Tax & Business Strategies Monthly Newsletter - January 2008

Tax Planning Strategies
Exclusion for Members of Qualified Volunteer Emergency Response Organizations
Home Mortgage Debt Forgiveness Relief
Home Sale Exclusion Liberalized for Surviving Spouse
IRS Has $110 Million in Refund Checks Looking for a Home

Business & Management Practices
1099 Due Date Looming
Can You Write Off a Bad Debt?

General Information
Congress Finally Passes AMT Patch for 2007
Mortgage Insurance Premium Deduction Extended
Misclassified Workers to File New Social Security Tax Form

Briefs
Happy New Year!
Hybrid Vehicle Credit Update
Self-Prescribed Diagnostic Medical Procedures

TAX PLANNING STRATEGIES

Exclusion for Members of Qualified Volunteer Emergency Response Organizations

As part of the Mortgage Relief Act of 2007, and effective for tax years beginning after Dec. 31, 2007 and before Jan. 1, 2011, the new law provides for an exclusion from gross income to members of qualified volunteer emergency response organizations for any:

(1) Qualified state or local tax benefit; and
(2) Qualified payment (has an annual limit).

A Qualified State or Local Tax Benefit - is any reduction or rebate of state or local income, real property, or personal property taxes on account of services performed by individuals as members of a qualified volunteer emergency response organization. Unlike qualified payments, there is no cap on the amount excludable. However, the amount of state or local taxes taken into account by a taxpayer in determining his Schedule A deduction for taxes is reduced by the amount of any qualified state or local tax benefit.

A Qualified Payment - is a payment (whether reimbursement or otherwise) provided by a state or political subdivision on account of the performance of services as a member of a qualified volunteer emergency response organization. The amount of these payments considered "qualified," and therefore excludable, is limited to $30 multiplied by the number of months during the year that the taxpayer performs such services. The expenses paid or incurred by the taxpayer in connection with the performance of services that he may deduct as a Schedule A charitable contribution are allowed only to the extent they exceed the amount of excluded qualified payments.

Limited Qualified Payment Exclusion - The maximum exclusion for qualified payments in a year is $360 ($30 × 12 months). However, this exclusion apparently isn't a simple $30 a month allowance. Rather, the payments are determined on a yearly basis ($30 × number of months of service). Thus, a taxpayer who serves for 12 months could exclude $360 received during the year even if it was received all in one month (for example, in the first or last month of the year).

A Qualified Volunteer Emergency Response Organization - is any volunteer organization which is: (1) organized and operated to provide firefighting or emergency medical services for persons in the state or its political subdivision; and (2) required (by written agreement) by the state or political subdivision to furnish firefighting or emergency medical services in the state or political subdivision.

This new tax benefit does not take effect until 2008, but please give us a call if you have any questions.


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Home Mortgage Debt Forgiveness Relief

After weeks of debate and procrastination, Congress finally passed the Mortgage Forgiveness Debt Relief Act of 2007 just days from recessing for the holidays. One of the most important provisions of that new law was the provision allowing a taxpayer to exclude debt forgiveness income from their income.

Under tax law, a taxpayer is required to treat debt forgiveness as income on their tax return. Let's say a taxpayer owes $500,000 on the home mortgage. The home is foreclosed upon; after the sale, the lender only recovers $450,000 of the debt. The taxpayer would be required to include the $50,000 difference as income unless they had filed Title 11 bankruptcy or qualified for the insolvent taxpayer exclusion. This is also the case if a taxpayer negotiates a reduced mortgage or a voluntary reconveyance with the lender instead of suffering a foreclosure.

Under the new law, taxpayers can exclude up to $2 Million ($1 Million for MS) of qualified principal residence acquisition debt on the taxpayer’s qualified principal residence discharged on or after January 1, 2007 and before January 1, 2010. The basis of the taxpayer’s home is reduced by the excluded amount, but not below zero. In some circumstances, this could result in a higher gain on the home sale, which may or may not be fully excludable under the home sale exclusion rules.

Caution – The exclusion does not apply to a taxpayer’s designated 2nd (vacation) residence.



Caution – The exclusion only applies to the discharge of qualified principal residence acquisition debt. Thus, equity debt is not included as part of the exclusion. Acquisition indebtedness of a principal residence is indebtedness incurred in the acquisition, construction, or substantial improvement of an individual's principal residence that is secured by the residence. It includes refinancing of debt to the extent the amount of the refinancing doesn't exceed the amount of the refinanced indebtedness.

If any loan is discharged, in whole or in part, and only part of the loan is qualified principal residence indebtedness, the mortgage forgiveness exclusion applies only to so much of the amount discharged as exceeds the amount of the loan (as determined immediately before the discharge) which is not qualified principal residence indebtedness. Thus, where there is a mixed loan (part acquisition and part equity debt), the sequence of forgiveness is treated as applying to the acquisition debt first and then to the equity debt.

The exclusion doesn't apply to the discharge of a loan:

• If the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the taxpayer's financial condition.
  
  
• Of a taxpayer in a Title 11 bankruptcy.

An insolvent taxpayer (other than one in a Title 11 bankruptcy) can elect to have the mortgage forgiveness exclusion not apply and can instead rely on the exclusion for insolvent taxpayers. Thus, where a taxpayer has significantly tapped the equity in the home, and has a significant amount of debt discharge that does not qualify for the exclusion, it may be to their advantage to forgo the mortgage relief exclusion and instead use the insolvent taxpayer exclusion.

If you are unfortunate to find yourself in these circumstances, please call this office for a consultation to see how this new law will affect you.


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Home Sale Exclusion Liberalized for Surviving Spouse

Previous to the passage in December of the new Mortgage Relief Tax Act, a surviving spouse could use the up-to-$500,000 exclusion if the husband and wife file a joint return for the year of sale. This meant that the house had to be sold in the year of the deceased spouse’s death to get the higher joint exclusion. Thus, if the home is sold in a year after the year of a spouse's death—when a joint return would no longer be allowed to be filed—the surviving spouse can only get a maximum home sale exclusion of $250,000.

New Law - The Mortgage Relief Act of 2007 included a provision, effective for sales and exchanges after Dec. 31, 2007, that allows a surviving single spouse to qualify for the up-to-$500,000 exclusion if the sale occurs no later than 2 years after the deceased spouse's death and the couple met the qualifications for the $500,000 exclusion immediately before the spouse's death.

Note: Keep in mind that the surviving spouse, depending upon the state of residence and the manner in which the title is held, will have a 50% or 100% step up (or step down) in basis of the home as a result of the spouse’s death.

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IRS Has $110 Million in Refund Checks Looking for a Home

The Internal Revenue Service is looking for 115,478 taxpayers who are due refund checks worth about $110 million after the checks were returned as undeliverable. The refund checks, averaging about $953, can be claimed as soon as taxpayers update their addresses with the IRS. Some taxpayers have more than one check waiting.

The “Where is My Refund?” tool on IRS.gov enables taxpayers to check the status of their refunds. A taxpayer must submit his or her social security number, filing status and amount of refund shown on their 2006 return. The tool will provide the status of their refund and in some cases provide instructions on how to resolve delivery problems.

Updating Your Address - Refund checks are mailed to a taxpayer’s last known address. Checks are returned to the IRS if a taxpayer moves without notifying the IRS or the U.S. Postal Service.

Taxpayers can update their addresses with the IRS on the Internet's "Where is My Refund?” feature. Also, taxpayers checking on a refund will be prompted to provide an updated address if there is an undelivered check outstanding within the last 12 months. Taxpayers checking on a refund over the phone will be given instructions on how to update their addresses. A taxpayer can also ensure the IRS has his or her correct address by filing IRS Form 8822, Change of Address.

Those who do not have access to the Internet and think they may be missing a refund should first check their records or contact their tax preparer, then call the IRS's toll-free assistance line at 1-800-829-1040 to update their address.

Direct Deposit Can Stop Lost Refunds - Signing up for direct deposit can put an end to undelivered refunds, as well lost or stolen refund checks. Taxpayers can receive refunds directly into personal checking or savings accounts. Direct Deposit is available for filers of both paper and electronic returns. Taxpayers can sign up for direct deposit on their tax form.

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BUSINESS & MANAGEMENT PRACTICES

1099 Due Date Looming

If you use independent contractors to perform services for your business or rental and you pay them more than $600 for the year, you are required to issue them a Form 1099 at the end of the year to avoid facing the loss of the deduction for their labor and expenses. The due date for mailing the recipient their copy of the 1099 is January 31st. It is not uncommon to have a repairman out early in the year, pay him less than $600, then use his services again later and have the total for the year exceed the $600 limit. As a result, you overlook getting the information needed to file the 1099s for the year. Therefore, it is good practice to always have individuals who are not incorporated complete and sign the IRS Form W-9 the first time you use their services. Having a properly completed and signed Form W-9 for all independent contractors and service providers eliminates any oversights and protects you against IRS penalties and conflicts.

IRS Form W-9, Request for Taxpayer Identification Number and Certification, is provided by the government as a means for you to obtain the data required to file the 1099s from your vendors. It also provides you with verification that you complied with the law should the vendor provide you with incorrect information. We highly recommend that you have a potential vendor complete the Form W-9 prior to engaging in business with them. The form, available from this site, can either be printed out or filled onscreen and then printed out. The W-9 is for your use only and is not submitted to the IRS.

In order to avoid a penalty, copies of the 1099s need to be sent to the IRS by the last day of February. They must be submitted on magnetic media or on optically scannable forms (OCR forms). This firm prepares 1099s in OCR format for submission to the IRS with the 1098 submittal form. This service provides recipient copies and file copies for your records. Use the worksheet to provide us with the information we need to prepare your 1099s.

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Can You Write Off a Bad Debt?

Most small businesses have receivables that cannot be collected. These receivables can be from the sale of products, providing services to customers, or a combination of the two.

Whether or not a bad debt deduction will apply generally depends upon which accounting method is used (either the cash or accrual method). Why does this make a difference? Let’s look at what happens under both methods of accounting.

• 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.

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GENERAL INFORMATION

Congress Finally Passes AMT Patch for 2007

Just prior to breaking for the holidays, the House and the Senate finally passed a one-year AMT patch by increasing the AMT exemption amounts, thereby avoiding a huge tax increase for an estimated 23 million taxpayers. The legislation also allows certain personal tax credits to be deducted for one more year.

Congress created the AMT in 1969 in response to concerns that 155 very-wealthy families were avoiding taxes by claiming extensive deductions. Congress was attempting to see to it that high-income taxpayers would pay at least a minimum tax. About 2,000 taxpayers were affected in that first year.

The tax was not indexed for inflation; so as income increased, the number of taxpayers affected has slowly increased. In 2006, approximately 4 million taxpayers were affected by the AMT.

Congress has enacted several temporary fixes to the AMT in recent years to spare the middle-income taxpayers from the AMT. They did this by increasing the AMT exemption. If this temporary patch had not been made for 2007, it is estimated that as many as 23 million taxpayers would have been affected by the AMT next year.

2007 AMT Exemption Amounts - (before phase-out)

Unmarried Taxpayers - $44,350 (would have been $33,700)
Married Filing Jointly & Surviving Spouse - $66,250 (would have been $45,000)
Married Filing Separately - $33,125 (would have been $22,500)

Under this one-year patch, the sum of the following credits may offset both regular tax and AMT:

• Dependent care credit;
• Credit for the elderly and permanently and totally disabled;
• Mortgage credit;
• Child tax credit;
• Hope and Lifetime Learning credits;
• Adoption credit;
• Saver's credit;
• Non-business energy property credit for energy-efficient improvements to a principal residence;
• Residential energy efficient property credit for photovoltaic, solar hot water, and fuel cell property added to a residence; and
• First-time D.C. homebuyer credit.

Although Congress has had several proposals, they have not dealt with the AMT issue for 2008.

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Mortgage Insurance Premium Deduction Extended

New Law - The Mortgage Relief Act extends the rules treating qualified mortgage insurance premiums as deductible qualified residence interest for three years. Thus, they apply if the amounts: (1) are paid or accrued before Jan. 1, 2011; (2) aren't properly allocable to any period after Dec. 31, 2010; and (3) are paid or accrued with respect to a mortgage insurance contract issued after Dec. 31, 2006.

To be deductible, the premiums must have been paid in connection with acquisition debt for a mortgage insurance contract issued after Dec. 31, 2006. It must be for a qualified residence (first and second homes) and the premiums must have been paid or accrued after Dec. 31, 2006 and before Jan. 1, 2011.

The deductible amount of the premiums phases out ratably by 10% for each $1,000 (or fraction thereof) by which the taxpayer's AGI exceeds $100,000 (10% for each $500 (or fraction thereof) by which a married separate taxpayer's AGI exceeds $50,000).

Qualified mortgage insurance means mortgage insurance provided by the Veterans Administration (VA), Federal Housing Administration (FHA), or Rural Housing Administration (RHA), and private mortgage insurance, as defined by Sec. 2 of the Homeowners Protection Act of '98 (12 U.S.C. 4901), as in effect on Dec. 20, 2006. Prepaid premiums for mortgage insurance, other than that provided by the VA or RHA, are not fully deductible in 2007 but must be amortized over the period to which they apply. The unamortized balance is not deductible if the mortgage is paid off before the end of its term.

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Misclassified Workers to File New Social Security Tax Form

The Internal Revenue Service has developed a new form for employees who have been misclassified as independent contractors by an employer. Form 8919, Uncollected Social Security and Medicare Tax on Wages, will now be used to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation.

Generally, a worker who receives a Form 1099 for services provided as an independent contractor must report the income on Schedule C and pay self-employment tax on the net profit, using Schedule SE. However, sometimes the worker is incorrectly treated as an independent contractor when they are actually an employee. When this happens, Form 8919 will be used beginning for tax year 2007 by workers who performed services for an employer but the employer did not withhold the worker’s share of social security and Medicare taxes.

In addition, the worker must meet one of several criteria indicating they were an employee while performing the services. The criteria include:

• The worker has filed Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, and received a determination letter from the IRS stating they are an employee of the firm.
  
  
• The worker has been designated as a Section 530 employee by their employer or by the IRS prior to January 1, 1997.
  
  
• The worker has received other correspondence from the IRS that states they are an employee.
  
  
• The worker was previously treated as an employee by the firm and they are performing services in a similar capacity and under similar direction and control.
  
  
• The worker’s co-workers are performing similar services under similar direction and control and are treated as employees.
  
  
• The worker’s co-workers are performing similar services under similar direction and control and filed Form SS-8 for the firm and received a determination that they were employees.
  
  
• The worker has filed Form SS-8 with the IRS and has not yet received a reply.

By using Form 8919, the worker’s Social Security and Medicare taxes will be credited to their social security record. To facilitate this process, the IRS will electronically share Form 8919 data with the Social Security Administration.

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BRIEFS

Happy New Year!

We would like to take this opportunity to thank you for your continued patronage and wish you and your family a very Happy New Year. We look forward to assisting you with the preparation of your returns this tax season.

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Hybrid Vehicle Credit Update

Nissan Motors - The Internal Revenue Service has acknowledged the certification by Nissan North America, Inc. that its 2008 Nissan Altima Hybrid vehicle meets the requirements of the Alternative Motor Vehicle Credit as a qualified hybrid motor vehicle. The credit amount for the hybrid vehicle certification of the 2008 Nissan Altima Hybrid is $2,350.

American Honda Motor Company - The Internal Revenue Service announced that American Honda Motor Company, Inc, has submitted quarterly reports indicating that its cumulative sales of qualified vehicles to retail dealers reached the 60,000-vehicle limit during the calendar quarter ending Sept. 30, 2007. Thus, the credit for all new qualified hybrid passenger automobiles or light trucks manufactured by Honda will begin to phase out on Jan. 1, 2008.

Vehicles purchased before Jan. 1, 2008 qualify for the full credit. For Honda hybrid vehicles bought on or after Jan. 1, 2008, and on or before June 30, 2007, the credit is 50 percent of the otherwise allowable credit amount. Taxpayers buying vehicles on or after July 1, 2008, and on or before Dec. 31, 2008, can only get 25 percent of the credit.

Here are the credit amounts for Jan. 1, 2008 – June 30, 2008:

• Honda Accord Hybrid AT, Model Year 2007 – $650
• Honda Accord Hybrid Navi AT, Model Year 2007 – $650
• Honda Civic Hybrid CVT, Model Year 2007 – $1,050
• Honda Civic Hybrid CVT, Model Year 2008 – $1,050

Here are the credit amounts for July 1, 2008 – Dec. 31, 2008:

• Honda Accord Hybrid AT, Model Year 2007 – $325
• Honda Accord Hybrid Navi AT, Model Year 2007 – $325
• Honda Civic Hybrid CVT, Model Year 2007 – $525
• Honda Civic Hybrid CVT, Model Year 2008 – $525

Beginning Jan. 1, 2009, taxpayers who buy a Honda hybrid cannot claim the related tax credit.

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Self-Prescribed Diagnostic Medical Procedures

It has become quite common for individuals to schedule medical diagnostic procedures as a precaution and without any symptoms of illness and a recommendation by their physician. This has raised a number of questions, since to be deductible, a medical expense must be related to the diagnosis, mitigation, treatment, cure or prevention of disease, or any condition affecting any structure or function of the body, including obstetrical services.

A recent IRS Revenue Ruling clarifies that the tax code does not limit the deduction to amounts paid for the least expensive form of medical care applicable, and (2) a physician's recommendation, while often important to determine whether certain expenses are for medical or personal reasons, is unnecessary when the expenditures are for items wholly medical in nature and that serve no other function.

The Revenue Ruling cites three scenarios that clarify the Tax Code limitations and when a physician’s recommendation is not required.

• Scenario #1 – The cost of an annual physical examination qualifies as a medical expense even though the taxpayer was not experiencing any symptoms of illness.
  
  
• Scenario #2 - The cost of a full body scan qualifies as a medical expense even though the taxpayer was not experiencing any symptoms of illness and even though the procedure was not recommended by a physician. The reasoning was that it was wholly medical in nature and served no other function.
  
  
• Scenario #3 - The cost of a kit for a self-administered pregnancy test qualified as a medical expense, even though it tested the healthy functioning of the body rather than attempted to detect disease.

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