The federal government has decided to refund the long-distance telephone excise tax through the taxpayers’ 2006 tax returns. This is leading towards increased complexity in preparing the 2006 returns next tax season.

Background - As a result of several tax court rulings, the IRS announced in May 2006 that it will stop collecting the federal 3% excise tax on long-distance telephone service. In addition, taxpayers will be able to claim a refund of the excise tax billed to them on their telephone bills after February 28, 2003 on their 2006 tax returns.

Originally, the IRS had indicated it would develop a simplified method. However, nothing such as this is ever that simple. It appears the rebate will be a little more complicated than originally envisioned;

o The IRS is developing a 1040PC-2 to be used by taxpayers who are not otherwise required to file a return and are filing for the rebate only.

o For those taxpayers who do not have a business phone, then a simplified method is being developed for the rebate.

o For those with business phones, the actual amount of the excise tax must be determined for the rebate purpose. Thus, business returns (including Schedule C returns) must base their rebate on actual excise tax changes from the phone bills. And since the excise tax was originally deducted as a business expense (it was included in the phone expense deduction), the rebate will be taxable income in the subsequent year.

If you have a business, you will need to determine the actual excise tax paid on long-distance calls. You may use the attached worksheet to pull the information together. You are encouraged to take action now, so that your tax appointment is not hampered or your tax returns delayed by this one-year anomaly. Please call if you have questions or need assistance.

Accrual – If the accrual method is used, all of your billings must be treated as income whether or not they have been collected. This means that the taxable income already includes the income from your deadbeat customers. Therefore, these items are considered a bad debt when those receivables become uncollectible and can be deducted. If the accrual method of accounting is used, bad debts are deductible.

Cash – On the other hand, if the cash method of accounting is used, income is not reported until it is received (unlike the accrual method). Since the income was never reported in the first place, a deduction cannot be taken if you are never paid for the goods or services you provided. This is a hard concept to understand, so let’s consider the following example. Jack has a cash basis business with two customers. He invoices both customers for $5,000. One pays Jack promptly, while the other skips out on him without making payment. Jack actually has income of $5,000. If he were allowed to deduct the uncollected $5,000, he would end up with $0 income. However, this is not the case. Generally, cash basis businesses don’t have bad debt deductions, although there are some exceptions (discussed below).

A taxpayer's loan to a customer or supplier may be a business debt if there is some element of necessity for the loan, which is proximately related to the taxpayer's business. An example is a builder who makes advances to a building material supplier and never receives the supplies. In such cases, assuming the taxpayer can prove the debt is worthless, the loan will result in a bad debt for either an accrual or cash basis taxpayer.

Proof of Worthlessness – Proving a debt (or receivable) is worthless requires the taxpayer or business to show that the debt has become worthless and that reasonable steps were taken to collect the debt.

Non-Business Bad Debts – Some bad debts may actually be personal debts, such as personal loans to individuals. In those cases, the bad debt is not deducted as a business expense but is treated as a short-term capital loss on Schedule D instead. The bottom loss for any year on Schedule D is limited to $3,000 ($1,500 for married filing separate taxpayers). Unless the Schedule D contains gains to offset additional losses, a non-business bad debt could be limited to $3,000 per year. The good news is that any amount not deductible in a particular year carries over to the next subsequent year.

If you still have questions, please give us a call for additional information.

Home as a Retirement Planning Vehicle

For most Americans, more often than not, their home represents their largest asset. So when it comes time to retire, the home plays a key role. Conventional techniques in using the home’s equity for retirement include:

o Selling the home, downsizing and using the extra cash to generate or supplement retirement income. However, this requires the retiree to leave his or her existing home and relocate away from friends and family.

o Refinancing the home using the equity to meet retirement needs. However, this, in turn, burdens the retiree with additional monthly payments.

A reverse mortgage, on the other hand, allows an individual to remain in his or her home, use the home equity, and not incur any additional monthly payments. Being the only limitation, the FHA conventional loan cap also represents the maximum home value that can be used in computing the allowable reverse mortgage. Thus, as the home’s value increases and exceeds that limit, the benefits of a reverse mortgage may diminish.

Eligibility Requirements

Generally, there are no income requirements since the loan is based on the home equity and the borrower’s longevity.

• Age – Homeowner(s) who are at least 62 years of age and occupy the property as their principal residence are eligible. Note: All individuals on title must be at least 62 years of age. Thus, a younger spouse (under age 62) on the title would make the couple ineligible.

• Type of Homes - Eligible properties include single-family homes, condominiums, town homes and two to four dwelling units.

• Existing Mortgages - Generally, the home must be owned free and clear (or only have a small remaining balance that can be paid off with the reverse mortgage).

• Eligibility Certificate - Borrowers are required to obtain an eligibility certificate issued after receiving a free HUD-approved counseling session (discussed later).

• Asset or Income Requirements - There are no asset or income requirements on borrowers to qualify for HUD's reverse mortgages.

How much cash can someone receive?

The amount that can be borrowed is based on a HUD formula that factors in the age of the youngest homeowner, the interest rate, appraised value, and the county where the property is located. Based on a loan at current (at the time this was prepared) low interest rates, a 65-year-old with a home value of @ $400,000 living in Los Angeles County, could qualify for a loan payout of @ $170,000. At age 75, it would increase to @ $214,000 given the same parameters. An 85-year-old could qualify for @ $259,000 while a 95-year-old could get the max payout of $ 296,000 --- up to the FHA loan limit for each city and county. These limits change from time to time, and the FHA loan limit currently is $362,790 in most major metropolitan areas.

Loan Options

• Tenure Plan: Best described as a life annuity. You can receive equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence. In other words, the tenure payment will continue to be the same amount for the borrower’s lifetime, even if the loan exceeds the equity in the home or if the home declines in value.

• Term: Receive equal monthly payments for a fixed period of months selected by the borrower.

• Line of Credit: Establish a line of credit that the borrower can draw on at anytime in any amount up to the maximum principal limit.

• Lump Sum: Take all or any part of the loan at the time of closing.

• Modified Tenure: A combination of a line of credit with monthly payments for as long as the borrower remains in the home.

• Modified Term: A combination of a line of credit with monthly payments for a fixed period of months selected by the borrower.

• Loan Restructures: Homeowners whose circumstances change can restructure their payment options for a nominal fee of $20.

Possible Uses

Funding for Healthcare or Long-Term Care Insurance - Most Americans recognize the need for a long-term care insurance program to protect both their assets and relieve any potential burden on their family. Many seniors, when faced with this situation, are forced to use their savings or impact their monthly income for long-term care coverage.

A reverse mortgage allows seniors to stay in their homes, be self-sufficient, and not deplete existing savings or income. An elderly person could use a reverse mortgage to fund the purchase of a prepaid long-term care insurance policy without reducing their current income or depleting their non-housing assets.

Provide Funding for Estate Taxes - When the tax-free equity release is used to fund life insurance products, a reverse mortgage is a creative and effective way to secure the future for heirs. It gives homeowners, particularly those with substantial wealth built up in their homes, the comfort of having more control over their estate and assuring the legacy they leave retains its value by:
• Lowering the total estate value subject to taxes.
• Providing life insurance for the homeowner’s heirs to pay estate taxes.

Enhance Income – In 2004, the average income of men aged 65 and over was $28,000 and $15,000 for women. Tapping the equity in their home can help millions of house rich and cash poor seniors supplement their income.

Modifying the Home for Elderly Hazards - Many seniors are without the financial means to modify their homes and vehicles for age-related issues such as ramps, bathroom fixtures, lifting devices, medical beds, safety devices, etc. Proceeds could even be used to fund in-home care.

Reverse Mortgage an Alternative to Nursing Home - It is often desirable for an elderly person to remain in his or her own home with proper in-home care rather than entering a nursing home. A reverse mortgage loan may make this a feasible alternative to a nursing home. If this approach is taken, don’t forget the household help is deductible in the same manner as the nursing home. Also, household employees must be paid by payroll.

Please call this office if you have additional questions.

The Federal Government has been supplementing the Medicare B insurance premiums for some years as the costs have exceeded the funds generated from the premiums. Beginning in 2007, the premiums will be increased for higher-income individuals based upon their modified AGI for the two years prior. Thus, for 2007, the modified AGI for 2005 will be used. (Note: If the 2005 AGI information is not available, the 2004 AGI information will be used.) The IRS will provide the Social Security Administration with the taxpayer’s filing status, identity information, AGI and AGI modifications.

The modified AGI for making the adjustment is the Federal AGI plus the following:
o Tax-exempt interest income;
o United States savings bonds interest used to pay higher education tuition and fees if the interest was excluded from income on Form 8815;
o Excluded foreign earned income and housing costs;
o Income derived from sources within Guam, American Samoa, or the Northern Mariana Islands; and
o Income from sources within Puerto Rico.

The tables below represent the adjustments for 2007 based on filing status.

Inflation Adjustments - The $80,000 and $160,000 thresholds will be adjusted annually, in $1,000 increments, based on the Consumer Price Index.

Notification - Medicare beneficiaries will be notified at the end of 2006 about the increase, if any, that applies to them.

Amended AGI – If the taxpayer subsequently amends the tax return for the year on which the AGI adjustment is based and there is a significant reduction in AGI for that year, the taxpayer can submit a copy of the amended return and the premium will be retroactively adjusted.

Effect of Major Life-Changing Events – The Social Security Administration will use a more recent tax year’s modified AGI, rather than the one of the second prior year, if the taxpayer experiences a major-life changing event, defined as:

o Death of a spouse;
o Taxpayer’s marriage or divorce;
o Taxpayer or spouse stopping work or reducing the number of hours worked;
o Reduction in income from income-producing property due to certain casualties or disasters; and
o Reduction in income or loss of income from certain pensions, such as when a pension plan is terminated.

Married Couples – The monthly adjustment applies to each premium, so if both spouses are Medicare beneficiaries, the couple will actually pay double the premium adjustment.

Subsidy Phase-Out – The government’s subsidy of the Medicare B premium for the affected higher-income taxpayers is being phased out over a three-year period.

Thus, in 2008, the monthly adjustments will double the 2005 increase based on the 2006 AGI, and the 2009 increase will be triple based on the 2007 AGI.

Tax Planning Strategies – There is nothing a taxpayer can do about adding back the foreign income exclusion or the income derived from Puerto Rico or the U.S. Possessions. However, there are “other” income strategies that can be employed to reduce the impact of the adjustments, especially for taxpayers close to an AGI bracket change:

o Invest in investment vehicles with deferred income (such as tax-deferred annuities), thus lowering the current AGI and bunching the income into one year when the annuity is surrendered.

o Plan IRA or pension plan distributions so as to stay under an increased AGI bracket and/or bunch or increase distributions in one year to make up for lower distributions in other years (but watch out for the RMD at age 70.5).

o Consider deferring the age 70.5 RMD to the subsequent year and doubling up the distributions in that subsequent year if it makes sense.

o Carefully plan stock profits and the exercise of stock options.

o Carefully plan the sale of assets such as land, rentals, etc. Consider installment sales or 1031 exchanges.

Since the brackets are step functions, if a taxpayer is close to the next bracket, reducing the AGI by just a few dollars could save a substantial amount in Medicare B premiums. However, the AGI used will be the one from two years prior. Therefore, the rates for 2007 are already cast in concrete and cannot be altered by tax planning since 2005 has already passed. However, there is still time to plan for the 2006 income, which will affect the 2008 Medicare-B rates.

Please call this office if you believe your 2006 income will be close to one of the thresholds and tax planning might be appropriate.

>> back to top

Periodically, the IRS issues Statistic of Income Bulletins (SOI) in which they publish statistics on data they are tracking for the administration and collection of taxes. For the first time, the bulletin includes statistics on non-cash contributions. It remains to be seen whether this is a prelude to a non-cash contribution compliance program.

Although the bulletin goes into significant detail on various types of contributions, including real estate, securities, art, etc., this article will only examine the more commonly encountered non-cash contributions (such as clothing, household goods, vehicles, etc.). To view the full bulletin, go to: http://www.irs.gov/pub/irs-soi/03inccart.pdf.




The accuracy of the classifications is doubtful, since many non-cash contributions are listed under terms such as “household and clothing” and “household goods” (which includes clothing, electronics, furniture, appliances, etc.), and those totaling under $500 need not be reported on the 8283 at all.

Congress and the IRS have already stepped in to curtail the vehicle contributions, which is small compared to the other three listings. Are they looking at reining in the others as well?

During the dotcom boom, many employees of internet-related companies took advantage of incentive stock options (ISOs) that allowed them to acquire shares of the company stock at significantly discounted prices. Although, for regular tax purposes, the gain from the exercise of options is not taxable until the stock is ultimately sold, it is subject to the alternative minimum tax (AMT) in the year the option is exercised.

Thus, there would have been significant tax in the year of exercise, but no money from the stock since it is required to be held for one year to qualify for the beneficial long-term capital gains rates. To many, it was a balancing act since they would put their returns on extension and then sell some or all of the stock after a year to receive the cash to pay the AMT tax.

When the tech bubble burst in 2000, the stocks for which these individuals incurred an AMT liability plunged in value, and they found themselves owing an AMT on income they would never see. This left many in that industry with huge tax liabilities on income that would never be realized.
The IRS has taken a hard line stance on the issue noting that the taxpayers had the opportunity to sell the stock when they exercised the option and pay tax on the ordinary income from the sale. Instead, they knowingly chose the more risky avenue in an attempt to reduce the tax burden and, as a result, got burned in a stock melt down. Thus, the IRS (and apparently Congress) are making no effort to relieve those affected except through existing procedures.

Recently, one of the affected taxpayers filed an offer-in-compromise where he offered to pay $4,457, the cash value of his life insurance policy, against the liability that then exceeded $125,000. His offer was based on doubt as to collectibility and his inability to pay the full amount due to insufficient assets and income. He also attached a statement in which he explained that an offer-in-compromise was necessary because of the impact the AMT had on his family's finances and lifestyle in 2000. The statement included information about his family, their finances and his mental anguish and frustration with the unfairness of the situation posed by the AMT problem.

An IRS Revenue Officer rejected the offer because the taxpayer had the ability to pay the outstanding tax liability in full and apprised him of his options. The issue ultimately ended up in tax court where the court concluded that the taxpayer failed to establish that IRS abused its discretion on the basis of the promotion of effective tax administration when it refused his OIC. The Court said that the factors outlined in the regulations that support a finding of economic hardship describe more dire circumstances than the contentions made by the taxpayer.

In their July 19, 2006 News Release (IR 2006-116), the Internal Revenue Service warned taxpayers to be on the lookout for a new e-mail scam that uses the Treasury Department's Electronic Federal Tax Payment System (EFTPS) as a hook to lure individuals into disclosing their personal information.

The system, which is used by more than six million taxpayers, allows businesses and individuals to pay all their federal taxes online or by phone.

The new e-mail scam, fraught with grammatical errors and typos, looks like a page from IRS.gov and claims to be from the "IRS Antifraud Comission" (sic), a fictitious group. The e-mail claims someone has enrolled the taxpayer's credit card in EFTPS and has tried to pay taxes with it. The e-mail also says there have been fraud attempts involving the taxpayer's bank account. The e-mail claims money was lost and "remaining founds" (sic) are blocked. Recipients are asked to click on a link that will help them recover their funds, but the subsequent site asks for personal information that the thieves could use to steal the taxpayer’s identity.

“The IRS does not send out unsolicited e-mails asking for personal information,” said IRS Commissioner Mark W. Everson. “Don’t be taken in by these criminals.” Additionally, the IRS never asks people for their PIN numbers, passwords or similar secret access information for their credit card, bank or other financial accounts.

This latest e-mail scam is the first one known to reference EFTPS.

The IRS has seen a recent increase in these scams. Since November, 104 different scams have been identified, with 22 of those coming in June (the most since 40 were identified in March during the height of the filing season).

Many of these schemes originate outside the United States. To date, investigations by the Treasury Inspector General for Tax Administration have identified sites hosting more than two dozen IRS-related phishing scams. These scam web sites have been located in many different countries, including Argentina, Aruba, Australia, Austria, Canada, Chile, China, England, Germany, Indonesia, Italy, Japan, Korea, Malaysia, Mexico, Poland, Singapore and Slovakia, as well as the United States.

Other scams claim to come from the IRS, tell recipients that they are due a federal tax refund, and direct them to a web site that appears to be a genuine IRS site. The bogus sites contain forms or interactive web pages similar to IRS forms or web pages but which have been modified to request detailed personal and financial information from the e-mail recipients.

Tricking consumers into disclosing their personal and financial information, such as secret access data or credit card or bank account numbers, is fraudulent activity which can result in identity theft. Such schemes perpetrated through the Internet are called “phishing” for information.

The information fraudulently obtained is then used to steal the taxpayer’s identity and financial assets. Typically, identity thieves use someone’s personal data to empty the victim’s financial accounts, run up charges on the victim’s existing credit cards, apply for new loans, credit cards, services or benefits in the victim’s name and even file fraudulent tax returns.

When the IRS learns of new schemes involving use of the IRS name or logo, it issues consumer alerts warning taxpayers about the schemes.

The IRS also has established an electronic mailbox for taxpayers to send information about suspicious e-mails they receive which claim to come from the IRS. Taxpayers should send the information to: phishing@irs.gov.

More than 8,000 bogus e-mails have been forwarded to the IRS, with nearly 1,300 forwarded in June alone.

The IRS’s mail box allows taxpayers to send copies of possibly fraudulent e-mails involving misuse of the IRS name and logo to the IRS for investigation. Instructions on how to properly submit one of these communications to the IRS may be found on their web site. Enter the term "phishing" in the search box in the upper right hand corner. Open the article entitled “How to Protect Yourself from Suspicious E-Mails” and scroll through it until you find the instructions. Following these instructions helps ensure that the bogus e-mails relayed by taxpayers retain critical elements found in the original e-mail. The IRS can use the information, URLs and links in the bogus e-mails to trace the hosting web sites and alert authorities to help shut down these fraudulent sites.

However, due to the volume the mailbox receives, the IRS cannot acknowledge receipt or reply to taxpayers who submit their bogus e-mails. The phishing@irs.gov mailbox is only for suspicious e-mails and not for general taxpayer contact or inquiries.

For information on preventing or handling the aftermath of identity theft, visit the Federal Trade Commission’s consumer and OnGuardOnLine Web sites. Click on "Topics" to find the identity theft and phishing areas on OnGuardOnLine.

For information on identity theft prevention and victim assistance in relation to tax administration, visit the IRS Identity Theft Web page which can be found on the IRS website. Enter the term "identity theft" in the search box in the upper right hand corner.

For schemes other than phishing, please report the fraudulent misuse of the IRS name, logo, forms or other IRS property by calling the Treasury Inspector General for Tax Administration’s toll-free hotline at 1-800-366-4484.

Effective July 16th and per the provisions of the Tax Increase Prevention and Reconciliation Act of 2005, the IRS has adopted some tough new procedures associated with the submission of an offer-in-compromise (OIC) - IR 2006-106; Fact Sheet 2006-22.

These changes affect all offers received by the IRS on or after July 16, 2006 (regardless of the postmark date on the offer). Under the new rules, taxpayers submitting lump-sum offers must make a nonrefundable, up-front payment to the IRS while the service considers the merits of the offer. The amount of the up-front payment is:

o For Lump-Sum Offers (offers of payment is five or less installments) – 20% of the offer.

o For Periodic Payment Offers – Payment of the first proposed installment.

Failure to Submit Up-front Payments will produce the following actions:

o For Lump-Sum Offers – Where no up-front payment is submitted, the offer will be returned to the taxpayer as being unprocessable. If less than the 20% up-front payment is submitted, the IRS will ask the taxpayer to pay the remaining balance in order to avoid having the offer returned. If it isn't paid, the IRS will return the offer and retain the $150 application fee.

o For Periodic Payment Offers – Failure to submit the first proposed installment with the offer will result in the offer being returned to the taxpayer as being unprocessable.

Application of the Up-Front Payments – The up-front payments are not refundable and are considered payments on tax. Thus, if the offer is rejected, the up-front payments will be applied to the taxpayer’s liability. A taxpayer can specify the application of any payment made under the above rules to the assessed tax or to other amounts at the submission of the offer. If a taxpayer fails to specify, then the IRS will apply the payments in the best interest of the government.

Specification Strategy - The application of any partial payment won't matter if the offer is accepted, but it might if the offer is rejected. To prepare for that possibility, if the offer is being made with respect to more than one tax year, the taxpayer should consider applying any payments made under the offer to more recent years, rather than to those nearing the expiration of the limitation period for collection. This will avoid having the payments credited to a tax liability that might be rendered uncollectible by the running of the statute of limitations.

Up-Front Payment Waivers Possible - Taxpayers qualifying as low-income or filing an offer based solely on doubt as to liability can receive a waiver of the new partial payment requirements.

o Low-Income Taxpayer Offers - A low-income taxpayer is an individual whose income falls below poverty levels based on guidelines established by the U.S. Department of Health and Human Services. Until further guidance, taxpayers claiming the low-income exception should use the worksheet to Form 656-A, Income Certification for Offer in Compromise Application Fee to determine if they qualify.

o Doubt as to Liability Offers - An offer is considered to be submitted solely on the basis of doubt as to liability if the taxpayer submits the offer on Form 656-L, Offer in Compromise (Doubt as to Liability), or if the offer is submitted on Form 656, Offers in Compromise, and it is clear on the face of the form that the only basis on which the taxpayer relies in making the offer is doubt as to liability.

Offers are submitted using Form 656, Offers in Compromise. The form provides detailed instructions for completing the offer and includes all of the necessary financial forms. When submitting Form 656, taxpayers must include an application fee of $150 unless they qualify for the low-income exemption or are filing a doubt-as-to liability offer. The $150 user fee will be applied to the assessed tax or other amounts due. Taxpayers may continue to use the 2004 revision of the form until the new version, revised to reflect the new law, is available.

>> back to top

The IRS recently announced (IR-2006-112) that rebates or cash incentives offered by employers to employees in order to encourage the purchase of hybrid cars constitute taxable compensation. Employers must include the cash incentive amounts on the employees' year-end Form W-2.

The exclusion for fringe benefits under “qualified employee discounts” does not apply, since the vehicles are not produced or offered for sale in the ordinary course of the taxpayer’s business. A number of businesses are offering this incentive to employees including Bank of America and Google.

>> back to top

A surviving spouse who is the sole beneficiary of the decedent spouse's IRA can simply leave the account as-is, or may roll over the decedent's IRA into an IRA established in the spouse's own name (or, alternatively, elect to treat the decedent's IRA as the surviving spouse's own IRA). However, making the right choice can have profound consequences for a spouse under age 59-1/2.

The portion of a pre-age-59-1/2 distribution from an IRA generally is subject to a 10% penalty tax unless one of several exceptions applies. One of these exceptions provides that the penalty tax doesn't apply to distributions made to the beneficiary on or after the account owner's death. However, if the beneficiary spouse chooses to roll the inherited IRA into his or her own account, any subsequent distributions are no longer treated as made to a beneficiary. Thus, distributions would be subject to the 10% early distribution penalty if the surviving spouse is under age 59-1/2 at the time of the distribution.