill, originally introduced in the last Congress, was revised in early June after the House passed a prior version in April. However, the original House-approved bill (HR 1957) was quickly doomed in the Senate because of controversy surrounding the IRS’s Free File program.

The provision codifying the IRS’s Free File program was removed from the original bill, and the measure was reintroduced as HR 3151. Congress then quickly sent it to the president’s desk.

Taxpayer First Act Provisions

The Taxpayer First Act aims to reform the IRS into a more taxpayer-friendly agency. It requires the IRS to develop a comprehensive customer service strategy, as well as a plan to redesign the IRS’s structure, modernize its technology, and enhance its cyber security.

The measure also:

• codifies and enhances an independent Office of Appeals within the IRS;
• waives the application fee for an offer in compromise (OIC) by a low-income taxpayer;
• sets new electronic filing requirements;
• clarifies information available about low-income taxpayer clinics (LITCs);
• codifies the Volunteer Income Tax Assistance (VITA) Program;
• requires notice regarding the closure of taxpayer assistance centers (TACs);
• improves the IRS whistleblower program;
• modifies the private debt collection program;
• clarifies procedures for equitable relief from joint liability;
• establishes new safeguards on seizing funds believed to be structured to avoid the $10,000 financial reporting requirement; and
• modifies procedures for the issuance of summons and notice of third-party contacts by the IRS.

Hill Reaction

"This signing is the culmination of a lengthy, bipartisan process undertaken by the [House] Ways and Means Committee to implement pro-taxpayer reforms at the IRS for the first time in more than 20 years," Senate Finance Committee (SFC) Ron Wyden, D-Ore., said in a July 1 statement. "New protections for low-income taxpayers, practical enforcement reforms, and upgraded assistance for taxpayers and small businesses will all now go into place."

Additionally, the House’s top Republican tax writer issued a statement after Trump signed the IRS reform legislation. "I’m proud that after three years of thoughtful bipartisan work, our bold package of reforms to the Internal Revenue Service are the law of the land," Ways and Means ranking member Kevin Brady, R-Tex., said on July 1. "Thank you to President Trump for signing this historic legislation, which is the biggest and boldest step in over 20 years to redesign and restructure the IRS into an agency with a singular mission – quality taxpayer service."

The House has approved a bipartisan repeal of the Affordable Care Act’s (ACA) so-called "Cadillac"excise tax on certain high-cost insurance plans.

The House has approved a bipartisan repeal of the Affordable Care Act’s (ACA) so-called "Cadillac"excise tax on certain high-cost insurance plans.

ACA Cadillac Tax Repeal

The Middle Class Health Benefits Tax Repeal Bill (HR 748) cleared the House on the evening of July 17 by a 419-to-6 vote. The bipartisan bill would repeal the 40 percent excise tax under the ACA known as the "Cadillac tax" on certain high-cost employer-sponsored health care plans.

Congress has repeatedly delayed the ACA’s "Cadillac" tax, which is currently set to go into effect in 2022. However, HR 748 would fully repeal the tax.

Although the measure has bipartisan support in the Senate, as for when it will get its legs in the upper chamber remains to be seen. Lately, Senate Majority Leader Mitch McConnell, R-KY., has been viewed on Capitol Hill as focusing more on moving nominations than considering tax bills.

HR 748’s Large Price Tag May Signal Hope for Tax Extenders

Notably, HR 748 dodged House Democrats’ "pay as you go" rules for tax legislation, thus carrying with it a large price tag with no offsets. The nonpartisan Congressional Budget Office (CBO) has estimated that the bill would cost the federal government more than $196 billion over 10 years.

Senate Finance Committee (SFC) Chairman Chuck Grassley, R-Iowa, has signaled that Democrats’ support for repealing the ACA’s "Cadillac"tax without pay-fors may signal a newly opened door for tax extenders. Grassley has consistently expressed that he is focused on addressing the previously and soon to be expired tax breaks known as tax extenders but has been waiting for the Democratic controlled House to send such a bill, noting that tax legislation must originate in the House.

However, House Democrats’ tax extenders bill, the Taxpayer Certainty and Disaster Tax Relief Bill of 2019 (HR 3301) would offset its costs by causing the GOP tax law’s increase in estate tax exemption amounts to sunset early at the beginning of 2023. Under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), the estate tax provisions would expire at the start of 2026.

The bill cleared the House Ways and Means Committee last month but has not yet reached the House floor. Senate Republicans have called any proposal to repeal provisions under the TCJA a "nonstarter."

The IRS has released final regulations that clarify the employment tax treatment of partners in a partnership that owns a disregarded entity.

The IRS has released final regulations that clarify the employment tax treatment of partners in a partnership that owns a disregarded entity.

The Treasury Department and the IRS had issued the temporary regulations ( T.D. 9766) to clarify that the rule that a disregarded entity is treated as a corporation for employment tax purposes does not apply to the self-employment tax treatment of any individuals who are partners in a partnership that owns a disregarded entity. The temporary regulations continued to explicitly provide that the owner of a disregarded entity who is treated as a sole proprietor for income tax purposes is subject to self-employment taxes. A notice of proposed rulemaking ( REG-114307-15) cross-referencing T.D. 9766was published on the same day.

The final regulations adopt the proposed regulations as amended. The corresponding temporary regulations are removed.

Disregarded Entity

These regulations affect partners in a partnership that owns a disregarded entity, and contain amendments to 26 CFR part 301. Generally, under Reg. §301.7701-2(c)(2)(i) and except as otherwise provided, a business entity that has a single owner and is not a corporation under Reg. §301.7701-2(b)is disregarded as an entity separate from its owner (a disregarded entity). However, Reg. §301.7701-2(c)(2)(iv)(B) treats a disregarded entity as a corporation for purposes of employment taxes imposed under Subtitle C of the Internal Revenue Code. This exception to the treatment of disregarded entities does not apply to taxes imposed under Subtitle A of the Code, including self-employment taxes.

Effective Date

These regulations are effective on July 2, 2019.

Final regulations allow employers to voluntarily truncate employees’ social security numbers (SSNs) on copies of Forms W-2, Wage and Tax Statement, furnished to employees. The truncated SSNs appear on the forms as IRS truncated taxpayer identification numbers (TTINs). The regulations also clarify and provide an example of how the truncation rules apply to Forms W-2.

Final regulations allow employers to voluntarily truncate employees’ social security numbers (SSNs) on copies of Forms W-2, Wage and Tax Statement, furnished to employees. The truncated SSNs appear on the forms as IRS truncated taxpayer identification numbers (TTINs). The regulations also clarify and provide an example of how the truncation rules apply to Forms W-2.

Why Truncate?

The Protecting Americans from Tax Hikes (PATH) Act of 2015 ( P.L. 114-113) amended Code Sec. 6051(a)(2) by replacing the requirement that employers include employees’ SSNs on copies of Forms W-2 furnished to employees with a requirement to use an "identifying number for the employee."Because the SSN was no longer required to appear on Forms W-2 furnished to employees, the IRS published proposed regulations in 2017 to allow employers to truncate employees’ SSNs on those Forms W-2 ( REG-105004-16). The amendments were intended to aid employers’ efforts to protect employees from identity theft.

The final regulations adopt the proposed regulations without substantive changes to the content of the rules.

SSN Truncation on Forms W-2

The final regulations permit employers to truncate employees’ SSNs on copies of:

• Forms W-2 furnished to employees to report wages paid, employment taxes withheld, etc.;
• Forms W-2 furnished to employees to report wages paid in the form of group-term life insurance;
• Forms W-2 furnished to payees to report third-party sick pay; and
• Forms W-2c furnished to correct errors on Forms W-2.

The regulations do not apply to any other forms. Also, truncation is not mandatory; the regulations permit truncation but do not require it.

Under the general truncation rules, a TTIN cannot be used on a statement or document if a statute, regulation, other guidance published in the Internal Revenue Bulletin, form, or instructions:

• specifically requires use of an SSN, IRS individual taxpayer identification number (ITIN), IRS adoption taxpayer identification number (ATIN), or IRS employer identification number (EIN); and
• does not specifically permit truncation.

For instance, an employer cannot truncate an employee’s SSN on copies of Forms W-2 filed with the Social Security Administration.

The IRS intends to incorporate the revised regulations into forms and instructions.

Effective Date; Applicability Date

The final regulations are effective on July 3, 2019, but when they apply varies. Reg. §31.6051-1, Reg. §31.6051-3, and Reg. §1.6052-2, as amended, apply for statements required to be filed and furnished under Code Sec. 6051 and Code Sec. 6052 after December 31, 2020. Reg. §31.6051-2, as amended, applies on July 3, 2019. Reg. §301.6109-4, as amended, applies to returns, statements, and other documents required to be filed or furnished after December 31, 2020.

IRS final regulations provide rules that apply when the lessor of investment tax credit property elects to pass the credit through to a lessee. If this election is made, the lessee is generally required to include the credit amount in income (50 percent of the energy investment credit). The income is included in income ratably over the shortest MACRS depreciation period that applies to the investment credit property. No basis reduction is made to the investment credit property.

IRS final regulations provide rules that apply when the lessor of investment tax credit property elects to pass the credit through to a lessee. If this election is made, the lessee is generally required to include the credit amount in income (50 percent of the energy investment credit). The income is included in income ratably over the shortest MACRS depreciation period that applies to the investment credit property. No basis reduction is made to the investment credit property.

Partners and S shareholders who receive the credit (i.e., are the ultimate credit claimants) must make income inclusions in proportion to their share of the credit.

No Basis Increase for Partners and S Shareholders

The regulations resolve a contentious issue against taxpayers. They provide that a partner’s income inclusions are not treated as an item of partnership income under subchapter K. A similar rule applies to S corporations. Therefore, basis adjustment rules that would increase a partner’s outside basis or S shareholder’stock basis if the income inclusion amounts were treated as items of income do not apply. The IRS says its interpretation is appropriate because the investment credit and limitations on the investment credit are determined at the partner and S shareholder level.

Coordination With Recapture Rules

If a recapture event occurs an adjustment is made to the lessee’s (or ultimate claimant’s) gross income to account for any difference between the amounts that were included in income and the credit that is allowed after recapture. Special rules are provided when the amount of the unrecaptured credit exceeds the income inclusions and when the income inclusions exceed the unrecaptured credit.

Election to Accelerate Income Inclusion Upon Lease Termination

The lessee (or ultimate claimant) may make an irrevocable election to include in gross income any remaining income inclusion amounts in the tax year in which a lease terminates or is otherwise disposed of. If a partner or S shareholder disposes of its partnership or S corporation interest, the partner or S shareholder may also make an irrevocable election to include remaining inclusion amounts in income in the year of disposition. These elections may only be made if the recapture period has expired and a recapture event had not occurred during the recapture period.

Effective Date

The final regulations are effective on July 17, 2019 and apply to investment credit property placed in service on or after September 19, 2016.

Effective July 17, 2019, the list of preventive care benefits that can be provided by a high deductible health plan (HDHP) without a deductible or with a deductible below the applicable minimum deductible is expanded. The list now includes certain cost effective medical care services and prescription drugs for certain chronic conditions.

Effective July 17, 2019, the list of preventive care benefits that can be provided by a high deductible health plan (HDHP) without a deductible or with a deductible below the applicable minimum deductible is expanded. The list now includes certain cost effective medical care services and prescription drugs for certain chronic conditions.

HDHPs and Health Savings Accounts

Individuals covered by an HDHP generally may establish and deduct contributions to a Health Savings Account (HSA). To qualify as an HDHP, a plan may not provide benefits for any year until the minimum deductible for that year is satisfied. However, an HDHP is not required to have a deductible for preventive care.

Current Rule for Chronic Conditions

Under the existing rule, preventive care generally does not include any service or benefit intended to treat an existing illness, injury, or condition. As a result, the cost barriers for care have resulted in some individuals diagnosed with certain chronic conditions failing to get effective and necessary care that would prevent making the chronic condition worse. Failure to address chronic conditions can lead to amputation, blindness, heart attacks, and strokes that require considerably more extensive medical intervention.

Treatments for Chronic Care as Preventive Care

The following medical care services are now classified as preventive care for someone with that chronic condition:

• angiotensin converting enzyme (ACE) inhibitors for individuals diagnosed with congestive heart failure, diabetes, or coronary artery disease;
• anti-resorptive therapy for individuals diagnosed with osteoporosis or osteopenia;
• blood pressure monitor for individuals diagnosed with hypertension;
• peak flow meter for individuals diagnosed with asthma;
• inhaled corticosteroids for individuals diagnosed with asthma;
• glucometer for individuals diagnosed with diabetes;
• hemoglobin A1c testing for individuals diagnosed with diabetes;
• insulin and other glucose lowering agents for individuals diagnosed with diabetes;
• retinopathy screening for individuals diagnosed with diabetes; and
• statins for individuals diagnosed with heart disease and/or diabetes.

The continuity safe harbor placed-in-service date deadlines for the investment tax energy credit (Code Sec. 48) and the renewable electricity production credit (Code Sec. 45(a)) may be tolled if a construction delay is caused by national security concerns raised by the Department of Defense (DOD).

The continuity safe harbor placed-in-service date deadlines for the investment tax energy credit (Code Sec. 48) and the renewable electricity production credit (Code Sec. 45(a)) may be tolled if a construction delay is caused by national security concerns raised by the Department of Defense (DOD).

Background

In general, the energy credit may only be claimed if construction on a qualified facility begins before January 1, 2022. In the case of the production credit, construction must begin before January 1, 2017 (January 1, 2020 for a wind facility). Once construction begins, taxpayers are required to make continuous progress toward completion under either a continuous construction test or a continuous efforts test. These tests are deemed satisfied under the continuity safe harbor if the facility is placed in service within four calendar years after the calendar year in which construction begins.

Tolling Requirements

A construction deadline in the continuity safe harbor is tolled if all of the following requirements are satisfied:

• one or more necessary government permits or approvals for construction have been issued;
• construction has begun;
• the DOD provides written notice that the construction plan should be modified in the interest of national security;
• the plan is modified in a way that is acceptable to the DOD to mitigate the national security concerns; and
• as a result of the plan modification, new or additional permits or licenses must be obtained which will delay the placed-in-service date of the facility or energy property.

Tolling Period

The tolling period of the continuity safe harbor begins on the day the DOD provides written notice that the plan of construction requires modification to meet national security concerns.

The tolling period ends when one of the following events occurs:

• all new or additional permits or licenses are obtained;
• written confirmation is received that all of the required new or additional permits or licenses will not be issued; or
• the relevant federal or state authorities are notified in writing that the modification to the plan will no longer be pursued.

The maximum length of the tolling period is four years.

No Rulings

The IRS will not issue private letter rulings or determination letters regarding the application of the tolling provision or the beginning of construction requirement.

Modified Rulings

Notice 2013-29, 2013-1 C.B. 1085, Notice 2013-60, 2013-2 C.B. 431, Notice 2014-46, 2014-2 C.B. 520, Notice 2015-25, 2015-13 I.R.B. 814, Notice 2016-31, 2016-23 I.R.B. 1025, Notice 2017-4, 2017-4 I.R.B. 541, and Notice 2018-59, 2018-28 I.R.B. 196, are modified.

The Treasury and IRS have issued proposed regulations on provisions dealing with passive foreign investment companies (PFICs). Proposed regulations published on April 25, 2015, also have been withdrawn ( NPRM REG-108214-15).

The Treasury and IRS have issued proposed regulations on provisions dealing with passive foreign investment companies (PFICs). Proposed regulations published on April 25, 2015, also have been withdrawn ( NPRM REG-108214-15).

U.S. persons who own interests in PFICs are subject to rules that limit deferral on passive income earned by foreign corporations ( Code Sec. 1291– Code Sec. 1298). In general, a PFIC is a foreign corporation that in any given year:

• has income that is 75 percent or more passive income (income test); or
• owns, on average, assets that are 50 percent or more passive-income-producing (asset test).

The proposed regulations provide general guidance regarding PFICs, and guidance on the PFIC insurance exception. Specifically, the proposed regulations cover:

• the determination of ownership in a PFIC, and the treatment of certain income received or accrued by a foreign corporation and assets held by a foreign corporation under Code Sec. 1297;
• rules for determining whether a U.S. person that directly or indirectly holds stock in a PFIC is treated as a PFIC shareholder, and whether a foreign corporation is a PFIC; and
• whether a foreign insurance company is a qualifying insurance company (QIC) under Code Sec. 1297(f), and the amounts of income and assets that a QIC can exclude under the PFIC insurance exception.

General Guidance

The proposed regulations specify that, in applying the asset test, the period over which the average percentage is calculated is at least quarterly. However, taxpayers are allowed to use a shorter period, such as a monthly of daily measurement of asset values.

The proposed regulations address attribution of ownership under the look-through subsidiary rules of Code Sec. 1297(c) for determining PFIC status. These rules treat a foreign corporation (FC1) that owns 25 percent or more of another foreign corporation (FC2) as owning and earning a proportional amount of the other foreign corporation’s income and assets. The proposed regulations allow attribution from FC2 to FC1, if FC1 has a greater than 50 percent ownership interest in FC2.

The proposed regulation also provide a partnership look-through rule for the treatment of a partnership interest owned by a foreign corporation, for purposes of determining whether the foreign corporation is a PFIC. Under the rule, the same 25 percent ownership threshold applies to partnership interests as is applied to interests in corporations.

PFIC Insurance Exception

The income of a QIC derived in the active conduct of a trade or business is not treated as passive income for purposes of determining whether a corporation is a PFIC. The QIC test is based on the ratio of the foreign insurance company’s "applicable insurance liabilities" to total assets. Applicable insurance liabilities are the smallest of:

• insurance liabilities on the company’s most recent applicable financial statement (AFS);
• liabilities required by local law or regulation; or
• as provided under Treasury regulations.

Current law allows a foreign corporation to use a local AFS if it does not do financial reporting based on the rigorous and widely-accepted U.S. generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS).

The proposed regulations provide a special rule for foreign corporations that change their method of preparing their AFS by ceasing to prepare this statement under either U.S. GAAP or IFRS without a non-federal tax business purpose for the change. The foreign corporation must continue to prepare its AFS under either U.S. GAAP or IFRS. Failing to do so will mean the foreign corporation has no applicable insurance liabilities for the QIC test.

Additionally, if an AFS is prepared under local accounting standards that do not require discounting unpaid losses and other loss reserves on an economically reasonable basis, AFS insurance liabilities must be reduced under U.S. GAAP or IFRS discounting principles.

Applicability Date

The proposed regulations are proposed to apply to tax years of U.S. persons that are shareholders in certain foreign corporations beginning on or after the date of publication of the Treasury Decision adopting these regulations as final regulations in the Federal Register.

Until the regulations are final:

• taxpayers may choose to apply the proposed regulations (other than Proposed Reg. §1.1297-4and Proposed Reg. §1.1297-5) for open tax years;
• U.S persons and shareholders in certain foreign corporations may apply Proposed Reg. §1.1297-4 and Proposed Reg. §1.1297-5, for tax years beginning after December 31, 2017; and
• taxpayers may rely on Notice 88-22, 1988-1 CB 489, providing guidance on the income and asset tests.

Comments

Written or electronic comments and requests for public hearing must be received by September 9, 2019. Send submissions to: CC:PA:LPD:PR (REG-105474-18), room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (REG-105474-18), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC 20224, or sent electronically via the Federal eRulemaking Portal at www.regulations.gov (IRS REG-105474-18).

Proposed regulations would provide an exception to the unified plan rule for multiple employer plans (MEPs). The purpose is to reduce the risk of plan disqualification due to noncompliance by other participating employers. The regulations would apply on or after the publication date of final regulations in the Federal Register. They cannot be relied upon until then. Comments and requests for a public hearing must be received by October 1, 2019.

Proposed regulations would provide an exception to the unified plan rule for multiple employer plans (MEPs). The purpose is to reduce the risk of plan disqualification due to noncompliance by other participating employers. The regulations would apply on or after the publication date of final regulations in the Federal Register. They cannot be relied upon until then. Comments and requests for a public hearing must be received by October 1, 2019.

Multiple Employer Plans

A MEP is a single plan with adopted by multiple unrelated employers. Multiple employer plans under Code Sec. 413(c) can be structured either as:

• an open MEP where an organization with employees takes the lead by establishing the plan for its own employees, and has other unrelated employers join the plan as co-sponsors;
• a closed MEP in which a group or association of employers that meets a commonality requirement takes the lead in establishing the plan, and members are free to adopt it.

Open MEPs are often established by organizations that specialize in providing benefits for smaller employers (typically, 401(k) plans). Note that MEPs are distinct from union multiemployer plans governed by Code Sec. 413(b), but share some of the same rules.

Under the unified plan rule in the current regulations for both MEPs and multiemployer plans, a qualification or operational failure by one employer can result in a total plan failure for all participating employers. The administration is trying to change that, to encourage MEP participation.

Proposed Exception

Under the proposed regulations, an eligible defined contribution MEP would qualify for an exception to the unified plan rule. The exception turns on the ability of the MEP plan administrator under the terms of the plan to spin off the assets and account balances attributable to employees of a noncompliant participating employer into a separate plan and then termination of that plan. A spinoff could be either a spinoff initiated by the unresponsive participating employer and implemented by the plan administrator, or a spinoff-termination implemented by the plan administrator.

The exception would be available if the participating employer is responsible for a qualification failure that it is unable or unwilling to correct. It would also be available if the participating employer is nonresponsive to the plan administrator’s reasonable and timely requests for information or for action.

Exception Requirements

Under the proposed exception, a defined contribution MEP would not be disqualified on account of a participating employer failure if the following conditions are satisfied:

• the MEP satisfies certain eligibility requirements, including established practices and procedures to promote compliance and a requirement to adopt relevant plan language;
• the MEP plan administrator provides notice and an opportunity for the unresponsive participating employer to take remedial action;
• the administrator implements a spinoff in the event the unresponsive participating employer fails to take appropriate remedial action; and
• the administrator complies with any information request by the IRS or a representative of the spun-off plan made in connection with an IRS examination of the spun-off plan, including an information request related to the unresponsive participating employer’s participation in the MEP for years prior to the spinoff.

Participating employer failures would include known compliance failures, as well as failure to provide information to the MEP plan administrator so that the administrator can determine whether there is an actual plan or operational failure.

During economic downturns, many people often look for ways to supplement their regular employment compensation. Or, you may be engaging in an activity - such as gambling or selling items on an online auction - that is actually earning you income: taxable income. Many individuals may not understand the tax consequences of, and reporting requirements for, earning these types of miscellaneous income. This article discusses how you report certain types of miscellaneous income.

Reporting your miscellaneous taxable income

For most people, gambling winnings and hobby income are uncommon types of taxable income. Gambling winnings and hobby income, as well as prizes and awards, represent "miscellaneous income" and are reported on Line 21 of your Form 1040 as "other income."

Hobby income

Hobbies are generally considered under the tax law as activities that are not pursued "for profit." However, the tax law provides that if your hobby shows a profit in at least three of the last five tax years, including the current year, you are assumed to be trying to make money. However, you can rebut the assumption -- that you are not out to run a profitable business even if you regularly have losses -- with evidence to the contrary. Just because you love what you are doing in a sideline business does not mean it's a hobby for tax law purposes. In fact, one secret to business success is often enjoying your work. Profits you receive from an activity that is a hobby and not a for-profit business are reported as "other income" on Line 21 of your Form 1040.

Hobby losses and expenses

You cannot deduct your hobby expenses in excess of income you derived from the hobby, and you can only deduct qualifying expenses if you itemize your deductions. Expenses that you incurred in generating hobby income are generally deductible as miscellaneous itemized deductions, subject to the two-percent floor, on Schedule A. If you incurred losses in connection with your hobby activities, you may generally be able to deduct these "hobby losses" but only to the extent of income produced by the activity.

However, some expenses that are deductible whether or not they are incurred in connection with a hobby (such as taxes, interest and casualty losses) are deductible even if they exceed hobby income. These expenses, however, will reduce the amount of your hobby income against which your hobby expenses can be offset. Your hobby expenses then offset the reduced income in the following order:

1. Operating expenses, generally;

2. Depreciation and other basis adjustment items.

As mentioned above, your itemized deduction for hobby expenses is subject to the two-percent floor on miscellaneous itemized deductions.

Gambling winnings

Gambling winnings, whether legal or illegal, are included in your gross income. If you have winnings from a lottery, raffle, or other types of gambling activities, you must report the full amount of your winnings on Line 21 of your Form 1040 as "other income." The taxable gains are the amount by which your winnings exceed the amount you wagered. If any taxes were withheld from your winnings, you should receive a Form W-2G showing the total paid to you in Box 1, and the amount of income taxes withheld in Box 2. You need to include the amount in Box 2 in the amount of taxes paid on Line 59 of your 1040.

Gambling losses

You can deduct your gambling losses as an itemized deduction for the year on Schedule A (Form 1040), line 28. However, you cannot deduct gambling losses that exceed your winnings. Thus, you can deduct losses from gambling up to the amount of your gambling winnings. You cannot reduce your gambling winnings by your gambling losses and report the difference. You must report the full amount of your winnings as income and claim your losses (up to the amount of winnings) as an itemized deduction. Therefore, your records should show your winnings separately from your losses.

You can reduce your gambling winnings by your wagering losses regardless of whether the underlying transactions are legal or illegal. Moreover, gambling losses may be offset against all gains arising out of wagering transactions, and not merely against gambling winnings. However, gambling losses can only be used to offset gambling gains during the same year.

Moreover, you cannot use your gambling losses to reduce taxable income from non-gambling sources, and they cannot be used as a carryover or carryback to reduce gambling income from other years. For example, the value of complimentary goods you might receive from a casino as an inducement to gamble are gains from which gambling losses can be deducted.

Casinos, lotteries and other payers of gambling winnings of $600 or more ($1,200 for bingo or slot machines and $1,500 for keno) report the winnings on Form W-2G, Certain Gambling Winnings.

If you have any questions about tax and reporting requirements in connection with hobby activities and other sources of income, please call our office.

The saver's credit is a retirement savings tax credit that can save eligible individuals up to $1,000 in taxes just for contributing up to $2,000 to their retirement account. The saver's credit is an additional tax benefit on top of any other benefits available for your retirement contribution. It is a nonrefundable personal credit. Therefore, like other nonrefundable credits, it can be claimed against your combined regular tax liability and alternative minimum tax (AMT) liability.

Who qualifies for the saver's credit

To qualify for the credit, you must be 18 years old (as of the close of the tax year of the contribution), not a full-time student, and not claimed as a dependent on another's return. The calculation of the credit amount depends on a percentage of your adjusted gross income (AGI).

The credit can be claimed for contributions or deferrals made to a number of retirement plans, including: traditional and Roth IRAs (other then rollover contributions), voluntary "after-tax" employee contributions to Section 403(b) annuities and qualified retirement plans, qualified cash or deferred arrangements, including elective contributions made to 401(k) plans, tax sheltered annuities, SIMPLE plans, simplified employee pensions (SEPs), and eligible deferred compensation plans of governmental employers.

Determining your credit amount

IRS Form 8880, Credit for Qualified Retirement Savings Contributions, is used to calculate the amount of the saver's credit, which is then reported on Line 51 of Form 1040. The credit is determined as a percentage of your "qualifying contribution." A taxpayer's qualifying contribution is limited to $2,000 per year. The percent varies depending on your adjusted gross income (AGI).

For 2009, the credit is 50 percent of the maximum $2,000 ceiling for married couples filing jointly with a combined AGI of $33,000 or less. For example, if each spouse makes the maximum $2,000 contribution for the credit, for a total of $4,000, they can claim a total saver's credit of $2,000 ($4,000 x 50 percent) on their joint return). If AGI for 2009 is above $33,000 but not over $36,000, the credit is 20 percent of qualifying contributions ($800 in the above example: $4,000 x 20 percent). If AGI for 2009 is above $36,000 but not over $55,500, the credit is 10 percent of qualifying contributions.

For single taxpayers, if AGI for 2009 is $16,500 or less, the percentage is 50 percent. If AGI for 2009 is above $16,500 but not over $18,000, the credit is 20 percent of qualifying contributions. If AGI for 2009 is above $18,000 but not over $27,750, the credit is 10 percent of qualifying contributions. For 2009, the credit is phased out when AGI exceeds $55,000 for joint return filers, $41,625 for heads of households, and $27,750 for single and married filing separately.

Contribution reductions

The amount of contributions to be taken into account in determining the credit, however, must be reduced by any distributions from such qualified retirement plans over a "test period." The test period includes the current tax year, two preceding tax years, and the following tax year up to the due date of the return including extensions. A qualifying contribution is also reduced by nontaxable distributions received from Roth IRAs during the testing period (unless you roll them over). The contribution reduction rule even applies to "special" distributions, such as those taken to pay first-time homebuyer expenses or higher education costs.

Exceptions apply for certain distributions, such as trustee-to-trustee transfers or rollover distributions to other qualified retirement accounts (for example, a rollover from a traditional IRA to a Roth IRA).

Example. Jenny contributes $2,500 to her 401(k) during Year 4, but took a $1,000 taxable IRA withdrawal during Year 2. Her qualifying contribution for purposes of computing her saver's credit for Year 4 is $1,500 ($2,500-$1,000).

The saver's credit is available in addition to other benefits you receive contributing to a retirement plan. For example, if you make a $1,000 deductible contribution to a traditional IRA, you may also qualify to take the saver's credit for that contribution. In fact, since your deduction for the IRA contribution reduces AGI, you may even qualify for a higher credit percentage.

A consequence of the economic downturn for many investors has been significant losses on their investments in retirement accounts, including traditional and Roth individual retirement accounts (IRAs). This article discusses when and how taxpayers can deduct losses suffered in Roth IRAs and traditional IRAs ...and when no deduction will be allowed.

Traditional IRAs

Losses on investments held in a traditional IRA, funded only by contributions that you deducted when you made them, are never deductible. Even when you cash out the IRA after retirement, losses cannot be deducted. The theory behind this rule is that you already received a tax benefit in your deduction for making contributions and any loss lowers the amount of taxable income you must realize when you make retirement withdrawals. The technical explanation is that you are presumed to have a zero basis in your account.

On the other hand, if you make nondeductible traditional IRA contributions, and liquidate all of the investments in your traditional IRA, a loss can be recognized if the amounts distributed are less than the remaining unrecovered basis in the traditional IRA. You claim a loss in a traditional IRA on Schedule A, Form 1040, as a miscellaneous itemized deduction subject to the two percent AGI floor.

Example. During 2008, you made $2,000 in nondeductible contributions to a traditional IRA. Your basis in the IRA at the end of 2008 is $2,000. During 2008, the IRA earned $400 in dividend income and you withdrew $600 from the account. As a result, at the end of 2008 the value of your IRA was $1,800 ($2,000 contributed plus $400 dividends minus $600 withdrawal). You compute and report the taxable portion of your $600 withdrawal and your remaining basis on Form 8606, Nondeductible IRA.

In 2009, the year you retired, your IRA lost $500 in value. At the end of 2009, your IRA balance was $1,300 ($1,800 balance at the end of 2008 minus the $500 loss). Your remaining basis at that time in your IRA is $1,500 ($2,000 nondeductible contributions minus the $500 basis in the prior withdrawal). You withdraw the $1,300 balance remaining in the IRA. You can claim a loss of $200 (your $1,500 basis minus the $1,300 withdrawn) on Form 1040, Schedule A. The allowable loss is further subject to the two percent adjusted gross income (AGI) floor on miscellaneous itemized deductions.

If you made significant nondeductible contributions to an IRA over the last few years, and may be considering withdrawing the entire balance in all of your traditional IRAs before the end of the year in order to recognize a loss, keep in mind doing so will mean losing the opportunity to defer gain if the value of your investments in the accounts increases. Those withdrawn amounts cannot be recontributed at a later date.

Roth IRA losses

When you experience losses on Roth IRA investments, you can only recognize the loss for income tax purposes, if and when all the amounts in the Roth IRA accounts have been distributed and the total distributions are less than your basis (e.g. regular and conversion contributions).

To report a loss in a Roth IRA, all the investments held in your Roth IRA (but not traditional IRAs) must be liquidated. Moreover, the loss is an ordinary loss for income tax purposes, not a capital loss, and can only be claimed as a miscellaneous itemized deduction subject to the two percent of AGI floor that applies to miscellaneous itemized deductions on Form 1040, Schedule A.

Since all Roth IRAs must be completely liquidated to generate a loss deduction, it generally provides only a small comfort to investments gone sour. Closing all your Roth IRAs generally forgoes future appreciation on that amount.

You may have done some spring cleaning and found that you have a lot of clothes that you no longer wear or want, and would like to donate to charity. Used clothing that you want to donate to charity and take a charitable deduction for, however, is subject to a few rules and requirements.

Under IRS guidelines, clothing, furniture, and other household items must be in good used condition or better, to be deductible. Shirts with stains or pants with frayed hems just won't cut it. Furthermore, if the item(s) of used clothing are not in good used condition or better, and you wish to deduct more than $500 for a single piece of clothing, the IRS requires a professional appraisal.

For donations of less than $250, you must obtain a receipt from the charity, reflecting the donor's name, date and location of the contribution, and a reasonably detailed description of the donation. It is your responsibility to obtain this written acknowledgement of your donation.

Used clothing contributions worth more than $500

If you are deducting more than $500 with respect to one piece of used clothing you donate, you must file Form 8283, Noncash Charitable Contributions, with the IRS. For donated items of used clothing worth more than $500 each, you must attach a qualified appraisal report is to your tax return. The Form 8283 asks you to include information such as the date you acquired the item(s) and how you acquired the item(s) (for example, were the clothes a holiday gift or did you buy the items at the store).

Determining the fair market value of used clothing

You may also need to include the method you used to determine the value of the used clothing. According to the IRS, the valuation of used clothing does not necessarily lend itself to the use of fixed formulas or methods. Typically, the value of used clothing that you donate, is going to be much less than you when first paid for the item. A rule of thumb, is that for items such as used clothing, fair market value is generally the price at which buyers of used items pay for used clothing in consignment or thrift stores, such as the Salvation Army.

To substantiate your deduction, ask for a receipt from the donor that attests to the fact that the clothing you donated with in good, used condition, or better. Moreover, you may want to take pictures of the clothing.

If you need have questions about valuing and substantiating your charitable donations, please contact our office.

Employers commonly use per-diem allowance arrangements to reimburse employees for business expenses incurred while traveling away from home on business. Each year, the IRS publishes per-diem rates for travel within the continental U.S. The per-diem rates for meals, lodging and incidental expenses can be used instead of using your actual expenses. There are two approved methods for substantiating your per-diem expenses, including the "high-low" method (found in IRS Publication 1542). This article is intended to help you calculate your per-diem travel expenses under the "high-low" method.

What is required under a per-diem plan?

Per diems require only that your employee substantiate the time, place, and business purpose of these expenses. When you use the "high-low" method for calculating the per-diem rate allowance, your expenses under this method will be deemed substantiated as long as it does not exceed IRS-established federal per diem rates for two categories:

1. Lodging; and

2. Meals.

The federal per-diem rates for these two categories are listed in IRS Publication 1542.

The high-low method

As mentioned, one of the two approved methods for using the per-diem rates is the "high-low" method. The high-low method is a simplified method for figuring your lodging, meals and incidental expenses. This method requires employers to use only two per-diem rates to reimburse employee travel expenses--one for high-cost locations and one for low-cost locations. For 2009, the per-diem rate for travel to a "high-cost" locality is $296 ($198 for lodging and $58 for meals and incidental expenses). The 2009 per-diem rate for travel to "low-cost" areas is $158 ($113 for lodging and $45 for meals and incidental expenses).

Under the high-low method, there are a significant number of localities (published n Publication 1542) that qualify for a "high" 2009 per diem rate of $296. Any locality not listed as "high" is automatically considered "low cost" and qualifies for a per diem rate of $158. The federal per-diem rates are deemed substantiated as long as they do not exceed the high or low cost set by the IRS for the area.

While the past year has not been stellar for most investors, the tax law in many instances can step in to help salvage some of your losses by offsetting both present and future taxable gains and other income. Knowing how net capital gains and losses are computed, and how carryover capital losses may be used to maximum tax advantage, should form an important part of an investor's portfolio management program during these challenging times.

Net capital losses

Capital assets yield short-term gains or losses if the holding period is one year or less, and long-term gains or losses if the holding period exceeds one year. The excess of net long-term gains over net short-term losses is net capital gain.

Short-term capital losses, including short-term capital loss carryovers, are applied first against short-term capital gains. If the losses exceed the gains the net short-term capital loss is applied first against any net long-term capital gain from the 28-percent group (collectibles), then against the 25-percent group (recapture property), and last against the 15- (or zero) percent group. Long-term capital losses are similarly netted and then applied against the most highly taxed net gains that a taxpayer has.

If an investor's capital losses exceed capital gains for the year, he or she may offset losses against ordinary income to the extent of the lesser of: the excess capital loss; or $3,000 ($1,500 for married persons filing separate returns). Although several bills have been introduced to raise these dollar levels, which have not been adjusted for inflation for decades, none has yet to see the light of day.

Carryovers

Individuals may carry net capital losses to future tax years but not back to prior years. There is no limit on the number of years to which net capital losses may be carried over as there is with corporate taxpayers. Short-term and long-term capital losses are carried forward and retain their character. Capital loss carryovers that originate in several years are applied in the order in which incurred.

Dividend offsets. While qualified dividends are taxed at the net capital gains rate, they do not take part in the general computation of net capital gains and, therefore, are not reduced by capital losses, either in the same year or in carried forward years. Although your overall portfolio may have experienced a loss for the year, you must still pay tax on your dividend income.

If you need any advice on how to structure your portfolio over the next year to take advantage of current losses while protecting future gains from as much income tax as possible, please do not hesitate to call this office.