News + Updates

FAQ…do I need a receipt for every gift to charity

The IRS requires that taxpayers substantiate their donations to charity. Whatever the donation is, whether money or a household item or clothing, the substantiation rules must be followed. The rules are complex and frequently tripped up taxpayers who had good intentions but failed to satisfy the IRS’s requirements.

Substantiation

One way to understand the IRS’s requirements is to break them down by monetary amount and the type of donation, money and/or household items or clothing.

  • To deduct a contribution of cash, check, or other monetary gift (of less than $250), a taxpayer must maintain a bank record, payroll deduction records or a written communication from the organization containing the name of the organization, the date of the contribution and amount of the contribution.
  • To claim a deduction for contributions of cash or property equaling $250 or more, the taxpayer must have a bank record, payroll deduction records or a written acknowledgment from the qualified organization showing the amount of the cash and a description of any property contributed, and whether the organization provided any goods or services in exchange for the gift.
  • If the total deduction for all noncash contributions for the year is over $500, the taxpayer must file Form 8283, Noncash Charitable Contributions, with the IRS.
  • Donations valued at more than $5,000 generally require an appraisal by a qualified appraiser.

The IRS also requires that donations of clothing and household items be in good used condition or better to be deductible. Special rules apply to donations of motor vehicles, boats and aircraft.

Tax Court sheds light

In April, the U.S. Tax Court issued an instructive decision (Kunkel, TC Memo. 2015-71) on the steps taxpayers must take to deduct a contribution to a charitable organization. The taxpayers in Kunkel made a number of donations, some by cash and others of household items and clothing, but the court disallowed nearly all of the claimed deductions because the taxpayers failed to follow the rules.

In this case, the taxpayers reported $42,000 in charitable contributions, comprising $5,000 in cash and $37,000 in noncash donations. The noncash contributions were donations of books, clothing, furniture, and household items. The taxpayers told the IRS that they took the household items, clothing and books to charities in batches, which they claimed were worth less than $250 because they believed this eliminated the need to get receipts. Other times, one or more charities came to the taxpayers’ residence and picked up the household items (however, the taxpayers were not home at the time of the pickup and the charities left undated doorknob hangers as receipts).

The Tax Court reminded the taxpayers that for all contributions of $250 or more, a taxpayer generally must obtain a contemporaneous written acknowledgment from the charity. The court found it implausible that the taxpayers had made their donations in batches worth less than $250. The court calculated that this would mean they had made these donations on 97 different occasions in one year. The court also found that the doorknob hangers were inadequate substantiation of their claimed donations. The doorknob hangers not specific to taxpayer, did not describe the property contributed, and were not contemporaneous written acknowledgments, the court found.

This article is a very high level overview of the IRS’s substantiation requirements for donations to charity. If you have any questions about the substantiation or other requirements for a gift you are making to a charity, please contact our office for more details.

Tax extenders take first steps to passage before Congress breaks for August recess

Just before Congress recessed for its August break, a package of tax extenders was approved by the Senate Finance Committee (SFC). The House and Senate both struggled to find ways to pay for a multi-year federal highway and transportation spending bill, and disagreed over the extent of cuts to the IRS’s fiscal year (FY) 2015 budget. Congress did not, however, take action on proposals to allow small businesses to reimburse employees for health insurance costs.

Tax extenders

Unless renewed, many tax incentives available in 2014 will not be available in 2015. The list of these popular but temporary tax breaks is long, numbering more than 50, and impacting all types of taxpayers. For individuals, the extenders include the state and local sales tax deduction, higher education tuition deduction, teachers’ classroom expense deduction, transit benefits parity, and more. For businesses, the expired extenders include the research tax credit, Code Sec. 179 small business expensing, Work Opportunity Tax Credit (WOTC), special expensing rules for television and film productions, Production Tax Credit, and others.

In July, the SFC voted to extend the expired tax provisions for two years: retroactive to January 1, 2015 and forward through 2016. That way, taxpayers can take advantage of the incentives in 2015 and 2016.

The SFC also enhanced some of the extenders. The SFC voted to increase the Code Sec. 179 expensing maximum amount and phase-out threshold in 2015 and 2016 to $500,000 and $2 million respectively, indexed for inflation beginning after 2014. The proposal would also extend the definition of Code Sec. 179 property to include computer software and $250,000 of the cost of qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property for two years.

The SFC did not leave out another popular business incentive: bonus depreciation. The SFC package would extend 50 percent bonus depreciation to qualified property purchased and placed in service before January 1, 2017, (before January 1, 2018, for certain longer-lived and transportation assets).

Although the extenders have moved through the SFC, their passage in the full Senate is uncertain. Many lawmakers want the cost of the extenders (estimated at $95 billion over 10 years) to be offset by revenue raisers. The SFC bill includes three revenue raisers, two related to energy and a proposal to modify mortgage information reporting requirements for lenders. Like past years, the fate of the extenders will likely be decided late in the year. Our office will keep you posted of developments.

Highway funding

At press time, Congress was still seeking a path to pass a multi-year federal highway and transportation spending bill. A temporary highway funding bill is scheduled to expire after July 31, 2015. As with the extenders, much of the debate is on how to pay for highway and transportation projects.

Senate Majority Leader Mitch McConnell, R-Ky., proposed a six-year highway bill partially paid for with extensions of current funding provisions and tax compliance measures. The bill is funded for three years with revenue for the remaining three years to be determined at a future date. McConnell proposed to pay for his bill, among other revenue raisers, by modifications to mortgage information reporting, revoking or denying a U.S. passport to individuals with delinquent tax obligations, and allowing employers to transfer excess defined-benefit-plan assets to retiree medical accounts and group-term life insurance.

Meanwhile, the House approved a short-term highway patch. The House bill includes a provision similar to the Senate’s mortgage information reporting proposal. House Democrats have reproposed the GROW AMERICA Act, which would pay for highway and transportation spending by limiting tax-motivated corporate inversions.

IRS budget

In June, the House Appropriations Committee voted to fund the IRS at $10.1 billion for FY 2016, which represents a cut of some $838 million compared to FY 2015. The full House did not take up the bill before the August recess. The Senate Appropriations Committee also approved a cut to the IRS’s budget, but not at the same amount. The Senate bill would reduce the IRS’s FY 2016 budget by $470 million.

Small businesses

The Affordable Care Act imposes a number of market reforms. One consequence of these reforms has been to limit the use of health reimbursement arrangements (HRAs) for small businesses to reimburse employees for health insurance costs. Reform legislation has been introduced in the House and Senate.

The Small Business Healthcare Relief Act would allow many small businesses to use pre-tax dollars to give employees a defined contribution; and permit employees to use these funds as an HRA to purchase health coverage on the individual market, as well as for qualified out-of-pocket medical expenses. The bill has bipartisan support and could come up for a vote after the August recess.

If you have any questions about the tax proposals making their way through Congress, please contact our office.

Preliminary filing season stats show successes and challenges for IRS

Preliminary information from the 2015 filing season shows a mixed bag of success and failures for the IRS. The IRS successfully processed returns and issued refunds, taking into account new requirements under the Affordable Care Act. At the same time, taxpayers experienced significant difficulties in contacting the IRS and tax-related identity theft increased compared to last year.

Returns and refunds

So far this year, the IRS has processed 126 million individual tax returns, compared with 125.6 million last year. The IRS has issued 91.8 million refunds, compared with 94.8 million last year. According to the IRS, the average refund is $2,711, up from $2,686 last year. The IRS also reported that visits to its website jumped 12 percent this year compared to 2014.

Affordable Care Act

Effective January 1, 2014, individuals must carry minimum essential health coverage or make a shared responsibility payment, unless exempt. At the start of the filing season, the IRS launched a campaign to educate taxpayers about the individual shared responsibility requirement. At that time, the IRS estimated that at least two-thirds of filers would report having minimum essential health coverage, such as employer-provided coverage. Many other taxpayers would be exempt; and others would be required to make a shared responsibility payment.

Looking at the preliminary data, the IRS reported that 76 percent of filers checked a box on their returns to report they had minimum essential coverage in 2014. Approximately 12 million taxpayers claimed an exemption from the individual mandate. Some 7.5 million taxpayers made a shared responsibility payment. However, according to the IRS, some 300,000 individuals overpaid their shared responsibility payment.

The IRS also processed some 2.6 million claims for the Code Sec. 36B premium assistance tax credit. The credit helps offset the cost of health insurance through the ACA Marketplace. The average Code Sec. 36B credit amount was $3,000.

Customer service

The IRS cautioned taxpayers that budget cuts would negatively impact customer service during the filing season and the filing season reflected its prediction. In 2014, the IRS answered 71 percent of all calls from taxpayers. This year, the percentage fell to 37 percent and wait times increased. The IRS also expanded its use of so-called courtesy holds (which automatically disconnect a caller after a certain amount of time). The IRS made 8.8 million courtesy disconnects during the 2015 filing season.

Note. National Taxpayer Advocate Nina Olson recently told Congress that the decline in customer service has consequences beyond long wait times. “For a tax system that relies on voluntary self-assessment by its taxpayers, none of this bodes well,” Olson said. “In fact, there is a real risk that the inability of taxpayers to obtain assistance from the government, and their consequent frustration, will lead to less voluntary compliance and more enforced compliance.”

Identity theft

Tax-related identity theft continues to grow as criminals find new ways to scam unsuspecting taxpayers. In 2014, the IRS reported discovering some 700,000 fraudulent returns. So far this year, the IRS has identified some 1.5 million fraudulent returns. The IRS also received approximately 1.6 million calls to its Identity Protection Specialized Unit (IPSU).

The IRS also has had to deal with fallout from the May 2015 breach of its Get Transcript app. Criminals were able to access more than 100,000 taxpayer accounts, including names, Social Security numbers and dates of birth of dependents.

If you have any questions about the 2015 filing season, please contact our office. All of these statistics are preliminary and could change as the IRS continues to process data. The IRS typically publishes tax return statistics about 15- to 18 months after the close of the tax year in order to provide time for all returns to be filed.

IRS reports decline in audit coverage following budget shortfalls

The IRS budget has suffered significant funding cuts to the past few fiscal year (FY) budgets. Most recently, IRS Commissioner John Koskinen told reporters that the IRS has been forced to absorb a $346 million cut to its FY 2015 budget. Such drastic reductions directly impact the IRS’s ability to enforce the nation’s tax laws. This became evident after the IRS issued its annual Data Book for FY 2014. (The Data Book provides statistical information on examinations, collections, taxpayer assistance, and other activities.) This year, the Data Book indicated that IRS audit rates have fallen for individuals and large corporate taxpayers between FY 2013 and FY 2014. On the other hand, the audit rate for partnerships increased slightly, ostensibly as a result of the IRS’s recent policy favoring more audits of this long-neglected sector.

Exam coverage: individuals

Individual returns filed in 2013, including both business and nonbusiness taxpayers, were audited at just under an overall 0.9 percent rate during FY 2014, based on more than 145.2 million individual returns filed. The audit rate for individuals in all income categories declined from FY 2013 to FY 2014. The drop was highest for taxpayers with income between $1 and $5 million. The audit rate for this category of taxpayers dropped by nearly three percentage points.

Individual business tax returns with and without the earned income credit (other than farm returns), were audited at a 1.59-percent rate, based on 679,093 audited returns out of nearly 42.7 million filed. This represents a decline from the 1.78 rate from FY 2013, based on 759,179 audited returns out of nearly 42.7 million filed.

Exam coverage: corporations

The IRS examined nearly 1.35 percent of all corporate returns (other than S corps) during FY 2014, based on a total of nearly 1.92 million returns and 25,905 examinations. The IRS reported that during FY 2014 it recommended more than $17.1 billion in additions to tax for corporate returns. The additions to tax recommended for returns filed by corporate taxpayers with more than $20 billion in assets comprised approximately 50.6 percent of the total additions to tax. Large corporations with total assets between $5 billion and $20 billion experienced an audit rate of only 44 percent, representing a dramatic decrease from FY 2012 when the audit rate for this same category of taxpayer was nearly 61 percent.

Exam coverage: partnerships

Partnerships and S corps filed a total of approximately 8.4 million returns during FY 2014, a slight increase from FY 2013 when these types of entities filed 8.3 million returns. In addition, the audit rate increased slightly from 0.42 percent in FY 2013 to 0.43 percent for FY 2014. By contrast, the audit rate for all types of businesses fell slightly from 0.61 percent in FY 2013 to 0.57 percent in FY 2014. This trend is likely to continue as IRS officials have recently announced that the agency intends to concentrate more heavily on partnership audits in the future.

Commissioner Koskinen noted in the 2014 Data Book that during FY 2014, the IRS had audited tax returns of about 1.2 million individuals, nearly 12 percent less than the previous year. The figure was, in fact, the lowest it has been since FY 2005. Despite this, the IRS admitted that it had managed to hold steady the number of tax returns processed (approximately 240 million) and amount of revenue collected (approximately $3.1 trillion). However, the IRS estimated that as a result of the enforcement cuts, the federal government likely will lose an estimated $2 billion in revenue that otherwise would have been collected.

How the IRS resolves an identity theft case

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

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

Initiating an ID theft case

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

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

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

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

IDVerify.irs.gov

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

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

Resolving the case

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

After resolution

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

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

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

Latest breach

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

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

FAQ…Can I deduct the cost of sending my child to summer camp?

Now that summer 2015 is officially here and the main filing season is out of the way, tax planning may be far from your mind. However, typical summer traditions can yield tax benefits. For example, when school lets out for the summer, some parents may decide to send their young children to summer camp. Whether parents do this to supplement their children’s education, enhance their athletic skills, provide social opportunities, or simply to get them out of the house, some working parents may be able to deduct certain expenses associated with the cost of sending children to day camp. That’s where the child care and dependent credit under Code Sec. 21, might especially come into play.

Child Care and Dependent Credit Basics

A taxpayer, who incurs expenses to obtain day care for child under age 13 so that the taxpayer and his or her spouse can be gainfully employed (or look for gainful employment), may be able to claim the child care and dependent tax credit on Form 1040, (line 49), Form 1040A (line 31), or Form 1040NR (line 47). Taxpayers may also claim the credit for expenses paid for care for certain other qualifying individuals, such as physically or mentally incapacitated dependents.

Taxpayers who qualify for the child and dependent care tax credit must claim it by completing and filing Form 2441, Child and Dependent Care Expenses, along with their tax returns. Taxpayers may not claim the credit if they file a Form 1040EZ, Income Tax Return for Single and Joint Filers With No Dependents, or Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents.

A taxpayer who qualifies may claim a credit in an amount between 20 to 35 percent of employment-related child care expenses. Such expenses can include the cost of sending a child to day camp, something that can run up a hefty bill of more than $100 or $500 per week!

In general, to claim the child and dependent care credit, the taxpayer must meet the following requirements:

  • The taxpayer must live with the child(ren) or qualifying person(s) for more than half of the tax year;
  • The child and dependent care expenses must be incurred to allow the taxpayer to work or look for work. (If the taxpayer or the spouse is a stay-at-home parent, unfortunately, the child care costs are nondeductible);
  • The taxpayer must have income from work during the year. (The amount of the employment-related expenses taken into account in calculating the child and dependent care credit may not exceed the lesser of the taxpayer’s earned income or the earned income of his spouse if the taxpayer is married at the end of the tax year);
  • The taxpayer must have made payments for child and dependent care to someone the taxpayer or his spouse could not claim as a dependent. If the person to whom payments were made was the taxpayer’s child, the child must have been 19 or over by the end of the year;
  • If married, the taxpayer must file a joint return (unless an exception applies);
  • The taxpayer must include the taxpayer identification number of the qualifying individual on the return;
  • The taxpayer must provide specified information regarding service providers, including the name, address and taxpayer identification number (TIN) of the provider (no TIN is required if the provider is a tax-exempt organization);
  • A taxpayer must substantiate any child and dependent care credit claimed by providing adequate records or other sufficient evidence of work-related expenses, etc.

Summer Camp Costs

Because day camp is comparable to day care, the IRS allows taxpayers to factor in the costs of sending a child to day camp when determining the amount of the child and dependent care credit they may claim. The cost of sending a child to a day camp may be a work-related expense, even if the camp specializes in a particular activity, such as computers, music, football, or soccer. Furthermore, taxpayers are not required to seek out the least expensive day camp option in order to claim the credit. The IRS regulations provide that “the manner of providing care need not be the least expensive alternative available to the taxpayer.”

Reg. §1.21-(1)(d)(6) provides that the cost of sending your child to an overnight camp, however, is not considered a work-related expense. Similarly, summer school and tutoring programs are not considered to be for the care of a qualifying individual and the costs are not employment-related expenses.

The regulations under Code Sec. 21 provide two examples intended to outline the distinction between a summer day camp, for which expenses are deductible, and a tutoring program, for which expenses are nondeductible. They state: To be gainfully employed, N sends her 9-year old child to a summer day camp that offers computer activities and recreational activities such as swimming and arts and crafts. The full cost of the summer day camp may be for deductible care. In contrast, to be gainfully employed, O sends her 9-year old child to a math tutoring program for two hours per day during the summer. The cost of the tutoring program is not for deductible care.

According to the IRS, the question of whether or not an expense qualifies for the dependent care credit depends on the nature and primary purpose of the services provided and is primarily a question of fact. In order for an expense to qualify in full for the dependent care credit, any portion of the expense for purposes other than care must be minimal or insignificant and inseparable from the portion of the expense for care. If a significant portion of the expense is for purposes other than care, an allocation must be made as to which portion of the costs are for deductible care and which portion of the costs are for other purposes. An expense that is primarily for a purpose that is not care, such as education, does not qualify for the dependent care credit.

Amounts paid for clothing, schooling and entertainment are not considered qualified expenses for purposes of calculating the child care and dependent credit. However, if these amounts are incidental to and cannot be separated from the cost of caring for the qualifying person, the regulations provide that these expenses can be counted toward the credit for qualified dependent care. This means that costs to purchase clothing, horseback riding chaps, soccer cleats, football padding, violin strings, or other gear that may be used by the child while at the day camp are nondeductible because they are technically personal in nature and not for the well-being of the child. However, if the day camp provides a lunch and snacks to the children attending the day camp, the regulations provide that the cost of this lunch and the snacks may be included in the cost of care for the child if they are incidental to and inseparably a part of the care.

The cost of transporting a qualifying individual to a place where care is provided is not generally a qualifying expense unless it is provided by a dependent care provider. If a day camp takes a child or qualifying person to or from the day camp location, that transportation is for the care of the child. This includes transportation by bus, subway, taxi, or private car.

Forfeited amounts

A taxpayer may include the cost of fees paid to an agency to get the services of a day camp provider, including deposits and application fees. However, if the taxpayer changes his or her mind and either does not send the child to day camp or selects another program, any forfeited deposit will not be considered “for the care of a qualifying person” and will therefore become nondeductible.

Credit Amount

The amount of the child care and dependent credit is subject to a cap calculated as a percentage of the taxpayer’s employment-related expenses, as well as a dollar limit. A maximum credit of 35 percent of employment-related expenses is available to taxpayers with adjusted gross income (AGI) of $15,000 or less. The credit percentage is reduced by one percentage point for each $2,000 of adjusted gross income, or fraction thereof, above $15,000. The minimum credit percentage is 20 percent, and it applies to a taxpayer with AGI in excess of $43,000.

In addition, the maximum amount of eligible expenses that may be used to calculate the final credit amount is $3,000 for taxpayers with one qualifying individual and $6,000 for taxpayers with two or more qualifying individuals. Therefore, the maximum credit amount is $1,050 for taxpayers claiming expenses for one child and $2,100 for taxpayers claiming expenses related to two or more children.

Any child care benefits provided by an employer will reduce dollar-for-dollar the amount of expenses a taxpayer may use to calculate the credit.

The child care and dependent credit is nonrefundable, meaning that if the taxpayer already has no tax liability for the year in which he or she incurred qualified expenses for purposes of the credit, he or she will receive no tax benefit from claiming the credit.

Liability for the “nanny” tax

Employers of course have to pay employment taxes on the wages they pay to their employees. A nanny who takes care of a child is considered a household employee, and the parent or other responsible person is her household employer. Housekeepers, maids, babysitters, and others who work in or around the residence are employees. Repairmen and other business people who provide services as independent contractors are not employees. An individual who is under age 18 or who is a student is not an employee.

Payments and Withholding

As a household employer, the parent must withhold and pay Social Security and Medicare taxes if the cash wages paid to the nanny exceed the threshold amount for the year. If the amount paid is less than the threshold, the parent does not owe any Social Security or Medicare taxes. The threshold for 2015 is $1,900. If the employee earns more than $1,000 in any calendar quarter, the parent must also pay federal unemployment (FUTA) tax on wages paid, up to $7,000. Publication 926, Household Employer’s Tax Guide, has more information about withholding and paying employment taxes.

If the amount paid is more than the threshold, the parent must withhold the employee’s share of Social Security and Medicare taxes unless the parent chooses to pay both the employee’s and the employer’s share. The taxes are 15.3 percent of cash wages, 7.65 percent each for the employee and the employer. This includes 6.2 percent for Social Security and 1.45 percent for Medicare (hospitalization insurance).

The parent is not required to withhold income tax from the nanny’s wages. However, the parent and the nanny may agree to withholding income tax from the nanny’s wages. The nanny must provide a filled-out Form W-4, Employee’s Withholding Allowance Certificate, to the employer.

The employment taxes amounts are part of the parent’s tax liability and can trigger an estimated tax penalty if not enough is paid during the year. The parent submits estimated tax payments on Form 1040-ES, Estimated Tax for Individuals.

Forms to File

If the parent must pay Social Security and Medicare taxes, or if the parent withholds income tax, the parent must file Schedule H, Household Employment Taxes, with the parent’s Form 1040. The parent may also need to file a Form W-2, Wage and Tax Statement, and furnish a copy of the form to the nanny. To complete Form W-2, the parent must obtain an employer identification number (EIN) from the IRS, either by applying online or by submitting Form SS-4, Application for Employer Identification Number.

FAQ: Can an S corporation own an interest in another business entity?

An S corporation may own an interest in another business entity. An S corporation can be a member of an affiliated group by owning 80 percent or more of the stock of a C corporation. The group then can elect to file on a consolidated basis, if other affiliated group rules are met. But the S corporation itself cannot join the consolidated group.

Although in general only individuals can be shareholders in an S corporation, an S corporation can own an S corporation if the subsidiary corporation would otherwise qualify as an S corporation if the parent’s shareholders held the subsidiary’s shares directly, and the taxpayer elects qualified S corporation status for the subsidiary. Generally, for federal tax purposes a corporation that is a qualified S corporation subsidiary is not treated as a separate corporation, and all assets, liabilities, and items of income, deduction, and credit of a qualified S corporation subsidiary are treated as assets, liabilities, and items of income, deduction, and credit of the S corporation.

An S corporation can also be a partner in a partnership or a member of an LLC.

For further information on how an S corporation may hold or acquire interests in another business, please contact our offices.

Year-end tax legislation renews extenders, cuts IRS funding

Eleventh-hour votes in Congress in December renewed a package of tax extenders for 2014, created new savings accounts for individuals with disabilities, cut the IRS’ budget, and more. At the same time, the votes helped to set the stage for the 114th Congress that convenes this month. Republicans have majorities in the House and Senate and have indicated that taxes are one of the top items on their agenda for 2015.

Extenders

The Tax Increase Prevention Act of 2014, signed into law by President Obama in December extends more than 50 individual, business and energy tax incentives retroactively to January 1, 2014. As a result, taxpayers can claim these incentives on their 2014 returns filed in 2015. The Act includes all of the popular incentives for individuals, such as the state and local sales tax deduction and higher education tuition deduction, as well as many business incentives, including the research tax credit, bonus depreciation and enhanced Code Sec. 179 expensing. A handful of extenders were not renewed, mostly targeted to energy efficiency. If you have any questions about the renewal of the extenders for 2014, please contact our office.

ABLE Act

As part of the extenders package, Congress approved the Achieving a Better Life Experience (ABLE) Act of 2014. The Act establishes ABLE accounts for individuals with disabilities. Funds in ABLE accounts may be used for qualified expenses of persons with disabilities. To fund these accounts, the Act:

  • Adjusts for inflation some civil tax penalties
  • Authorizes the IRS to certify qualifying professional employer organizations
  • Excludes dividends from controlled foreign corporations from the definition of personal holding company income
  • Increases the IRS’ levy authority on payments to Medicare providers
  • Raises the Inland Waterways Trust Fund financing rate

IRS budget

The IRS goes into the 2015 filing season with a reduced budget. The omnibus spending agreement, signed into law by President Obama on December 16, cuts the IRS’ fiscal year (FY) 2015 budget by some $345 million. The omnibus spending agreement also instructs the IRS to improve its response times in helping victims of identity theft and reduce refund fraud. In response to the budget cuts, IRS Commissioner John Koskinen said the agency will freeze hiring and take other steps to reduce expenses. Koskinen also cautioned that revenue collection and tax enforcement could be impaired by the budget cuts as the agency will have to make do with less. Taxpayer audits were singled out by Koskinen as one area where cutbacks could have a negative effect.

Affordable Care Act

Congress also clarified the status of so-called expatriate health plans under the Affordable Care Act. These plans cover very specific groups of people, including participants in a group health plan who are aliens residing outside the United States and U.S. nationals about whom there is a good faith expectation of being abroad, in connection with his or her employment, for at least 180 days in a 12-month period.

The omnibus spending agreement exempts expatriate health plans, employer sponsors of these plans, and insurance issuers providing coverage under these plans from the health care coverage requirements of the Affordable Care Act. Additionally, the omnibus spending agreement treats these plans as providing minimum essential coverage for purposes of the Affordable Care Act’s individual mandate.

Multi-employer pension plans

The extenders package and the omnibus spending agreement amend the rules governing multi-employer pension plans. The provisions, supporters argued, are intended to shore-up many struggling plans. Opponents countered that the changes weaken protections for beneficiaries. The amendments to the multi-employer pension rules are very technical. Please contact our office for more details

114th Congress

The Tax Increase Prevention Act did not extend the extenders beyond 2014. As of January 1, 2015, they all expired again. During 2014, proposals to extend the incentives for two years or make them permanent were floated in Congress. The GOP-controlled House vote to make permanent bonus depreciation, enhanced Code Sec. 179 expensing and some charitable giving breaks, but these bills were not taken up by the Democratic-controlled Senate. This could change in the 114th Congress. The new leaders of the tax-writing committees, Rep. Paul Ryan, R-Wisc., chair of the House Ways and Means Committee, and Sen. Orrin Hatch, R-Utah, chair of the Senate Finance Committee, have both indicated their interest in addressing the extenders as part of comprehensive tax reform.

Any movement toward comprehensive tax reform will require cooperation between the White House and the Republican-controlled Congress. In December, President Obama said that he would be willing to work with Republicans on corporate tax reform but any decrease in the corporate tax rate would need to be paid for by revenue raisers elsewhere. The President also said that he wants to preserve and make permanent some temporary enhancements to individual tax breaks, such as the earned income credit. New Senate Majority Leader Mitch McConnell, R-Ky., also said in December that he could work with the White House.

Please contact our office if you have any questions about the 2014 year-end legislation or the new Congress.

 

FAQ: Why use a partnership instead of an S corporation?

Taxpayers that plan to operate a business have a variety of choices. A single individual can operate as a C corporation, an S corporation, a limited liability company (LLC), or a sole proprietorship. Two or more individuals can form a partnership, a corporation (C or S), or an LLC.

Nontax considerations

State law and nontax considerations are an important consideration in choosing the form of the business and may play a decisive role. A general partner of a partnership has unlimited liability for the debts of the business. This can be modified by using a limited partnership (LP), which must have at least one general partner and at least one limited partner. The general partner still have unlimited liability, but a limited partner’s liability is limited to its contribution to the partnership. A corporation has limited liability; shareholders generally are not responsible for the liabilities of the corporation beyond their contributions to the entity.

Federal tax considerations

At the same time, it is crucial to consider federal tax requirements and consequences when choosing the form of business entity. A primary federal tax consideration is avoiding a double layer of tax on business income. This can be accomplished by operating as a passthrough entity, such as a partnership or S corporation. Income is not taxed at the entity level. It passes through to partners and shareholders and is taxed at their rates.

In contrast, C corporations are taxable entities. Furthermore, when a C corporation pays a dividend to its shareholders, this generally is taxable to the shareholder. It must be noted that income of a passthrough entity is allocable and taxable to its owners, whether or not the income is actually distributed to the partner or shareholder. Dividends are not taxed unless there is an actual distribution.

While a partnership is organized under state law, an S corporation is a creature of the federal tax system. The S corporation is a regular corporation for state law purposes.

Advantages of partnerships

Unlike an S corporation shareholder, anyone or any entity can be a partner. S corporations are limited to 100 shareholders; only certain individuals, estates and trusts are eligible to be shareholders. C corporations and nonresident aliens cannot be shareholders of an S corporation.

S corporations are limited to a single class of stock; income and losses must be allocated on the same basis to each shareholder. Having only one class of stock may affect the corporation’s ability to raise capital. A partnership can have different classes of partners and has more flexibility for allocating income and losses to different types of partners.

Partnership liabilities can increase a partner’s basis in the partnership, offsetting distributions of cash and reducing their taxation. The increased basis allowed partners to use losses generated by the partnership. Liabilities of an S corporation do not create stock basis; separate bases in stock and debt must be calculated. This lack of basis may limit the use of losses generated by the S corporation.

Contributions of appreciated property by a partner to the partnership generally are not taxable, even if the partner is not part of a group controlling the partnership. Contributions by a shareholder to a corporation are tax-free only if the shareholders are part of a group controlling 80 percent of the corporation after the contribution. However, a partnership must follow special allocation rules for handling built-in gain on contributed property, whereas S corporations do not have special allocation rules in this circumstance.

Conclusion

In general, a partnership offers more flexibility than an S corporation in the treatment of taxes. However, S corporation shareholders do have limited legal liability, while general partners are not insulated from the partnership’s debts and liabilities.

 

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