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By Editor, July 7, 2011

The recent storms have made the tax treatment of losses, and recoveries related to such events an important topic.  Special tax treatment is provided for Federally Declared Disaster Areas, including an option to claim the loss deduction on the 2010 (prior year) tax return and exclusion from taxation of Qualified Disaster Relief Payments.

The following counties in Alabama have been determined to be Federally Declared Disaster Areas as a result of the recent storms:

Autauga, Bibb, Blount, Calhoun, Chambers, Cherokee, Chilton, Choctaw, Clarke, Colbert, Coosa, Cullman DeKalb, Elmore, Escambia, Etowah, Fayette, Franklin, Greene, Hale, Jackson, Jefferson, Lamar Lauderdale, Lawrence, Limestone, Madison, Marengo, Marion, Marshall, Monroe,  Morgan, Perry, Pickens, Shelby, St. Clair, Sumter, Talladega, Tallapoosa, Tuscaloosa, Walker, Washington, and Winston.

The IRS provides the following information regarding casualty losses:

Casualty Losses – Definition

A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.

• A sudden event is one that is swift, not gradual or progressive.
• An unexpected event is one that is ordinarily unanticipated and unintended.
• An unusual event is one that is not a day-to-day occurrence and that is not typical of the activity in which you were engaged.

Casualty Losses – Disaster Loss

A disaster loss is a casualty loss that occurred in an area determined by the President of the United States to warrant federal disaster assistance. These places are known as “Federally Declared Disaster Areas”.

Casualty Losses – Loss Proof

The following is information needed to support a casualty loss claim:

• The type of casualty (car accident, fire, storm, etc.) and when it occurred.
• That the loss was a direct result of the casualty.
• That you were the owner of the property, or if a lessee, that you were contractually liable for the damage.
• Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
• Documentary evidence to support the claimed allowable loss.

Casualty Losses – To Prove a Loss

Records may have to be reconstructed. The information gathered will be used for tax purposes, as well as insurance reimbursement.

Casualty Losses – Claiming Disaster Losses on a Return

• Affected taxpayers in a Federal Disaster Area have the option of claiming disaster-related casualty losses on their federal income tax return either in the tax year the casualty occurred or the immediate preceding tax year.
• Depending on when the disaster occurred, claiming the loss on an original or amended return for last year may get the taxpayer an earlier refund. But, waiting to claim the loss on this year’s return could result in a greater tax saving, depending on other income factors.

Casualty Losses – Pub 547 and Pub 584

• Individuals may deduct personal property losses that are not covered by insurance or other reimbursements, but they must first subtract $100 for each casualty event and then subtract ten percent of their adjusted gross income from their total casualty losses for the year.
• Details on figuring a casualty loss deduction can be found in IRS Publication 547, Casualty, Disasters and Thefts.
• Publication 584, Casualty, Disaster and Theft Loss Workbook is designed to help you figure loss on personal-use property. It contains schedules to help you compute loss on your main home, personal property and your vehicles. However, the schedules are for information purposes only. You must file Form 4684 to report your loss on Form 1040.

Casualty Losses – Determination

To determine the amount of casualty loss to claim for damaged or destroyed property, you must:

• Determine the adjusted basis of the property before the disaster.
• Determine the decrease in Fair Market Value (FMV) of the property as a result of the disaster.
• Then, from the smaller of the adjusted basis or the FMV,
• Subtract any insurance or other reimbursement received.
• All individual losses are subject to:
  • 2% AGI limit if used for business by employee.
  • $100 deductible per event.
  • 10% AGI limit per annum.

Casualty Losses – Federally Declared Disaster Areas

In any federally-declared disaster area:

• No gain is recognized on any insurance proceeds received for “unscheduled” personal property that was part of the contents of a main home.
• Payments for the home and any scheduled property are treated as one payment. Any of this money used to replace any type of replacement property is not a recognized gain.
• Disaster relief payments or assistance do not reduce the casualty loss unless they replace lost or destroyed property.
• Disaster unemployment payments are unemployment income and are taxable.
• Post-disaster grants are generally not included in income. See IRC 139.  However, do not include as casualty losses any amounts covered by the grant payments.
• Taxpayers have the option to claim disaster-related casualty losses for either the year of occurrence or the prior year.  However, the State of Alabama allows a claim for the loss only in the year the loss occurs.
• Taxpayers should put the assigned Disaster Designation in red ink at the top of their tax forms. [For example, “Alabama/ Severe Storms, Tornadoes, Straight-line Winds and Flooding.” ]
• Taxpayers should include in income:
  • Temporary living payments from insurance that are in excess of the actual increase in temporary expenses.
  • The excess goes on line 21 of Form 1040.

Gains on Casualty Losses

If you receive an insurance payment or other reimbursement in excess of the adjusted basis of damaged or destroyed property you will have a gain:

• The gain is the amount received minus the adjusted basis in the property.
• If your main home is destroyed and the insurance proceeds result in a gain:
• You can treat this as a sale of residence subject to the same rules.
• If the home was not used or owned for 2 of the last five years a reduced maximum gain exclusion will apply.
• If located in a Federally Declared Disaster Area, you can postpone any “recognized” gain on your main home if you buy a new home within 4 years of the end of the year the disaster occurred, or
• You can recognize the gain and report it.
• You do not have to recognize gain on destroyed/damaged business property if it is replaced within two years of the end of the tax year in which the gain is realized.
• If received payment in 2011 resulting in a gain, you must replace the property prior to 1/1/2014 to defer the gain. 
• You cannot postpone the gain if you buy replacement property from a related party. This applies to:
  • C Corps
  • Partnerships in which more than 50% of the capital or profits is owned by a C Corp
  • All others if the total realized gain for the year is over $100,000.
• To defer the gain:
  • You must buy property specifically to replace the damaged or destroyed property in order to defer the gain.
  • The basis of the replacement property will be the adjusted basis of the property being replaced.

Reporting Casualty Gains/Losses

Report loss on return for year it occurred. If the event took place in a federally declared disaster, you can amend the prior year return.

The election to amend must be made by:

• Due date (without extensions) for filling your income tax return for the tax year in which the disaster actually occurred.
• Due date (with extensions) for filing the return for the preceding tax year.
• Once the election is made, it can be revoked within 90 days of making the election. The taxpayer must:
  • Return any refund or credit received from making the choice.
  • If revoked prior to getting a refund, must return refund within 30 days of receiving it for the revocation to be effective. 

Individual Returns:

• Losses go on Form 4684 and carry to Schedule A.
• Gains go on Form 4684 and carry to Schedule D.
• Includes losses on income-producing property and property used in performing services as an employee (held less than one year).
• Have the option to claim disaster-related casualty losses for either the year of occurrence or the prior year.

Business and income producing property:

• Losses are reported on Form 4684 and carry to various forms.
• Business use of home carries to Form 8829
• .Other business property carries to Form 4797.

Rental Properties:

• Report on Form 4684 and then on Form 4797.
• Have 2 years from the close of tax year when you realize the gain to replace the property and defer the gain.
• Losses are not limited by Form 8582.

Insurance Reimbursement after filing:

• If less than expected (and accounted for on casualty loss) include the difference as a loss on the return for the year when you can reasonably say you’re not getting any more money.
• If greater than expected (and accounted for on casualty loss) include the difference as income in the year received.

Reporting Casualty Gains/Losses –Net Operating Losses

• Individual or Business casualty losses can generate Net Operating Losses (NOL).
• NOLs generated by casualty losses can be carried back or forward the same as any other NOL.

Reporting Casualty Gains/Losses -What’s Not Included

Losses do not include:

• A reduction in profits or
• Loss of income.

The recent storms have been traumatic for many.  There is some tax relief to assist with recovery from these disasters.  Please contact us and we will help you take full advantage of the available tax relief.

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By Editor, May 4, 2011

IRA owners and beneficiaries who have reached age 70 1/2 are permitted to make cash donations to IRS-approved public charities directly out of their IRAs. These so-called qualified charitable distributions, or QCDs, are federal-income-tax-free to you, but you get no itemized charitable write-off on Form 1040. That’s OK because the tax-free treatment of QCDs equates to an immediate 100% deduction without having to worry about restrictions that can delay itemized charitable write-offs. QCDs have other tax advantages too. Here is what you need to know.

QCD Basics

A QCD is a cash payment of an otherwise taxable distribution, by your IRA trustee, directly to a qualified public charity. The funds must be transferred directly from your IRA trustee to the charity. You cannot receive the funds yourself and then make the contribution to the charity. However, the IRA trustee can give you a check made out to the charity that you then deliver to the charity.

You cannot arrange for more than $100,000 of QCDs in any one year. If your spouse has IRAs, he or she has a separate $100,000 limitation. If you are the beneficiary of an IRA (as opposed to an account owner), you too are eligible for the QCD deal if you are at least age 70 1/2.

You must get and keep substantiation of the contribution from the charity. Also, you must not have received any benefit in return for making the contribution.

The QCD privilege is scheduled to expire at the end of this year, so if you want to take advantage of the idea, it is not too soon to start thinking about it.

Income Tax Benefits

QCDs are not included in your Adjusted Gross Income (AGI). This lowers the odds that you’ll be affected by various unfavorable AGI-based phase-out rules. In addition, you don’t have to worry about the 50%-of-AGI limitation that can delay itemized deductions for garden-variety cash donations to public charities.

QCDs count as a payouts for purposes of the Required Minimum Distribution (RMD) rules. Therefore, you can donate all or part of your 2011 RMD amount (up to the $100,000 limit on QCDs) and thereby convert taxable RMDs into tax-free QCDs.

Does the QCD Deal Work for You?

The QCD privilege is beneficial for seniors in the following circumstances:

• You don’t itemize deductions. Under the “normal” rules, only itemizers get any income tax benefit from charitable donations. Making QCDs will save taxes whether you itemize or not because neither you nor your heirs will ever have to pay income taxes on the donated amounts.
• Your itemized charitable donations would be delayed by the 50%-of-AGI limitation. Making QCDs will avoid this unfavorable limitation.
• You want to avoid being taxed on RMDs that you are forced to take from your IRAs. The QCD strategy does the trick while also allowing you to satisfy your charitable inclinations.

Conclusion

If you’re interested in taking advantage of the tax-saving QCD strategy for 2011, you will need to arrange with your IRA trustee for money to be paid out to one or more qualifying charities by year-end.

If you have questions about QCDs or want more information, your Wilson Price accountant.

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By Editor, April 11, 2011

On April 5, the Senate, by a vote of 87 – 12, approved the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011 (the 1099 Act) retroactively repealing the expanded Form 1099 information reporting rules added by recent legislation. The bill was signed by President Obama on April 14^th.

Repeal of Expanded 1099 Reporting Rules for Businesses

Currently, businesses are required to file a Form 1099-MISC to report payments of $600 or more made to persons who provide nonemployee services to the business. Reporting is not required if the payments are made to a corporation.

Effective for payments made after 2011, the Health Care Act extended this 1099 reporting requirement to include gross payments of $600 or more for the purchase of any type of property. It also did away with the exception for corporations. So, thanks to the Health Care Act, starting in 2012, businesses were going to have to report all payments of $600 or more for the purchase of property and services, even those made to corporations.

Businesses quickly cried foul on this recordkeeping and reporting nightmare in the making—not even the IRS liked this provision. Congress and the President agreed on the need for its repeal. But in true Washington fashion, it took awhile. Finally, the 1099 Act repeals the Health Care Act’s extension of the Form 1099 reporting requirements for payments made to corporations and payments made for the purchase of property.

Bottom Line: The Form 1099 reporting rules for businesses do not change after 2011. Thus, businesses will have to report payments of $600 or more to service providers. However, payments to corporations will not need to be reported, nor will payments for property.

Repeal of Expanded 1099 Reporting Rules for Rental Real Estate

Before 2011, the 1099 reporting requirements applied only to payments made in the course of a trade or business. Payments made in a passive investment activity were not subject to these requirements. For payments made after 2010, the Small Business Jobs Act of 2010 (SBA) provided that (with a few exceptions not important for this article) any person receiving rental income from real estate (landlords) would be considered to be engaged in a trade or business and, thus, would be subject to the same 1099 reporting requirements that apply to businesses. Accordingly, thanks to SBA, for 2011, landlords would generally be required to file Form 1099-MISC to report payments of $600 or more made to noncorporate service providers (for things like yard care, painting, and accounting). And, for payments after 2011, they would be required to report payments made to corporations and payments made for the purchase of property just like other honest to gosh businesses.

Fortunately, the 1099 Act repeals the SBA extension of the 1099 reporting requirements to landlords who are not otherwise considered to be engaged in a trade or business of renting property. As a result, landlords making payments of $600 or more to a service provider (such as a plumber, painter, or accountant) will not be required to file Form 1099-MISC, unless their rental activities rise to the level of a trade or business.

Bottom Line: The 1099 reporting rules for landlords do not change after 2010.

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By Editor, March 4, 2011

Background

The Self-employed Health Insurance Deduction has long been available for the health insurance of the self-employed individual, his or her spouse, and any dependent children. But, there are a number of important taxpayer-friendly developments for 2010, including a surprising change in interpretation by the IRS.

IRC Sec. 162(l)(2) allows self-employed proprietors and partners, and more-than-2% S shareholders treated as partners for fringe benefits, to deduct 100% of their health insurance as a page 1, for-AGI income tax deduction. To be eligible for this deduction, the taxpayer must have a health insurance plan that can be considered as associated with a business activity. Also, the taxpayer must not be eligible to participate in a health insurance plan that is subsidized by any other employer. The deduction is limited to the taxpayer’s self-employment income, or in the case of an S shareholder, the wages subject to payroll taxes.

Nondependent Children under Age 27 Can Now Be Covered

One of the features of the Health Care legislation passed last March provides that effective as of 3/30/10, an employee may receive tax-free treatment for employer-provided health insurance for a child who has not attained age 27 by the end of the year, regardless of whether the child is eligible as a tax return dependent. Prior to this legislation, an employee would have had taxable compensation to the extent an employer paid for health insurance for a nondependent child.

This legislation made a corresponding change to the self-employed health insurance deduction of a self-employed taxpayer. If a self-employed individual pays the health insurance premium for a nondependent child who has not attained the age of 27 by 12/31/10, premiums paid after 3/30/10 are includable in the self-employed health insurance deduction.

Example 1: Phil, a self-employed proprietor, has been claiming the self-employed health insurance deduction for his family. The health policy covers himself, his spouse, and their 20 year-old dependent daughter, a college student. Phil’s older child, Flip, age 25, was recently laid off from his W-2 job in a nearby community and is again living at home. Phil is helping Flip by paying his separate health insurance policy and also covering a few other essential expenses. Beginning 3/30/10, Phil may include Flip’s health insurance premiums in computing the self-employed health insurance deduction on his Form 1040 .

Medicare Part B Premiums Can Count as Part of the Deduction

For several years, the IRS instructions to Form 1040, for the self-employed health insurance deduction line on page 1, have stated at that Medicare Part B premiums could not be treated as part of the deduction. Of course, this guidance was only applicable to someone over age 65 and older enrolled in Medicare who also had self-employment income. But many self-employed taxpayers stay active past age 65.

Surprisingly, the 2010 Form 1040 instructions, at line 29, now state “Medicare B premiums can be used to figure the deduction.”

We have not seen any other IRS guidance explaining this change in position. Earlier guidance on this point was informal: IRS instructions, an IRS Publication, and a 1995 Field Service Advisory memo (FSA 3042, 12/19/95). However, the current Form 1040 instructions can be relied upon, and apparently reflect an updated position of the IRS. Accordingly, the Medicare B premium should be claimed as part of the line 29 self-employed health insurance deduction beginning in 2010.

The Medicare B premium amount, of course, is disclosed on the Form SSA-1099 . For the last several years, the Medicare B premiums assessed by the Social Security Administration have been income-sensitive. For 2010, the annual amount ranges from approximately $1,300 to $4,200. Further, if both spouses are enrolled in Medicare, these amounts will generally be doubled.

Example 2: Ed and Edna, each age 67, both are enrolled in Medicare and receiving social security retirement benefits. Ed is still active as a self-employed partner in the farming partnership with their two sons. While Ed’s share of the partnership K-1 self-employment income is not large, he receives substantial rental income from the partnership for the use of his land, and he and Edna report a substantial AGI in their Form 1040. Their Medicare B premiums withheld from their social security benefits were the maximum in 2010 of $4,243 each. In preparing their Form 1040 for 2010, the IRS instructions indicate that Ed and Edna may claim the Medicare Part B premiums of $8,486 as additional self-employed health insurance.

For 2010 Self-employed Health Insurance

Is Deductible for SE Tax Purposes

In the September Small Business Jobs Act, Congress also adjusted the self-employed health insurance deduction in another manner. The legislation amended IRC Sec. 162(l)(4) to allow the deduction to be claimed both for income tax purposes and self-employment tax purposes in 2010. Previously, of course, the health insurance deduction had only been allowable for the income tax computation.

For 2010, this SE tax break makes the ability to claim post-3/30/10 health insurance for nondependent children (who do not attain age 27 by 12/31/10) more beneficial, and also makes the Medicare B premium deduction of greater value.

Other Implications of Reduced Self-employment Income in 2010

Does the reduction in self-employment income for 2010, because of the one-year deductibility of self-employed health insurance premiums, also affect other calculations driven by self-employment (SE) income? For example, a self-employed taxpayer’s earnings for qualified retirement plan purposes are based on SE income. So, for 2010, must SE income for this purpose be reduced by the health insurance deduction? And, the self-employed health insurance deduction itself is limited to the amount of the taxpayer’s SE income. Do we need to do a dreaded simultaneous equation to determine the health insurance deduction if SE income was low?

Here’s our analysis of these questions:

1. SE Income for Qualified Retirement Plan and IRA Funding. For both qualified plan and IRA purposes, earned income is defined by reference to IRC Sec. 401(c)(2) . In turn, IRC Sec. 401(c)(2) refers to net earnings from self-employment as defined in IRC Sec. 1402(a) . If the story ended here, we would need to reduce self-employed earnings for retirement plan funding in 2010 by the health insurance deduction. But the Committee Report to the legislation enacting the one year cut in SE income for health insurance says that “It is intended that earned income within the meaning of section 401(c)(2) be computed without regard to this deduction for the cost of health insurance.” It goes on to note that a technical correction to the legislation may be needed. As a result, SE income for retirement plan funding in 2010 should not be reduced for the health insurance deduction.

Income Limit for Self-employed Health Insurance Deduction. We won’t bore you with the citations on this one, as it is also addressed directly in the Committee Report of the September legislation. That language states that “earned income for purposes of the limitation applicable to the health insurance deduction is computed without regard to this deduction.” So again, we use SE income without the health insurance deduction as the business net income limit for this health insurance deduction (and no need to remember how to calculate a simultaneous equation!).

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By Editor, February 8, 2011

Information reporting required for rental property expense payments. Beginning with payments made in 2011, recipients of rental income from real estate must implement Form 1099 reporting.   Specifically, rental income recipients making payments of $600 or more to a service provider (such as a plumber, painter, or accountant) in the course of earning rental income are required to provide an information return (typically Form 1099-MISC) to IRS and to the service provider.

This means rental property owners should start now to acquire the names, addresses and social security or other taxpayer identification numbers for service providers, so that this information will be available when the time comes to issue the 1099s.

Exceptions. Exceptions are provided for individuals renting their principal residences (including active members of the military), taxpayers whose rental income doesn’t exceed an IRS-determined minimal amount, and those for whom the reporting requirement would create a hardship (under yet to be issued IRS regs).

Also, 1099-MISC reporting is not required for most payments to corporations during 2011, and is not required for credit card payments, if 1099 reporting for such payments is made by the credit card agency.

Increased information return penalties. For information returns required to be filed after December 31, 2010, the tax penalties for failure to timely file information returns are increased. For example, the minimum penalty for each failure due to intentional disregard will be increased from $100 to $250.

Back up withholding.  A payee furnishes social security number and other 1099 reporting data by completing Form W-9.  If a payee fails to provide such information, the rental property owner must implement 28% back up withholding with regard to such payee.

Illustration : A owns a 12-floor commercial building in the downtown area of City X. A rents out units as office or retail space in the building. A hires a plumber in 2011 to make repairs to the building and pays the plumber $2,000 for 2011. A is considered to be in a trade or business and must file an information return showing the $2,000 payment to the plumber.

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By Editor, January 6, 2011

Background

Before 2010, there was an often-unavoidable stumbling block for higher-income individuals who wanted to implement the Roth IRA conversion strategy. In those years, conversions were prohibited for folks with Modified Adjusted Gross Income (MAGI) in excess of $100,000. For 2010 and beyond, the MAGI restriction is history. The rule that made individuals who use married filing separate status ineligible for Roth IRA conversions is also history for 2010 and beyond. Thanks to the demise of these restrictions, 2010 was “the year of the Roth IRA conversion”. For taxpayers that made the conversion, the story is not over. In fact, 2011 is when the rubber meets the road for 2010 conversions.

2010 Converters Must Decide When Conversion Income Will Be Recognized

2010 converters can spread the taxable income triggered by 2010 conversions evenly over 2011 and 2012 (50% in each year) for federal income tax purposes and thereby defer the tax hit. In fact, this defer-and-spread deal happens automatically unless the taxpayer makes the alternative election to recognize all the conversion income in 2010. [See IRC Sec. 408A(d)(3)(A)(iii) .]

Going with the defer-and-spread deal is not a no-brainer. For example, if you believe you will pay a lower marginal tax rate in 2010, it might make sense to recognize all the conversion income in 2010 by reporting it on that year’s Form 1040. As we just explained, making that choice will require an election with the 2010 return.  As this was written, we did not have any details about how to make the election. We will tell you as soon as we know more.

No general rule of thumb can be offered for whether to recognize the income for 2010, or spread it over 2011 and 2012. Each taxpayer’s situation must be considered individually.

2010 Converters Have until 10/17/11 to Reverse Ill-fated Conversions

Another “safety valve” for Roth IRA conversions is the fact that converters are allowed to change their minds well after doing the deed. Any 2010 converter has until the extended due date for filing his 2010 Form 1040 to recharacterize the converted amount back to traditional IRA status. The extended due date for 2010 returns is 10/17/11 (for calendar-year taxpayers). A recharacterization reverses the earlier conversion and eliminates the related tax liability. The 10/17/11 deadline for reversing 2010 conversions applies whether or not the converter actually extends his 2010 Form 1040. [See IRC Sec. 408A(d)(6) and (7) and Reg. 301.9100-2(b) .]

Example: Fred converted two traditional IRAs into two Roth IRAs in 2010. In 2011, the values of the converted accounts plummet due to poor investment performance. In this bleak scenario, Fred would have to pay income tax on value that later disappeared. Bad idea! Thankfully, he has until 10/17/11 to reverse the 2010 conversions by recharacterizing the two Roth IRAs back to traditional IRA status. After the reversal, it’s as if the ill-fated conversions never happened. So, Fred won’t owe any tax on the now-reversed conversions.

Side Note: Regardless of whether taxpayers are 2010 converters, doing any 2011 conversions early in the year makes some sense because clients will have until 10/15/12 to reverse any ill-fated 2011 conversions. That’s almost two years to see how things go. Of course, if 2010 converters also do 2011 conversions, it puts extra variables in play regarding the best time to recognize income from the 2010 conversions.

Why 2010 Converters Should Extend Their Returns

There are two big reasons for 2010 converters to extend their 2010 returns to 10/17/11.

• First, it creates extra time for converters to decide if they are better served by: (1) going with the defer-and-spread deal that results in spreading the conversion income evenly between 2011 and 2012, or (2) making the election to report all the conversion income in 2010. Converters should have a better handle by next October on how much income they expect to have in 2011 and 2012. We hope and trust that the IRS will provide timely guidance not only on how to make this election, but also allowing it to be made on a timely filed extended return.
• Second, extending their 2010 returns will make it much easier for converters to handle any reversals of 2010 conversions. If the converter’s return is extended, the reversal is reported by simply showing no income from the now-reversed conversion on the original 2010 Form 1040. Simple! If the 2010 return is not extended and a 2010 conversion is reversed after the filing date, an amended 2010 return will have to be filed to report the reversal. Not so simple!

Conclusions

Doing Roth IRA conversions in 2010 made lots of sense for certain taxpayers, but the book is still open because decisions about 2010 conversions must be made in 2011. First and foremost, 2010 converters should consider to extending their returns to create extra time to make those decisions.