The IRS has issued final regulations modifying reporting obligations for partnerships involved in Code Sec. 751(a) exchanges of partnership interests. The regulations remove the requirement that partnerships furnish transferors with certain information relating to unrealized receivables and inventory items by January 31 following the exchange year. The regulations are effective for returns filed for tax years ending on or after May 20, 2026.

The IRS has issued final regulations modifying reporting obligations for partnerships involved in Code Sec. 751(a) exchanges of partnership interests. The regulations remove the requirement that partnerships furnish transferors with certain information relating to unrealized receivables and inventory items by January 31 following the exchange year. The regulations are effective for returns filed for tax years ending on or after May 20, 2026.

Under Code Sec. 6050K, partnerships must file Form 8308, Report of a Sale or Exchange of Certain Partnership Interests, for transfers involving Code Sec. 751(a) property. The IRS and Treasury Department received comments that many partnerships could not determine the information required for Part IV of Form 8308 by the January 31 furnishing deadline. As a result, the final regulations remove Reg. §1.6050K-1(c)(2) and revise Reg. §1.6050K-1(c)(1) to permit partnerships to furnish Form 8308 completed in accordance with the form instructions.

Although partnerships are no longer required to furnish Part IV information to transferors and transferees by January 31, they must still file a completed Form 8308, including Part IV, with Form 1065. The IRS finalized the regulations without substantive changes from the proposed regulations issued in 2025.

T.D. 10048

The IRS has issued guidance on qualified long-term care distributions from qualified retirement plans. The guidance affects providers of certified long-term care insurance (issuers), plan administrators, and individual participants receiving qualified long-term care distributions. The IRS also extended the general deadline for amending a plan to permit qualified long-term care distributions to December 31, 2027.

The IRS has issued guidance on qualified long-term care distributions from qualified retirement plans. The guidance affects providers of certified long-term care insurance (issuers), plan administrators, and individual participants receiving qualified long-term care distributions. The IRS also extended the general deadline for amending a plan to permit qualified long-term care distributions to December 31, 2027.

Background

The SECURE 2.0 Act of 2022 (SECURE 2.0 Act), permitted defined contribution plans to make qualified long-term care distributions, effective for distributions made after December 29, 2025. The 10 percent additional tax on early distributions would not apply to distributions under Code Sec. 401(a)(39). However, a qualified long-term care distribution would be included in the taxpayer’s gross income.

Disclosure Requirements

The guidance addresses content requirements and procedures for submitting an Issuer Disclosure to the IRS. There is no general deadline for submitting an Issuer Disclosure. However, an issuer must submit an Issuer Disclosure to the IRS before the issuer can file a long-term care premium statement with a defined contribution plan.

Distribution Requirements

Under the guidance, the plan administrator is permitted to rely on the issuer’s statement and the information provided on the long-term care premium statement in making a qualified long-term care distribution. It is optional for a plan to permit qualified long-term care distributions, but the exception to the 10% additional tax only applies if the plan permits qualified long-term care distributions, even if the employee uses a distribution to pay for long-term care insurance. Unlike other permitted distributions, a qualified long-term care distribution would not be eligible for an extended 3-year repayment to a retirement plan.

Reporting Requirements

The payment of a qualified long-term care distribution to an employee must be reported by the payor on Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc.

Further, issuers must make a return to the IRS using Form 1099-LPS, Long-Term Care Premiums Paid Statement. The issuer will report the long-term care premiums paid for the calendar year. The Form 1099-LPS must be filed with the IRS no later than February 1 of the calendar year following the calendar year the long-term care premium statement was filed with the plan.

Deadline Extension

The guidance extends the deadline for a plan sponsor of a defined contribution plan that is not a governmental plan, a section 403(b) plan maintained by a public school, or an applicable collectively bargained plan, to amend its plan to permit qualified long-term care distributions from December 31, 2026, to December 31, 2027. The deadlines to amend defined contribution plans that are applicable collectively bargained plans or governmental plans remain as provided in Notice 2024-02. Thus, Notice 2024-2, I.R.B. 2024-2, 316, is modified in part.

Notice 2026-33

The IRS finalized regulations treating income derived by individual members of an Indian tribe from fishing rights-related activities as compensation for purposes of limitations on benefits and contributions under a qualified retirement plan. These regulations are effective for plan years beginning on or after May 4, 2026, and affect participants, beneficiaries, sponsors, and administrators of Tribal plans.

The IRS finalized regulations treating income derived by individual members of an Indian tribe from fishing rights-related activities as compensation for purposes of limitations on benefits and contributions under a qualified retirement plan. These regulations are effective for plan years beginning on or after May 4, 2026, and affect participants, beneficiaries, sponsors, and administrators of Tribal plans.

Fishing rights-related income is exempt from federal income tax and employment tax under Code Sec. 7873. However, proposed reliance regulations would allow contributions to be made to qualified retirement plans based on fishing rights-related income. Also, plans that accept contributions of fishing rights-related income may still use safe harbor definitions of compensation. The IRS finalized this rule as proposed without material modification.

Although the final rule is somewhat limited in scope, the IRS addressed additional issues in the preamble. The IRS clarified that plan contributions attributable to a Tribal employee's fishing rights-related activiity is treated as investment in the contract under Code Sec. 72 . Thus, distributions of the amount contributed would generally be tax-free (subject to basis recovery rules) and distributions attributable to earnings would be taxable. The IRS also indicated that plans that permit designated Roth contributions may allow contributions attributable to fishing rights-related activity to be made on a Roth basis.

T.D. 10046

The IRS has introduced a streamlined option allowing taxpayers to extend the time to challenge disallowed Employee Retention Credit (ERC) claims, reducing the need for immediate refund litigation. The measure applies to taxpayers who received Letter 105-C or 106-C, are awaiting review by the IRS Independent Office of Appeals and have six months or less remaining in the statutory two-year period.

The IRS has introduced a streamlined option allowing taxpayers to extend the time to challenge disallowed Employee Retention Credit (ERC) claims, reducing the need for immediate refund litigation. The measure applies to taxpayers who received Letter 105-C or 106-C, are awaiting review by the IRS Independent Office of Appeals and have six months or less remaining in the statutory two-year period.

Taxpayers generally have two years from the disallowance notice to resolve the claim or file a refund suit, but an administrative appeal does not suspend this deadline. Once the period expires, the IRS cannot issue a refund even if the taxpayer later prevails. To address this, eligible taxpayers may execute Form 907, Agreement to Extend the Time to Bring Suit, provided it is signed by both parties before the limitation period ends.

The IRS now permits submission of Form 907 through its Document Upload Tool, with qualifying requests reviewed and confirmed in writing. While the IRS is issuing notices to eligible taxpayers, others meeting the criteria may also apply. The agency indicated that the initiative is intended to preserve taxpayer rights and facilitate administrative resolution of ERC disputes.

The IRS has established a significant issue ruling program for cerain corporate transactions (Rev. Proc. 2026-21). This program would not diminish the availability of letter rulings under existing programs. This procedure modifies and amplifies the ruling procedures provided in Rev. Proc. 2026-1, I.R.B. 2026-1, 1, and Rev. Proc. 2026-3, I.R.B. 2026-1, 143.

The IRS has established a significant issue ruling program for cerain corporate transactions (Rev. Proc. 2026-21). This program would not diminish the availability of letter rulings under existing programs. This procedure modifies and amplifies the ruling procedures provided in Rev. Proc. 2026-1, I.R.B. 2026-1, 1, and Rev. Proc. 2026-3, I.R.B. 2026-1, 143.

The significant issue ruling program allows taxpayers to request rulings on one or more issues that:

• are solely under the jurisdiction of the Associate Chief Counsel (Corporate);
• are significant issues, as defined in section 4.02 of Rev. Proc. 2026-21; and
• involve the tax consequences or characterization of a transaction (or part of a transaction) that is described in Code Sec. 332, 351, 355, 368, or 1036.

Significant Issue Ruling Program

Taxpayers may request, and the IRS may issue, a ruling on part of an integrated transaction described in the above provisions, or a ruling on a particular legal issue under a section of the Code or regulations with respect to a transaction (or part thereof) rather than a ruling that addresses all aspects of that section (or any other section) with respect to the transaction (or part thereof).

In addition, the IRS may rule on the tax consequences resulting from integrated transactions described in the above provisions to the extent that a significant issue is presented under related Code sections that address such tax consequences.

A significant issue generally is a germane and specific issue of law, provided that a ruling on the issue would not be a comfort ruling or the conclusion in such a ruling otherwise would not be essentially free from doubt.

The requests for ruling must contain (1) narrative description of the transaction that puts the significant issue in context; (2) statement identifying the issue; (3) analysis of the solvability of issue; and more.

Effect on Other Documents

Rev. Proc. 2026-1 and Rev. Proc. 2026-3 are modified and amplified.

Effective Date

The significant issue ruling program applies to all letter ruling requests described in section 4.01 of Rev. Proc. 2026-21 postmarked or, if not mailed, received by the IRS after May 5, 2026.

Rev. Proc. 2026-21

Other References:

• Code Sec. 332
• CCH Reference - FED ¶16,052.188

Other References:

• Code Sec. 351
• CCH Reference - FED ¶16,405.48

Other References:

• Code Sec. 355
• CCH Reference - FED ¶16,466.923

Other References:

• Code Sec. 368
• CCH Reference - FED ¶16,753.53

Other References:

• Code Sec. 1036
• CCH Reference - FED ¶29,702.11

The IRS has announced a new time-limited settlement opportunity for eligible taxpayers involved in conservation easement and historic preservation easement disputes with the IRS. The program aims to resolve cases faster and on terms that are generally more favorable than recent Tax Court decisions.

The IRS has announced a new time-limited settlement opportunity for eligible taxpayers involved in conservation easement and historic preservation easement disputes with the IRS. The program aims to resolve cases faster and on terms that are generally more favorable than recent Tax Court decisions. Since 2020, the IRS has settled 405 cases through earlier initiatives, although taxpayers still had to pay penalties and were allowed only limited deductions for certain out-of-pocket costs. More than 1,100 conservation easement cases currently remain pending before the IRS and the Tax Court. Under the new initiative, many eligible partnerships will not have to make an upfront payment to participate. In addition, taxpayers whose earlier settlement offers expired or were rejected may now have another chance to resolve their cases, while some partnerships that were not previously eligible may also qualify. IRS Chief Executive Officer Frank J. Bisignano said Congress created the conservation easement deduction to encourage legitimate preservation efforts rather than tax shelters based on inflated property values.

The IRS said partnerships that accept the offer during the initial 90-day period generally will not be allowed a charitable contribution deduction, but they may qualify for a limited deduction tied to certain out-of-pocket expenses. Those partnerships generally would face a 10 percent gross valuation misstatement penalty, while partnerships settling during an additional 45-day period generally would face a 20 percent penalty. Interest also will continue to accrue as required by law. At the same time, the IRS noted that courts have repeatedly reduced claimed deductions and upheld significant penalties in conservation easement disputes. Certain cases, such as those already tried or currently under appeal, will not qualify for the initiative. The IRS added that eligibility will depend on the status and specific facts of each case.

Following a 2026 tax filing season that was consistent with the 2025 season, the American Institute of CPAs offered legislators a series of recommendations to help improve filing season in the future.

Following a 2026 tax filing season that was consistent with the 2025 season, the American Institute of CPAs offered legislators a series of recommendations to help improve filing season in the future.

“Based on limited and anecdotal information, many practitioners noted that the IRS appeared to operating consistently compared with the prior year’s service,” AICPA said in a recent letter to the Senate Finance Committee’s top leadership following a hearing on the 2026 tax filing season, adding that data currently available shows “tax return processing remained relatively consistent, though the quality of telephone services appeared to vary depending on the hotline.”

AICPA did observe that while Internal Revenue Service modernization efforts have allowed for consistent customer service levels compared to recent prior years, “IRS customer service has not returned to pre-COVID-19 pandemic levels according to IRS data and the AICPA’s most recent annual membership survey.”

With that, the industry organization offered recommendations in the areas of governance and oversight, taxpayer services, and dedicated practitioner services.

In the area of IRS governance and oversight, AICPA recommended the following:

• Requiring a Government Accountability Office review to determine whether a private sector board with sufficient authority to hold the IRS accountable and oversee implementation of key recommendations from advisory groups;
• Re-establish the annual joint hearing review to focus on strategic and business plans, taxpayer service and compliance, technology and modernization, and the filing season; and
• The Joint Committee on Taxation should provide a bi-annual report on the overall state of the Federal tax system.

In the area of taxpayer service, the following recommendations were offered:

• Hire more qualified and experienced professionals from the private sector, adequately train all agency employees, skillfully manage IRS resources, and ensure organizational alignment between Congress, the executive branch, and the IRS;
• Congress should determine what the appropriate level of service is and then ensure that the appropriate resources are allocated to achieve that level;
• Continue to improve the technology infrastructure modernization; and
• Effectively utilize customer satisfaction surveys to assess IRS performance, improve the taxpayer experience, and effectuate modernization efforts or process improvement.

AICPA pushed for the passage of the Taxpayer Assistance and Services Act, which it states “would significantly improve IRS services, reinforce fairness and transparency in our tax system, and reduce tax administrative burdens on taxpayers and practitioners, including many critical tax provisions for which AICPA has previously advocated.”

In the area of dedicated practitioner services, AICPA recommended:

• Create consolidated dedicated “executive-level” practitioner services comparable to private sector services that are implemented and adapted based on practitioner feedback solicited periodically; and
• Continue to expand the functionality of a robust and enhanced tax professional account as part of the IRS’s online portal with account access to all of a practitioner’s client information, allowing for IRS to communicate directly with authorized practitioners, enable a centralized login system, and prioritize the protection and privacy of user identities and data;
• Provide practitioners with a robust practitioner priority hotline with high-skilled employees capable of resolving complex technical and procedural issues; and
• Assign customer service representatives to each geographic area to address unusual or complex issues that practitioners were unable to resolve through the priority hotlines.

The letter to the Senate Finance Committee leadership and other AICPA 2026 tax policy and advocacy comment letter can be found here.

Employees who qualify for the Earned Income Tax Credit (EITC) can elect to receive the credit in advance payments from their employer along with their regular pay during the year. Advance earned income tax credit (AETIC) payments result in the employee's receipt of larger paychecks throughout the year, but still provide for a tax refund after the employee files his or her Federal income tax return. However, the IRS reports that few eligible workers know about, or take advantage of, of the EITC and the AEITC. Employers should understand their processing and reporting obligations as they relate to the payment of an AEITC to an employee. Letting your employees know about the AEITC can provide them with what they will consider a valuable benefit at no tax cost and very little administrative expense to your business.

How the AEITC works

The AEITC permits taxpayers who are eligible for the EITC, and who have at least one "qualifying child" to receive portions of their EITC in installments throughout the year, as opposed to receiving a lump sum payment the following filing season. To receive AEITC payments, employees must complete and give to the employer Form W-5, Earned Income Credit Advance Payment Certificate. Employees can use either the paper form or an approved electronic format. This form is given to the employer and then processed through payroll.

The Form W-5 expires every December 31. Therefore, an eligible employee must file a new Form W-5 with the employer for each calendar year that the employee is eligible to receive the advance credit. Moreover, an employee may have only one Form W-5 in effect with a current employer at one time. If, however, an employee is married and his or her spouse works as well, each spouse should file individual Forms W-5.

Employer obligations to pay the AEITC

AEITC payments are not subject to withholding of income, social security or Medicare taxes.  Thus, an AEITC payment will not change the amount of income, social security or Medicare taxes that an employer withholds from their employees' wages. Therefore, the additional amounts will not alter the employee's Medicare or FICA amounts.

To calculate AETIC payments, an employer first computes the amount of the EITC and then adds the EITC payment to the employee's net pay for the pay period, after deductions. At the end of the year, the employer shows the total advance EITC payments made to the employee on Form W-2, box 9. The amount of AEITC payments does not need to be included as wages in box 1 of Form W-2.

Employer returns

Since AEITC payments are not taxable, the amounts do not add to employers' payroll taxes. Generally, employers make AEITC payments from withheld income tax and employee and employer social security and Medicare taxes, which must normally be paid to the IRS through federal tax deposits or with employment tax returns. Thus, the employer normally will subtract the advance payments from taxes that are typically deposited with the IRS. AEITC payments are treated as deposits of these taxes made on the day that the employer pays wages to his or her employees, for deposit due date purposes.

Employers can also deduct the EIC amount(s) paid to employees on Form 941, Employer's Federal Quarterly Tax Return. An employer would write the total amount of AEITC payments made to employees on line 9 of Form 941 (or line 8 of Form 944, Employer's Annual Federal Tax Return). This amount would then be subtracted from the employer's total taxes on line 8 of Form 941 (or line 7 of Form 944).

The American Recovery and Reinvestment Tax Act of 2009 (2009 Recovery Act) temporarily increases the AEITC amounts for 2009 and 2010. Previously, the credit percentage for the EITC for taxpayers with two or more qualifying children was 40 percent of the first $12,570 of earned income. The 2009 Recovery Act increases the percentage to 45 percent of the first $12,570 of earned income for taxpayers with three or more qualifying children. The EITC phaseout range has also been adjusted upward by $1,880 for joint filers for the same time period.

If, in any payroll period, the total amount of AEITC payments made to employees are more than the total amount of payroll taxes (including withheld income tax and both employee and employer shares of social security and Medicare taxes), employers may either:

1. Reduce each employee's AEITC payment proportionally so that the total AEITC payments equal the amount of taxes owed; or

2. Make full payment of the AEITC and treat the excess amount as an advance payment of employment taxes.

Employer's payment responsibilities

Employers are required to make AEITC payments to employees who give them a completed and signed Form W-5. Thus, employers should keep current W-5s on file for all employees who claim the EITC. However, an employer is not required to determine if an employee's Form W-5 is correct, but should contact the IRS if he or she has reason to believe that the form contains inaccurate information or an incorrect statement. The IRS allows employers to establish a system to electronically receive Forms W-5 from their employees. The IRS provides information on the electronic requirements for Form W-5 in Announcement 99-3, which can be accessed on www.irs.gov.

If you would like further information on your advance Earned Income Tax Credit reporting and processing responsibilities, or other employer reporting duties, please do not hesitate to contact our office today.

If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

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If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

Regardless of the type of record keeper you consider yourself to be, there are numerous ways to simplify the burden of logging your automobile expenses for tax purposes. This article explains the types of expenses you need to track and the methods you can use to properly and accurately track your car expenses, thereby maximizing your deduction and saving taxes.

Expense methods

The two general methods allowed by the IRS to calculate expenses associated with the business use of a car include the standard mileage rate method or the actual expense method. The standard mileage rate for 2017 is 53.5 cents per mile. In addition, you can deduct parking expenses and tolls paid for business. Personal property taxes are also deductible, either as a personal or a business expense. While you are not required to substantiate expense amounts under the standard mileage rate method, you must still substantiate the amount, time, place and business purpose of the travel.

The actual expense method requires the tracking of all your vehicle-related expenses. Actual car expenses that may be deducted under this method include: oil, gas, depreciation, principal lease payments (but not interest), tolls, parking fees, garage rent, registration fees, licenses, insurance, maintenance and repairs, supplies and equipment, and tires. These are the operating costs that the IRS permits you to write-off. For newly-purchased vehicles in years in which bonus depreciation is available, opting for the actual expense method may make particularly good sense since the standard mileage rate only builds in a modest amount of depreciation each year. For example, for 2017, when 50 percent bonus depreciation is allowed, maximum first year depreciation is capped at $11,160 (as compared to $3,160 for vehicles that do not qualify). In general, the actual expense method usually results in a greater deduction amount than the standard mileage rate. However, this must be balanced against the increased substantiation burden associated with tracking actual expenses. If you qualify for both methods, estimate your deductions under each to determine which method provides you with a larger deduction.

Substantiation requirements

Taxpayers who deduct automobile expenses associated with the business use of their car should keep an account book, diary, statement of expenses, or similar record. This is not only recommended by the IRS, but essential to accurate expense tracking. Moreover, if you use your car for both business and personal errands, allocations must be made between the personal and business use of the automobile. In general, adequate substantiation for deduction purposes requires that you record the following:

• The amount of the expense;
• The amount of use (i.e. the number of miles driven for business purposes);
• The date of the expenditure or use; and
• The business purpose of the expenditure or use.

Suggested recordkeeping: Actual expense method

An expense log is a necessity for taxpayers who choose to use the actual expense method for deducting their car expenses. First and foremost, always keep your receipts, copies of cancelled checks and bills paid. Maintaining receipts, bills paid and copies of cancelled checks is imperative (even receipts from toll booths). These receipts and documents show the date and amount of the purchase and can support your expenditures if the IRS comes knocking. Moreover, if you fail to log these expenses on the day you incurred them, you can look back at the receipt for all the essentials (i.e. time, date, and amount of the expense).

Types of Logs. Where you decide to record your expenses depends in large part on your personal preferences. While an expense log is a necessity, there are a variety of options available to track your car expenditures - from a simple notebook, expense log or diary for those less technologically inclined (and which can be easily stored in your glove compartment) - to the use of a smartphone or computer. Apps specifically designed to help track your car expenses can be easily downloaded onto your iPhone or Android device.

Timeliness. Although maintaining a daily log of your expenses is ideal - since it cuts down on the time you may later have to spend sorting through your receipts and organizing your expenses - this may not always be the case for many taxpayers. According to the IRS, however, you do not need to record your expenses on the very day they are incurred. If you maintain a log on a weekly basis and it accounts for your use of the automobile and expenses during the week, the log is considered a timely-kept record. Moreover, the IRS also allows taxpayers to maintain records of expenses for only a portion of the tax year, and then use those records to substantiate expenses for the entire year if he or she can show that the records are representative of the entire year. This is referred to as the sampling method of substantiation. For example, if you keep a record of your expenses over a 90-day period, this is considered an adequate representation of the entire year.

Suggested Recordkeeping: Standard mileage rate method

If you loathe recordkeeping and cannot see yourself adequately maintaining records and tracking your expenses (even on a weekly basis), strongly consider using the standard mileage rate method. However, taking the standard mileage rate does not mean that you are given a pass by the IRS to maintaining any sort of records. To claim the standard mileage rate, appropriate records would include a daily log showing miles traveled, destination and business purpose. If you incur mileage on one day that includes both personal and business, allocate the miles between the two uses. A mileage record log, whether recorded in a notebook, log or handheld device, is a necessity if you choose to use the standard mileage rate.

If you have any questions about how to properly track your automobile expenses for tax purposes, please call our office. We would be happy to explain your responsibilities and the tax consequences and benefits of adequately logging your car expenses.

Long-term care premiums are deductible up to certain amounts as itemized medical expense deductions. The amount is based upon your age. Unfortunately, most taxpayers do not have enough other medical expense deductions to exceed the non-deductible portion equal to the first 7 1/2 percent of adjusted gross income (10 percent if you are subject to alternative minimum tax (AMT)). Furthermore, more taxpayers now take the standard deduction rather than itemize, making even those medical expenses useless as a tax deduction.

A tax bill has been before Congress for several years now to allow long-term care premiums to be deductible "above the line," that is, by anyone irrespective of whether you itemize. The impetus behind this recommendation is that encouraging individuals to fund their own eventual eldercare is preferable to having federal Medicare payments to so. So far, however, Congress has not brought the matter to a vote. Some state income tax laws already allow such an above-the-line deduction.

Long-term care premiums. Long-term care insurance premiums are deductible in figuring itemized medical expense deductions up to the following amounts:

- Age 40 or younger: $290 in 2007; $310 in 2008;

- Over 40 but not older than 50: $550 in 2007; $580 in 2008;

- Over 50 but not older than 60: $1,110 in 2007; $1,150 in 2008;

- Over 60 but not older than 70: $2,950 in 2007; $3,080 in 2008; and

- Over 70: $3,680 in 2007; $3,850 in 2008.

Under the so-called "kiddie tax," a minor under the age of 19 (or a student under the age of 24) who has certain unearned income exceeding a threshold amount will have the excess taxed at his or her parents' highest marginal tax rate. The "kiddie tax" is intended to prevent parents from sheltering income through their children.

A child with earned income (wages and other compensation) in excess of the filing threshold is a separate taxpayer who is generally taxed as a single taxpayer. If a child in one of the following categories has unearned income (i.e., investment income) in excess of the "threshold amount" ($950 in 2009) that unearned income is taxed at the parent's marginal tax rate, as if the parent received that additional income.

• A child under the age of 19;
• A child up to age 18 who provides less than half of his or her support with earned income; or
• A19 to 23 year-old student who provides less than half of his or her support with earned income.

If the child's unearned income is less than an inflation-adjusted ceiling amount ($9,500 in 2009), the parent may be able to include the income on the parent's return rather than file a separate return for the child (and which the tax based on the parent's marginal rate bracket is computed on Form 8615).

Any distribution to a child who is a beneficiary of a qualified disability trust is treated as the child's earned income for the tax year the distribution was received.

Example:  Greta is a 16-year-old whose father is alive. In 2009, she has $3,000 in unearned income, no earned income, and no itemized deductions. Her basic standard deduction is $950, which is applied against her unearned income, reducing it to $2,050. The next $950 of unearned income is taxed at Greta's individual tax rate. The remaining $1,100 of her unearned income is taxed at her parent's allocable tax rate. Assuming her father's tax rate bracket is 25 percent, her tax on the $1,100 is $275.

A taxpayer's expenses incurred due to travel outside of the United States for business activities are deductible, but under a stricter set of rules than domestic travel. Foreign travel expenses may be subject to special allocation rules if a taxpayer engages in personal activities while traveling on business. Expenses subject to allocation include travel fares, meals, lodging, and other expenses incident to travel.  

Allocation expenses

Frequently, international business trips have a personal aspect. A taxpayer who travels outside of the United States for both business and pleasure may deduct no part of his or her travel expenses (airfare, cabs, hotel, meals, etc.) if the trip is not primarily related to business. However, business expenses incurred while at the destination are deductible even though the travel expenses are not.

If the trip is primarily related to business, then that portion of travel properly allocated to the business portion may be deducted. Proper allocation is based on the amount of time spent on each activity. "Primary purpose" is a purpose of more than 50 percent. Foreign travel for purposes of allocation is travel outside the 50 states and the District of Columbia.

The general "primary purpose" rule on foreign business travel, fortunately, has two huge exceptions, one for anyone who travels a week or less and the other for most employees on business trips under an expenses allowance arrangement.

The allocation rules do not apply to taxpayers:

• who do not have substantial control over the business trip;
• whose travel outside the United States is a week or less in duration; 
• who establish that a personal vacation was not a major factor in deciding to take the trip; and
• whose personal activities conducted during the trip are less than 25 percent of the total travel time.

Taxpayers who travel under reimbursement or other expense allowance arrangements are not considered to have substantial control over the business trip unless they are the managing executive of the employer or a party related to, or more than 10 percent owner of the employer.

Conventions

Business conventions come under a separate rule. A taxpayer cannot deduct travel expenses for attending a convention, seminar or similar business meeting held outside the "North American area" unless specific criteria are satisfied. The "North American area" includes not only the US, Canada, and Mexico but also Costa Rica, Honduras and many islands in the Atlantic, Caribbean, and the Pacific.

If you are unsure of how to allocate your business travel expenses and need additional information, please give our office a call. We would be glad to help.

With the subprime mortgage mess wreaking havoc across the country, many homeowners who over-extended themselves with creative financing arrangements and exotic loan terms are now faced with some grim tax realities. Not only are they confronted with the overwhelming possibility of losing their homes either voluntarily through selling at a loss or involuntarily through foreclosure, but they must accept certain tax consequences for which they are totally unprepared.

Many homeowners - whether in connection with their principal residence or a vacation property - may not anticipate that foreclosure and a home sale that produces a loss can trigger significant and unexpected income tax liabilities, especially when the sale does not produce enough gain to pay off outstanding mortgage debt.

Selling at a loss

Homeowners may be unpleasantly surprised to learn that they can not write-off losses incurred from the sale of their home. When a homeowner is forced to sell their personal residence for less than the price they paid, the loss incurred on the sale is considered to be a non-deductible personal expense for federal income tax purposes. What's more, if the homeowner eventually buys another home that is sold down the road at a taxable profit, previous losses cannot be used to offset that gain.

Faced with such a situation, the technique of renting out the home, rather than selling it, might help some homeowner buy time until better times. If renting eventually stops making financial sense, the homeowner who sells at a loss might then succeed in establishing a deductible business loss from the business of renting property. However, only losses incurred after the property is converted may be deducted.

Debt forgiveness

Homeowners who sell their property when their mortgage debt exceeds the net sale price of the home (a so-called "short sale") may find that they owe taxes to the IRS. For example, assume you paid $500,000 for a home that you sell for a net sale price of $400,000, but you have a mortgage of $550,000 on the property. For tax purposes, you have incurred a $100,000 loss on the sale because the sale price is lower than your tax basis in the property ($400,000 sale price - $500,000 basis = $100,000 loss). Moreover, you still owe $150,000 to your mortgage lender since a mortgage note is a personal liability in addition to being an encumbrance on the house itself. If the lender refuses to discharge the remaining debt, you'll have to pay off the loan and there is no tax break or write-off for doing so.

On the other hand, if the mortgage lender forgives part or all of the remaining $150,000 debt, the amount discharged is considered taxable income. With few exceptions, discharged debt of all types is treated as income, taxable at ordinary rates just like a salary. It is irrelevant to the IRS that no tangible income was actually received on the sale of the home or forgiveness of debt by the lender. You will owe taxes on the amount of mortgage debt that the lender discharges. What's more, there is no offset from your $100,000 loss on the sale of the property; nor is this income covered by the $250,000 exclusion on taxable gain on the sale of a principal residence ($500,000 for joint filers).

A lender who discharges any part or all of a homeowner's debt must report the forgiven debt on Form 1099-C (Cancellation of Debt) to you and to the IRS. You must report the amount of discharged debt as income on your tax return in the year the mortgage debt is forgiven.

Foreclosure

Foreclosure also produces tax consequences that may be wholly unanticipated by the homeowner. Taxable gains and income from mortgage debt forgiveness also occur in foreclosure. Tax liability upon foreclosure depends on whether you have a nonrecourse or recourse loan. A recourse loan permits the lender to sue the borrower for any outstanding debt. When a foreclosure occurs on the property of a homeowner with a nonrecourse loan, however, the lender is only entitled to collect the amount that the home is sold for, and the borrower has no further liability.

Example. Your tax basis in your home is $400,000. You have a recourse loan and your mortgage debt totals $350,000. But at the time of foreclosure the fair market value of your home has decreased to $325,000. However, the lender forgives the remaining unpaid mortgage debt of $25,000 (usually because the lender sees that the former homeowner has little assets left, the remaining debt would be hard to collect, and an immediate write off gives the lender an immediate tax deduction). Tax law treats you as having received ordinary income from the cancellation of the debt in the amount of $25,000.

Alternatively, if you had a nonrecourse loan in the amount of $350,000 and your home sold at auction for $325,000, you would have no further liability to the lender since it cannot pursue you for the lost $25,000. Therefore, since your mortgage lender cannot legally pursue you for the remaining $25,000, there will be no debt for them to discharge. Such nonrecourse loans, however, are very rare in personal, non-business settings.

Moreover, if property is foreclosed and sold at auction for more than the home's tax basis, the sale produces taxable gain. In this case, however, the gain from a foreclosure sale of an individual's principal residence may be excluded to the extent of up to $250,000 ($500,000 for married homeowners filing jointly), depending on the length of homeownership. No exclusion, however, is given on vacation property that is not a principal residence.

Future relief for homeowners?

In mid-April, Reps. Robert E. Andrews (D-New Jersey) and Ron Lewis (R-Kentucky), introduced the Mortgage Cancellation Relief Act of 2007 (H.R. 1876), a bill that would assist many homeowners affected by the loss of their home through foreclosure or short sale. The legislation would exempt discharged debt on primary home mortgages from treatment as income subject to income taxation. Currently, the bill is before the House Ways and Means Committee.

If you would like more information on the tax consequences of foreclosure or the potential implications of taking a loss on the sale of your home or vacation property, please call our office and we can discuss your options for minimizing your tax liabilities.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

Reasonable compensation is generally defined as the amount that would ordinarily be paid for like services by like enterprises under like circumstances. This broad definition is supplemented, for purposes of determining whether compensation is deductible as an ordinary and necessary expense, by a number of more specific factors expressed in varying forms by the IRS, the Tax Court and the Circuit Courts of Appeal, and generally relating to the type and extent of services provided, the financial concerns of the company, and the nature of the relationship between the employee and the employer.

Why IRS Is Interested

A chief concern behind the IRS's keen interest in what a company calls "compensation" is the possibility that what is being labeled compensation is in fact a constructive dividend. If employees with ownership interests are being paid excessive amounts by the company, the IRS may challenge compensation deductions on the grounds that what is being called deductible compensation is, in fact, a nondeductible dividend.

Another area of concern for the IRS is the payment of personal expenses of an employee that are disguised as businesses expenses. There, the business is trying to obtain a business expense deduction without the offsetting tax paid by the employee in recognizing income. In such cases, a business and its owners can end up with a triple loss after an IRS audit: taxable income to the individual, no deduction to the business and a tax penalty due from both parties.

Factors Examined

The factors most often examined by the IRS in deciding whether payments are reasonable compensation for services or are, instead, disguised dividend payments, include:

1. The salary history of the individual employee
2. Compensation paid by comparable employers to comparable employees
3. The salary history of other employees of the company
4. Special employee expertise or efforts
5. Year-end payments
6. Independent inactive investor analysis
7. Deferred compensation plan contributions
8. Independence of the board of directors
9. Viewpoint of a hypothetical investor contemplating purchase of the company as to whether such potential investor would be willing to pay the compensation.

Failure to pass the reasonable compensation test will result in the company's loss of all or part of its deduction. Analysis and examination of a company's compensation deductions in light of the relevant listed factors can provide the company with the assurance that the compensation it pays will be treated as reasonable -- and may in the process prevent the loss of its deductions.

Note: In the case of publicly held corporations, a separate $1 million dollar per person cap is also placed on deductible compensation paid to the CEO and each of the four other highest-paid officers identified for SEC purposes. (Certain types of compensation, including performance-based compensation approved by outside directors, are not included in the $1 million limitation.)

The S Corp Enigma

The opposite side of the reasonable compensation coin is present in the case of some S corporations. By characterizing compensation payments as dividends, the owners of these corporations seek to reduce employment taxes due on amounts paid to them by their companies. In these cases, the IRS attempts to recharacterize dividends as salary if the amounts were, in fact, paid to the shareholders for services rendered to the corporation.

Caution. In the course of performing the compensation-dividend analysis, watch out for contingent compensation arrangements and for compensation that is proportional to stock ownership. While not always indicators that payments are distributions of dividends instead of compensation for services, their presence does suggest the possibility. Compensation plans should not be keyed to ownership interests. Contingent and incentive arrangements are also scrutinized by the IRS. The courts have frequently ruled that a shareholder has a built-in interest in seeing that the company is successful and rewarding him for increasing the value of his own property is inappropriate. Similar to the reasonable compensation test, however, this rule is not hard and fast. Accordingly, the rules followed in each jurisdiction will control there.

Conclusions

Determining whether a shareholder-employee's compensation is reasonable depends upon many variables, such as the contributions that employee makes to your business, the compensation levels within your industry, and whether an independent investor in your company would accept the employee's compensation as reasonable.

Please call our office for a more customized analysis of how your particular compensation package fits into the various rules and guidelines. Further examination of your practices not only may help your business better sustain its compensation deductions; it may also help you take advantage of other compensation arrangements and opportunities.

A major repair to a business vehicle is usually deductible in the year of the repair as a "maintenance and repair" cost if your business uses the actual expense method of deducting vehicle expenses. If your business vehicle is written off under the standard mileage rate method, your repair and maintenance costs are assumed to be built into that standard rate and no further deduction is allowed.

Standard mileage rate

The standard mileage rate for business use of a vehicle is 48.5 cents per mile for 2007. The standard mileage rate replaces all actual expenses in determining the deductible operating business costs of a car, vans and/or trucks. If you want to use the standard mileage rate, you must use it in the first year that the vehicle is available for use in your business. If you use the standard mileage rate for the first year, you cannot deduct your repairs for that year. Then in the following years you can use the standard mileage rate or the actual expense method.

Actual cost

You can deduct the actual vehicle expenses for business purposes instead of using the standard mileage rate method. In order to use the actual expenses method, you must determine what it actually cost for the repairs attributable to the business. If you have fully depreciated your vehicle you can still claim your repair expenses.

Exceptions

Of course, the tax law is filled with exceptions and that includes issues relating to the deductibility of vehicle repairs and maintenance. Some ancillary points to consider:

• If you receive insurance or warranty reimbursement for a repair, you cannot "double dip" and also take a deduction;
• If you are rebuilding a vehicle virtually from the ground up, you may be considered to be adding to its capital value in a manner in which you might be required to deduct costs gradually as depreciation;
• If you use your car for both business and personal reasons, you must divide your expenses based upon the miles driven for each purpose.

You may want to calculate your deduction for both methods to determine which one will grant you the larger deduction. If you need assistance with this matter, please feel free to give our office a call and we will be glad to help.

Businesses benefit from many tax breaks. If you are in business with the objective of making a profit, you can generally claim all your business deductions. If your deductions exceed your income for the year, you can claim a loss for the year, up to the amount of your income from other activities. Remaining losses can be carried over into other years.

These are very generous tax breaks and sometimes people establish a business to generate losses. They have no intention of ever earning a profit. Other times, they genuinely hope to earn a profit but never do.

The IRS calls these activities "hobbies."  Expenses from these activities are never deductible in excess of any income that is declared earned from them. Recently, the IRS issued a new warning in the form of a Fact Sheet (FS-2007-18) to educate taxpayers about the differences between a for-profit business and a hobby.

No bright line

There's no bright line to distinguish a genuine business with a profit motive from a hobby. Over the years, the IRS and the courts have developed a list of factors to determine if an activity has a profit motive or is a hobby. No one factor is greater than the others and the list is not exhaustive. That means that the IRS and the courts have great leeway in their analyses.

Let's take a quick look at the factors:

How the business is run? Is the activity carried on in a businesslike manner?  Do you keep complete and accurate business records and books?  Have you changed business operations to increase profits?

Expertise. Do you have the necessary expertise to run the business? If you don't, do you seek help from experts?

Time and effort. Do you spend the time and effort necessary for the business to succeed?  

Appreciation.  Will business assets appreciate in value over time?  A profit motive can exist if gain from the eventual sale of assets, plus any other income, will result in an overall profit even if there's no profit from current operations.

Success with other activities. Have you engaged in similar activities in the past?

History of income or loss. This factor looks to when the losses occurred. Were they in the start-up phase? Maybe they were due to unforeseen circumstances. Losses over a very long period of time could, but not always, indicate a hobby.

Amounts of occasional profits. Are your occasional profits significant when compared to the size of your investment and prior losses?

Financial status of owner. Is the activity your only source of income?

Personal pleasure or recreation. Is your business of a type that is not usually considered to have elements of personal pleasure or recreation?

Your financial status

If the activity is your only source of income, you would think that the IRS would automatically treat it as a for-profit business. That's not true. Every case is different and the IRS and the courts look at all the circumstances.

A few years ago, there was a case in the U.S. Tax Court involving a married couple. The husband owned a house framing business. His income was about $33,000 a year. The wife worked as a secretary in an accounting department of a big corporation. Her income was about $28,000 a year.

Together, they also operated a horse breeding and racing activity. They had no experience in breeding or racing horses. They didn't have the best of luck either. Several of their horses suffered injuries and they were involved in a legal dispute over the ownership of one. They did seek help from experts and also kept good financial records.

The Tax Court looked at all the nine factors. It recognized that the couple had a very modest income from their employment and this factor weighed in their favor. However, some of the other factors went against them, especially the fact that they never made a profit after 16 years and lost nearly $500,000.  The court knew that the couple "hoped" to make a profit but hope wasn't enough and the court found their business was not engaged in for a profit.

Presumption

Generally, the IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five years, including the current year. If it appears that the business will not be profitable for some years, you won't be able to come within the presumption of profit motive. You'll have to rely on qualifying under the nine factors.

The IRS has a form on which you can officially elect to have the agency wait until the first five years are up before examining the profitability of your business.  While it's generally not necessary to file the form in order to take advantage of the presumption, it's usually a good idea.

Types of businesses

Although the IRS is not limited in the kind of businesses that it can challenge as being hobbies, businesses that look like traditional hobbies generally face a greater chance of IRS scrutiny than other types of businesses. These include horse breeding and racing, "gentlemen farming" and craft businesses operated from the home. There are many court cases about these activities and usually the taxpayers lose.

This is a very complicated area of the tax law and many people, like the secretary and her husband, honestly believe they are operating a for-profit business. But as we've seen, the IRS and the courts can, and often do, determine otherwise.

Don't hesitate to contact us if you have any questions about the differences between a business and a hobby ...and how you can set up your operations to have a better chance of falling on the right side of any argument with the IRS.

If someone told you that you could exchange an apartment house for a store building without recognizing a taxable gain or loss, you might not believe him or her. You might already know about a very valuable business planning and tax tool: a like-kind exchange. In some cases, if you trade business property for other business property of the same asset class, you do not need to recognize a taxable gain or loss.

Not a sale

An exchange is a transfer that is not a sale. Essentially, it is a trade of like property.

In an exchange, property is relinquished and property is received. If the transaction includes money or property that is not of a like kind (referred to as "boot"), the transaction does not automatically become a sale. Any gain realized in the transaction, however, is recognized in that tax year to the extent of boot received.

In a like-kind exchange, the basis in the property received is the same as the basis in the property relinquished, with some adjustments. Any unrecognized gain or loss on the relinquished property is carried over to the replacement property. At a future time, the gain or loss will be recognized. If there is boot in the exchange and the gain is recognized, basis is increased by the amount of recognized gain.

The like-kind rules also require that property must be business or investment property. The taxpayer must hold both the property traded and the property received for productive use in its trade or business or for investment. Additionally, most stocks, bonds and other securities are not eligible.

Example

Jesse owns an office supply company and wants to expand his business. Carmen owns a restaurant and also wants to expand her business. Both individuals own parcels of land for investment that would benefit their respective expansion plans. The adjusted basis of both properties is $250,000. The fair market value of both properties is $400,000. Jesse and Carmen engage in a like-kind exchange. Neither Jesse nor Carmen would report any gain or loss.

More than two properties

Like-kind exchanges can involve more than two properties. While the rules are complicated, the basic approach is to combine properties into groups consisting of the same kind or class. If you are interested in a like-kind exchange involving more than two properties, we can help you.

Timing

The exchange does not have to take place at a given moment. If property is relinquished, the replacement property can be identified and received anytime within a specific period. Replacement property must be identified within 45 days after property is relinquished. The replacement property has to be received within 180 days after the transfer but sooner if the tax return is due before the 180 days are over (although the due date takes into account any extension that is permitted).

Reporting

A like-kind exchange must be reported to the IRS. The report must be made even if no gain is recognized in the transaction.  Again, our office can help you make sure that everything that needs to be reported to the IRS is reported.