IRS Changes Applicability Date of Embedded Loan Rule; November AFRs Issued; Taxpayers Weren't Entitled to Losses from Brother's Business; Income Not Imputed to Employees Purchasing Optional Insurance; Applicable Dollar Amounts for PCORI Released ...
The first installment of Parker's annual two-part series on year-end tax planning recaps 2015's major changes affecting individual taxpayers, and strategies clients can use to minimize their 2015 tax bill. The online version of the article includes links to sample year-end client letters for individuals and businesses.
Modified Obamacare Definition of "Small Business" Indirectly Affects Cafeteria Plans
A change to the non-tax definition of "small businesses" under the ACA, intended to head off expected increases in insurance premiums for some employers after December 31, 2015, indirectly affects qualified benefits under cafeteria health plans. H.R. 1624 (10/7/15).
Ninth Circuit Rejects Assignment of Noncompete Income to Partnership that Contributed No Value to Joint Venture
No valid partnership existed where one party to a joint venture did not contribute anything of value and allocations between the parties did not conform to the joint venture agreement. Accordingly, the Ninth Circuit upheld the Tax Court in declining to assign any portion of the proceeds from a noncompetition agreement to the partnership. DJB Holding v. Comm'r, 2015 PTC 361 (9th Cir. 2015).
IRS and SSA Release Inflation-Adjusted Amounts for 2016; Social Security Wage Base and Many Other Amounts Unchanged
The IRS and the Social Security Administration have released annual inflation-adjusted amounts for deductions, credits, phaseouts, and other amounts for 2016. For only the second time since indexing began in 1972, the Social Security wage bases remains unchanged from the previous year. Rev. Proc. 2015-53.
The IRS has announced 2016 cost-of-living adjustments (COLA) for pension and retirement plans. IR-2015-118.
Eleventh Circuit Rejects Penalties Relating to Voluntary Disclosure under Amnesty Program
The Eleventh Circuit rejected accuracy related penalties, finding it was disingenuous for the IRS to apply penalties on a taxpayer who disclosed his participation in a tax shelter in response to an IRS Announcement that had said no penalties would apply to taxpayers who stepped forward. Kearney Partners Fund, LLC v. U.S., 2015 PTC 366 (11th Cir. 2015).
The IRS has issued proposed regulations that reflect the holdings of Obergefell v. Hodges, Windsor v. United States, and Rev. Rul. 2013-17. The proposed regs define terms in the Code describing the marital status of taxpayers in a gender-neutral way. The IRS also reiterates that domestic partnerships, civil unions, or other similar relationships are not considered "marriage" for federal tax purposes. REG-148998-13 (10/23/15).
Where a taxpayer's debt was discharged, he could not rely on statements from the lender and IRS employees that such discharge was excludible from income; nor was there was there any hardship provision that excluded such discharge from income because of the taxpayer's cancer. Dunnigan v. Comm'r, T.C. Memo. 2015-190.
IRS Goes After Law Firm for Tax Shelter Transactions, Assesses Over $11 Million in Penalties
The IRS assessed $11.28 million in fines under Code Sec. 6708 for a law firm's failure to register transactions the IRS deemed were tax shelters, and to turn over a list of participants. A district court needed additional fact finding to determine whether the fines were excessive and whether the firm had reasonable cause to withhold the list and, thus, judgment could not be entered at this stage. Callister Nebeker & McCullough v. U.S., 2015 PTC 365 (D. Utah 2015).
2015 Year-End Tax Planning for Individuals
The first installment of Parker's annual two-part series on year-end tax planning recaps 2015's major changes affecting individual taxpayers, and strategies clients can use to minimize their 2015 tax bill. The online version of the article includes links to sample year-end client letters for individuals and businesses.
Introduction
Just as the daylight hours are getting shorter, so is the time for practitioners to fine tune any last-minute strategies to lower their clients' 2015 tax bill. While year-end legislation extending certain expired tax benefits may still come to pass and be of benefit to individual taxpayers, there are other options practitioners should explore for potentially lowering a client's taxes. Often, the correct steps to take will depend on whether the client's income is predicted to go up or down next year.
The following article on year-end planning for individuals is the first of two installments in Parker's year-end tax planning series. An in-depth look at year-end planning for business will appear in the next issue of Parker's Federal Tax Bulletin.
CLIENT LETTERS for both individuals and businesses are available online now:
Practice Aid: See ¶320,131 for a comprehensive year-end letter for individuals. For a comprehensive year-end planning letter for businesses, see ¶320,130.
It's important that practitioners meet with clients before the end of the year to nail down any actions that may be appropriate with respect to their 2015 tax return. The following is a recap of changes affecting individual taxpayers in 2015, and a discussion of some tax strategies that practitioners may want to consider.
Income Subject to Top Tax Rate
For 2015, the top tax rate of 39.6% will apply to incomes over $413,201 (single), $464,851 (married filing jointly and surviving spouse), $232,426 (married filing separately), and $439,000 (heads of households). However, high-income taxpayers are also subject to the 3.8 percent net investment income tax and/or the 0.9 percent Medicare surtax. If clients are subject to one or both of these additional taxes, there are certain actions practitioners should discuss that can mitigate the damage of these additional taxes.
Retirement Plans Considerations
Fully funding a company 401(k) with pre-tax dollars will reduce current year taxes, as well as increase retirement nest eggs. For 2015, the maximum 401(k) contribution taxpayers can make with pre-tax earnings is $18,000. For taxpayers 50 or older, that amount increases to $24,000.
For taxpayers with a SIMPLE 401(k), the maximum pre-tax contribution for 2015 is $12,500. That amount increases to $15,500 for taxpayers age 50 or older.
If certain requirements are met, contributions to an individual retirement account (IRA) may be deductible. For taxpayers under 50, the maximum contribution amount for 2015 is $5,500. For taxpayers 50 or older but less than age 70 1/2, the maximum contribution amount is $6,500. Contributions exceeding the maximum amount are subject to a 6 percent excise tax. Even if a client is not eligible to deduct contributions, contributing after-tax money to an IRA may be advantageous because it will allow the client to later convert that traditional IRA to a Roth IRA. Qualified withdrawals from a Roth IRA, including earnings, are free of tax, while earnings on a traditional IRA are taxable when withdrawn.
If a client already has a traditional IRA, practitioners should evaluate whether it is appropriate to convert it to a Roth IRA this year. The client will have to pay tax on the amount converted as ordinary income, but subsequent earnings will be free of tax. And if the client has a traditional 401(k), 403(b), or 457 plan that includes after-tax contributions, a new rule allows him or her to generally rollover these after-tax amounts to a Roth IRA with no tax consequences. A rollover of a SIMPLE 401(k) into a Roth IRA may also be available. As with all tax rules, there are qualifications that apply to these rollovers that practitioners should discuss before their clients take any actions.
Additionally, the Treasury Department has introduced a starter retirement account known as "myRA," into which taxpayers may deposit tax refunds. The program allows individuals to establish a Roth IRA with a Treasury Department designated custodian. Taxpayers can continue to participate in the program until the account balance reaches $15,000 or until he or she has participated in the program for 30 years, whichever occurs first. At any time, individuals can transfer the balance to a commercial financial services provider to take advantage of a broader array of retirement products available in the marketplace. Because the accounts offered through the program are Roth IRAs, they have the same tax treatment and follow the same rules as Roth IRAs.
Finally, self-directed IRAs allow an IRA owner to have more control over the type of investments that will be held in the IRA. However, the large amount of money held in self-directed IRAs makes them attractive targets for fraud promoters. Thus, self-directed IRA can be costly if not properly managed. In addition, because of the types of investments taxpayers with self-directed IRAs are able to make, taxpayers have a greater risk of running afoul of the prohibited transaction rules. The prohibited transaction rules impose an excise tax on certain transactions - such as sales of property, the lending of money or extension of credit, or the furnishing of goods, services, or facilities - between an IRA and a disqualified person. If a client has a self-directed IRA, practitioners need to review the specifics of the arrangement.
Net Investment Income Tax Considerations
A 3.8 percent tax applies to certain net investment income of individuals with income above a threshold amount. The threshold amounts are $250,000 (married filing jointly and qualifying widow(er) with dependent child), $200,000 (single and head of household), and $125,000 (married filing separately). In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities. Thus, while the top tax rate for qualified dividend income is generally 20%, the top rate on such income increases to 23.8% for a taxpayer subject to the net investment income tax.
One way around the increased tax rate on dividend income is to invest instead in tax-exempt state and municipal bonds. The bonds generate tax-exempt income which isn't subject to the net investment income tax and is not included in determining if taxpayers meet the threshold amount for being subject to the net investment income tax. Note, however, that such income may be subject to state taxes and the alternative minimum tax. Additionally, taxpayers selling an appreciated asset, the gain from which will exceed the threshold amount for being subject to the net investment income tax, should consider selling the asset on an installment basis.
The net investment income tax also applies to income from trades or businesses that are passive activities. An activity is not generally considered passive if the taxpayer materially participates in the activity. If a client is engaged in an activity which may be considered passive and thus has the potential to trigger the net investment income tax, practitioners should evaluate the factors for determining material participation to see if they can help the client escape this tax.
Finally, since net capital losses can be used against capital gains, taxpayers may want to consider getting rid of some losing stocks.
Additional Medicare Taxes
An additional Medicare tax of 0.9 percent is imposed on wages and self-employment income in excess of a threshold amount. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case. Employers are required to withhold the extra .9 percent once an individual's wages pass $200,000. No deduction is allowed for the additional tax. However, married taxpayers may be due a credit if, for example, they use the married filing jointly status, one spouse had wages over $200,000, but joint wages are less than $250,000. On the flip side, married taxpayers may owe the additional .9 percent if they file jointly and each made under $200,000 of wages but together made over $250,000 in wages.
AMT Considerations
Because many deductions taken for regular tax purposes are not allowed for alternative minimum tax (AMT) purposes, clients may be subject to the AMT if he or she has excessive deductions. Deductions which typically throw taxpayers into an AMT situation include high state and local taxes, interest on home equity loans, a high number of dependent deductions, and a large amount of miscellaneous itemized deductions. For 2015, the AMT rate is 26% on alternative minimum taxable income (AMTI) up to $185,400 ($92,700 for married filing separately) and 28% on AMTI over that amount. Taxpayers are allowed an AMT exemption depending on filing status, but the exemption is phased out for taxpayer's above a certain income level.
If it looks like a client may be subject to the AMT this year, practitioners should discuss what actions can be taken to reduce his or her exposure. Since the calculation of the AMT begins with adjusted gross income, lowering a clients adjusted gross income by maximizing contributions to a tax-deferred retirement plan (e.g., 401(k)) or tax-deferred health savings account may be appropriate. Additionally, if a client uses his or her home for business, related expenses (e.g., a portion of the property taxes, mortgage interest, etc.) allocable to Schedule C will also reduce adjusted gross income.
American Opportunity Credit
If a client, his or her spouse, or a dependent incurred qualified education expenses to attend an accredited postsecondary institution (e.g., a college or university), he or she may be eligible for the American Opportunity Credit. The maximum annual credit is $2,500 per eligible student. Expenses which qualify for the credit include tuition and fees required for the enrollment or attendance at an eligible educational institution. For taxpayers with modified adjusted gross income in excess of $80,000 ($160,000 for joint filers), the amount of the credit is phased out. The credit is not available for married taxpayers filing separately.
Obamacare Considerations
Under Obamacare, there is a penalty, known as the "shared responsibility payment," for not having health insurance coverage. Clients who did not have health insurance for two or more months in 2015 may be liable for this penalty. However, clients may be eligible for an exemption from the penalty depending on their income. The penalty is 2 percent of the client's 2015 income or $325 per adult, whichever is higher, and $162.50 per uninsured dependent under 18, up to $975 total per family.
Extension of the Health Coverage Tax Credit
Taxpayers who receive benefits under certain trade adjustment assistance (TAA) programs or benefits from the Pension Benefit Guaranty Corporation (PBGC) generally are allowed a credit for a percent of amounts paid for qualified health insurance coverage. This Health Coverage Tax Credit (HCTC) was set to expire at the end of 2013 but was extended and modified by the Trade Preferences Extension Act of 2015. The HCTC can now be claimed for coverage through 2019.
Compliance Tip: Unfortunately, taxpayers who wish to claim the credit for 2014 must wait for IRS guidance. The credit cannot be claimed using an old or altered Form 8885 because, while the new law is similar to the version that expired in 2013, it includes modifications that affect how the credit is administered.
Child Tax Credit
The Trade Preferences Extension Act also added a provision which limits the refundable portion of the child tax credit for taxpayers who elect to exclude foreign earned income from tax.
Tax Extenders Legislation
Additional tax benefits may be available if Congress passes Tax Extender legislation introduced in the Senate in August. That legislation would retroactively extend many tax breaks that expired in 2014. If it passes, the bill will extend the following tax breaks through 2016:
- the deduction by elementary and secondary school teachers of up to $250 of qualified expenses they paid during the year ($500 on a joint return if both spouses were eligible educators) and expand the deduction to include expenses in connection with the professional development activities of an educator;
- the exclusion from income of imputed income from the discharge of acquisition indebtedness for a principal residence;
- the equalization of the tax exclusion for employer-paid mass transit and parking benefits and expands such exclusion to include bike sharing programs;
- the tax deduction for mortgage insurance premiums;
- the tax deduction for state and local general sales taxes in lieu of state and local income taxes;
- the tax deduction for contributions of property made for conservation purposes;
- the deduction from gross income for qualified tuition and related expenses; and
- the tax-free distributions from IRAs for charitable purposes.
Other Steps to Consider Before the End of the Year
The following are some of the additional actions practitioners should review before year end to see if they make sense for clients. The focus should not be entirely on tax savings. These strategies should be adopted only if they make sense in the context of the client's total financial picture.
Accelerating Income into 2015
Depending on the client's projected income for 2016, it may make sense to accelerate income into 2015 if the client expects 2016 income to be significantly higher. Options for accelerating income include:
(1) harvesting gains from the client's investment portfolio, keeping in mind the 3.8 investment income tax;
(2) as previously mentioned, converting a retirement account into a Roth IRA and recognizing the conversion income this year;
(3) taking IRA distributions this year rather than next year;
(4) for self-employed clients with receivables on hand, trying to get clients or customers to pay before year end; and
(6) settling lawsuits or insurance claims that will generate income this year.
Deferring Income into 2016
There are also scenarios (for example, if the client thinks that his or her income will decrease substantially next year) in which it might make sense to defer income into 2016 or later years. Some options for deferring income include:
(1) if a client is due a year-end bonus, having the employer to pay the bonus in January 2016;
(2) if a client is considering selling assets that will generate a gain, postponing the sale until 2016;
(3) delaying the exercise of any stock options;
(4) if a client is selling property, considering an installment sale; and
(5) parking investments in deferred annuities.
Deferring Deductions into 2016
If a client anticipates a substantial increase in taxable income, practitioners may want to explore pushing deductions into 2016 by looking at the following:
(1) postponing year-end charitable contributions, property tax payments, and medical and dental expense payments, to the extent deductions are available for such payments, until next year; and
(2) postponing the sale of any loss-generating property.
Accelerating Deductions into 2015
If a client expects his or her income to decrease next year, accelerating deductions into the current year can offset the higher income this year. Some options include:
(1) prepaying property taxes in December;
(2) making January mortgage payment in December;
(3) if a client owes state income taxes, making up any shortfall in December rather than waiting until the return is due;
(4) since medical expenses are deductible only to the extent they exceed 10 percent (7.5 percent for individuals age 65 before the end of the year) of adjusted gross income (AGI), bunching large medical bills not covered by insurance into one year to help overcome this threshold;
(5) making any large charitable contributions in 2015, rather than 2016;
(6) selling some or all loss stocks; and
(7) if a client qualifies for a health savings account, setting one up and making the maximum contribution allowable.
Life Events
Certain life events can also affect a client's tax situation. If the client got married or divorced, had a birth or death in the family, lost or changed jobs, retired during the year, should discuss the tax implications of these events.
Miscellaneous Items
Finally, these are some additional miscellaneous items to consider:
(1) Encourage clients that have a health flexible spending account with a balance to spend it before year end (unless their employer allows them to go until March 16, 2016, in which case they'll have until then). Clients may want to check with their employer to see if they give the optional grace period to March 15.
(2) If a client owns a vacation home that he or she rented out, practitioners should look at the number of days it was used for business versus pleasure to see if there are ways to maximize tax savings with respect to that property. For example, if the client spent less than 14 days at the home, it may make sense to spend a few more days and have the house qualify as a second residence, with the interest being deductible. For a rental home, rental expenses, including interest, are limited to rental income.
(3) Practitioners should also consider if there is any income that can be shifted to a child so that the income is paid at the child's rate.
(4) If a client has any foreign assets, there are reporting and filing requirements with respect to those assets. Noncompliance carries stiff penalties.
Modified Obamacare Definition of "Small Business" Indirectly Affects Cafeteria Plans
A change to the non-tax definition of "small businesses" under the ACA, intended to head off expected increases in insurance premiums for some employers after December 31, 2015, indirectly affects qualified benefits under cafeteria health plans. H.R. 1624 (10/7/15).
On October 7, 2015, President Obama signed into law H.R. 1624, the Protecting Affordable Coverage for Employees Act (PACE Act), which amended the Affordable Care Act's (ACA) non-tax definition of a "small business."
Originally, under the ACA, the definition of a "small business" was scheduled to change from employers with up to 50 employees to include employers with up to 100 employees after December 31, 2015. This change would have required many mid-sized businesses to be subject to different insurance rating rules and requirements.
The PACE Act prevents this scheduled change, keeping the ACA definition of a "small business" to employers with up to 50 employees. The law does, however, grant states the option to treat businesses with up to 100 employees as small employers.
Observation: The PACE Act does not modify the definition of an "applicable large employer" for purposes of the employer mandate and penalties under Code Sec. 4980H.
The bill is intended to protect businesses with 51 to 100 employees from potential healthcare premium increases. A report found that if the small group definition increased to 100 employees, healthcare premiums for mid-sized employers could increase by 18 percent. Subsequently, such employers may have chosen to self-insure instead of being subject to the ACA's requirements for small employers, thus further increasing premiums.
Although not designed as a tax measure, the PACE Act does have an indirect effect on cafeteria plan benefits. Under Code Sec. 125(f)(3), certain qualified health plans may be offered through cafeteria plans if the employee's employer is a qualified employer under the ACA. Because a "qualified employer" in this context is defined as certain small employers, the PACE Act's modification of the definition of "small employers" will affect qualified benefits under Code Sec. 125.
Ninth Circuit Rejects Assignment of Noncompete Income to Partnership that Contributed No Value to Joint Venture
No valid partnership existed where one party to a joint venture did not contribute anything of value and allocations between the parties did not conform to the joint venture agreement. Accordingly, the Ninth Circuit upheld the Tax Court in declining to assign any portion of the proceeds from a noncompetition agreement to the partnership. DJB Holding v. Comm'r, 2015 PTC 361 (9th Cir. 2015).
Background
Daren Barone and Gregory Watkins were experienced in asbestos removal and established a successful environmental remediation company, Watkins Contracting, Inc (WCI). To shield themselves from liability, the two men restructured WCI so that several corporate entities stood between them and the company. Barone and Watkins each formed a holding corporation, and the two corporations entered a partnership, WB Partners. Barone and Watkins also formed a third holding company, WB Acquisition, Inc., and transferred their interest in WCI to this company. Finally, WB Partners purchased all shares of WB Acquisition. As a result, WCI was owned by WB Acquisition, which was owned by WB Partners, which in turn was owned by Barone's and Watkins's holding corporations.
An opportunity arose to do environmental remediation work for a massive redevelopment project at the San Diego Naval Training Center. To win the contract, however, WCI had to post a large bond against the possibility that it would be unable to complete the work. To ensure that WCI could afford the bond, Barone and Watkins caused WCI and WB Partners to form NTC Joint Venture. Under the terms of the joint venture agreement, WCI would do the environmental remediation work, and WB Partners would supply financial guaranties. In exchange for these services, WCI would receive 30 percent of the venture's profits, and WB Partners would receive 70 percent. Barone and Watkins promised to provide financial services as necessary to support WB Partners' business.
NTC Joint Venture obtained an employer identification number and its own bank account. Notwithstanding the terms of the agreement, the joint venture's accountant opted not to file a tax return for the venture. Instead, the accountant believed that separately reporting WCI's and WB Partners' income from the NTC project was sufficient.
The joint venture's structure had significant federal income tax consequences. WCI would have to pay corporate income tax on its 30-percent share of the venture's profits. As a general partnership, WB Partners would pay no income tax on its 70-percent share; instead, that income would pass through to WB Partners' owners, the two holding corporations. The holding corporations were S corporations owned by tax-exempt retirement savings plans.
Because the NTC project was more profitable than expected, the NTC Joint Venture capped WB Partners' profits and awarded WCI approximately $1.6 million more than it was entitled to under the NTC Joint Venture agreement. This additional allocation resulted in an actual allocation of profits between WCI and WB Partners of 49.6 percent and 50.4 percent, respectively.
In 2003, while the NTC project was ongoing, WCI entered an asset purchase agreement with Kuranda Capital, LP. As part of the transaction, Watkins, Barone, and WCI agreed not to compete with Kuranda in the environmental remediation business. The agreement allocated $3.4 million of the purchase price to the noncompetition agreement. All of the noncompetition agreement's proceeds, including interest from the note, was reported on WB Partners' tax returns.
The IRS determined that the NTC Joint Venture was not a partnership for federal tax purposes and notified WB Acquisition and WB Partners of tax deficiencies for tax years 2002 through 2005. The taxpayers contested the deficiencies and took their case to the Tax Court. Before the court, they argued that WB Partners' financial guaranty was an essential contribution to the NTC Joint Venture because WCI could not have won the NTC project without it. Thus, they contended, they had the necessary intent to operate the NTC Joint Venture as a partnership.
Analysis
The Tax Court held that the NTC Joint Venture was not a valid partnership for tax purposes and, therefore, all of the joint venture's profits were taxable income to WCI. The Tax Court also held that the income from the noncompetition agreement was taxable income to WCI. Because WCI had substantially understated its income, the Tax Court upheld the IRS's assessment of accuracy-related penalties. The taxpayers appealed. On appeal, the taxpayers argue that WB Partners' financial guaranty and those of its owners and their employees were in fact a valuable contribution because WCI could not otherwise have posted a performance bond.
The Ninth Circuit affirmed the Tax Court's decision, holding that no valid partnership existed and that the income from the noncompete agreement was taxable to WCI. The court concluded that WB Partners contributed no value to the NTC Joint Venture. The court rejected the argument that WB Partners' financial guaranty was a valuable contribution to the joint venture, noting that WCI won the NTC bond based on the combined net worth and financial guaranties of, among others, WCI, WB Partners, Barone, and Watkins, and not based on WB Partners' guaranty alone. Additionally, the court said that the profit cap on the NTC project, which was at odds with the allocation described in the joint venture agreement, showed that WCI and WB Partners did not intend to share profits and losses as bona fide partners would.
With respect to the income from the noncompetition agreement, the Ninth Circuit noted that when a commercial transaction includes a noncompetition agreement, the portion of the proceeds allocated to that agreement is income to the persons who promised not to compete. The court found that the Tax Court erred in finding that only WCI was bound by the noncompetition agreement. Under California law, the court said, Barone and Watkins were free to sever their ties to WCI and perform environmental remediation services for another company. Thus, the noncompetition agreement bound Barone and Watkins personally not to compete with Kuranda in the environmental remediation business. As a result, WCI, Barone, and Watkins were entitled to a share of the noncompetition agreement. However, the court said, because WB Partners had no claim to Barone's and Watkins's future services, WB Partners was entitled to no share at all and the Tax Court did not err in declining to assign any portion of the proceeds of the noncompetition agreement to WB Partners.
Finally, the court held that because the taxpayers had not supplied their accountant with all the necessary and accurate information on which to prepare their returns, they could not avoid liability for the accuracy-related penalty.
For a discussion of the factors that are considered in determining if a valid partnership exists, see Parker Tax ¶20,105.
IRS and SSA Release Inflation-Adjusted Amounts for 2016; Social Security Wage Base and Many Other Amounts Unchanged
The IRS and the Social Security Administration have released annual inflation-adjusted amounts for deductions, credits, phaseouts, and other amounts for 2016. For only the second time since indexing began in 1972, the Social Security wage bases remains unchanged from the previous year. Rev. Proc. 2015-53.
Practice Aid: See Parker Tax ¶360,019 for a Quick Reference guide to the key amounts, limits, and rates for 2016. For a Quick Reference guide on key 2016 phaseout ranges, see Parker Tax ¶360,020.
The following is a roundup of the key inflation adjusted tax numbers for 2016 from Rev. Proc. 2015-53 and the Social Security Administration website.
Social Security Wage Base
The maximum wage base for the OASDI (social security) portion of FICA and the Self-Employment Tax for 2016 is $118,500, the same amount as last year (source: Social Security Administration website).
Taxable Income Subject to the Maximum Rates
The tax rate of 39.6 percent affects singles whose income exceeds $415,050 and married taxpayers filing a joint return whose income exceeds $466,950 (up from $413,200 and $464,850, respectively). The other marginal rates - 10, 15, 25, 28, 33 and 35 percent - and the related income tax thresholds are described in the revenue procedure.
Standard Deduction Amounts
The standard deduction rises to $6,300 for singles and married persons filing separate returns and $12,600 for married couples filing jointly (same as last year). The standard deduction for heads of households rises to $9,300 (up from $9,250).
The standard deduction amount for an individual who may be claimed as a dependent by another taxpayer cannot exceed the greater of (1) $1,050 (same as last year), or (2) the sum of $350 and the individual's earned income (same as last year).
The additional standard deduction amount for the aged or the blind is $1,250 (same as last year). The additional standard deduction amount is $1,550 (same as last year) if the individual is also unmarried and not a surviving spouse.
Itemized Deduction Limitation
The limitation for itemized deductions to be claimed on tax year 2015 returns of individuals begins with incomes of $259,400 or more ($311,300 for married couples filing jointly).
Personal Exemption and Phaseout Amounts
The personal exemption for tax year 2016 rises to $4,050 (up from $4,000 last year). However, the exemption is subject to a phase-out that begins with adjusted gross incomes of $259,400 ($311,300 for married couples filing jointly). It phases out completely at $381,900 ($433,800 for married couples filing jointly.)
Alternative Minimum Tax Exemption
The Alternative Minimum Tax exemption amount for tax year 2016 is $53,900 ($83,800, for married couples filing jointly). The 2015 exemption amount was $53,600 ($83,400 for married couples filing jointly).
Earned Income Credit
The 2016 maximum Earned Income Credit amount is $6,269 for taxpayers filing jointly who have three or more qualifying children (up from $6,242 last year). The revenue procedure has a table providing maximum credit amounts for other categories, income thresholds and phaseouts.
Estate Tax Exclusion
Estates of decedents who die during 2016 have a basic exclusion amount of $5,450,000 (up from $5,430,000 for estates of decedents who died in 2015).
Limit on Employee Contributions to FSAs
The annual dollar limit on employee contributions to employer-sponsored healthcare flexible spending arrangements (FSA) is $2,550 (same as last year).
Small Employer Health Insurance Credit
Under the small business health care tax credit, the maximum credit is phased out based on the employer's number of full-time equivalent employees in excess of 10 and the employer's average annual wages in excess of $25,900 for tax year 2015 (up from $25,800).
Gift Tax Exclusions
The annual exclusion for gifts is $14,000 (same as last year).
For 2015, the exclusion from tax on a gift to a spouse who is not a U.S. citizen is $148,000 (up from $147,000).
Kiddie Tax
The amount used to reduce the net unearned income reported on a child's tax return subject to the kiddie tax, is $1,050 (same as last year).
Foreign Earned Income Exclusion Amount
For 2016, the foreign earned income exclusion rises to $101,300 (up from $100,800 for 2014).
U.S. Savings Bond Interest Exclusion for Higher Education Expenses
The exclusion from income for U.S. savings bond interest for taxpayers who pay qualified higher education expenses, begins to phase out for modified adjusted gross income above $116,300 for joint returns (up from $115,750) and $77,550 (up from $77,200) for other returns. The exclusion is completely phased out for modified adjusted gross income of $146,300 for joint returns and $92,550 for other returns.
Medical Savings Accounts
For purposes of medical savings accounts, a "high deductible health plan" means, for self-only coverage, a health plan that has an annual deductible that is not less than $2,250 (up from $2,200) and not more than $3,350 (up from $3,300), and under which the annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits do not exceed $4,450 (same as last year).
For family coverage in tax years beginning in 2016, the term "high deductible health plan" means a health plan that has an annual deductible that is not less than $4,450 (same as last year and not more than $6,700 (up from $6,650), and under which the annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits do not exceed $8,150 (same as last year).
Long-Term Care Premiums
The limitations for eligible long-term care premiums includible in the term "medical care" are: for individuals with an attained age of 40 or less before the close of the tax year, $390; more than 40 but not more than 50, $730; more than 50 but not more than 60, $1,460; more than 60 but not more than 70, $3,900; and more than 70, $4,870.
Attorney Fee Award Limitation
The attorney fee award limitation is $200 per hour (same as last year).
Child Adoptions
The credit allowed for an adoption of a child with special needs is $13,460. The maximum credit allowed for other adoptions is the amount of qualified adoption expenses up to $13,460. The available adoption credit begins to phase out for taxpayers with modified adjusted gross income in excess of $201,920 and is completely phased out for taxpayers with modified adjusted gross income of $241,920.
Hope Scholarship Credit/Lifetime Learning Credit
The Hope Scholarship Credit is an amount equal to 100 percent of qualified tuition and related expenses not in excess of $2,000 plus 25 percent of those expenses in excess of $2,000, but not in excess of $4,000. Accordingly, the maximum Hope Scholarship Credit is $2,500. A taxpayer's modified adjusted gross income in excess of $80,000 ($160,000 for a joint return) is used to determine the reduction in the amount of the Hope Scholarship Credit otherwise allowable. A taxpayer's modified adjusted gross income in excess of $55,000 ($111,000 for a joint return) is used to determine the reduction in the amount of the Lifetime Learning Credit otherwise allowable.
Qualified Transportation Fringe Benefit
For taxable years beginning in 2014, the monthly limitation regarding the aggregate fringe benefit exclusion amount for transportation in a commuter highway vehicle and any transit pass is $130 (same as last year). The monthly limitation for the fringe benefit exclusion amount for qualified parking is $255 (up from $250).
IRS Releases Retirement Plan COLA Amounts for 2016
The IRS has announced 2016 cost-of-living adjustments (COLA) for pension and retirement plans. IR-2015-118.
Practice Aid: See ¶ 360,410 for a Quick Reference guide to the retirement and pension plan limitations for 2013-2016. For a Quick Reference guide on key 2016 phaseout ranges, see Parker Tax ¶360,020.
The following are the key inflation adjusted numbers.
IRA Contributions. The limit on annual contributions to an individual retirement arrangement (IRA) remains unchanged at $5,500. The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.
IRA Phaseout Amounts. The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (AGI) between $61,000 and $71,000 (same as last year). For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $98,000 to $118,000 (same as last year). For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple's income is between $184,000 and $194,000 (up from $183,000 and $193,000). For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
Limitation on IRA Deduction for Active Participants. The applicable dollar amount under Code Sec. 219(g)(3)(B)(i) for determining the deductible amount of an IRA contribution for taxpayers who are active participants filing a joint return or as a qualifying widow(er) is unchanged at $98,000. The applicable dollar amount under Code Sec. 219(g)(3)(B)(ii) for all other taxpayers (other than married taxpayers filing separate returns) remains $61,000. The applicable dollar amount under Code Sec. 219(g)(3)(B)(iii) for a married individual filing a separate return is not subject to an annual cost-of-living adjustment and remains $0. The applicable dollar amount under Code Sec. 219(g)(7)(A) for a taxpayer who is not an active participant but whose spouse is an active participant is increased from $183,000 to $184,000.
Roth IRA AGI Phaseout Amounts. The AGI phase-out range for taxpayers making contributions to a Roth IRA is $184,000 to $194,000 for married couples filing jointly (up from $183,000 to $193,000). For singles and heads of household, the income phase-out range is $117,000 to $132,000 (up from $116,000 to $131,000). For a married individual filing a separate return, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
Contributions to SEP IRAs and other Defined Contribution Plans. The Code Sec. 415 limitation on contributions to SEP IRAs and other defined contribution plans is unchanged at $53,000.
Elective Deferrals. The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government's Thrift Savings Plan is unchanged at $18,000.
Catch-up Contributions. The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government's Thrift Savings Plan remains unchanged at $6,000.
Annual Compensation Limitation. The annual compensation limit under Code Secs. 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) is unchanged at $265,000.
Dollar Limitation for Key Employees in a Top-Heavy Plan. The dollar limitation under Code Sec. 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan remains unchanged at $170,000.
Limitation for Definition of Highly Compensated Employees. The limitation used in the definition of highly compensated employee under Code Sec. 414(q)(1)(B) is unchanged at $120,000.
Maximum Account Balance in an Employee Stock Ownership Plan. The dollar amount under Code Sec. 409(o)(1)(C)(ii) for determining the maximum account balance in an employee stock ownership plan subject to a 5distribution period is unchanged at $1,070,000, and the dollar amount used to determine the lengthening of the 5distribution period remains at $210,000.
Eleventh Circuit Rejects Penalties Relating to Voluntary Disclosure under Amnesty Program
The Eleventh Circuit rejected accuracy related penalties, finding it was disingenuous for the IRS to apply penalties on a taxpayer who disclosed his participation in a tax shelter in response to an IRS Announcement that had said no penalties would apply to taxpayers who stepped forward. Kearney Partners Fund, LLC v. U.S., 2015 PTC 366 (11th Cir. 2015).
Pat Sarma was the founder of a large tech company, American Megatrends. After deciding to sell his company's stock in 2001, Sarma was approached by KPMG with advice on how to shield the gain from the stock sale. KPMG and a company named Bricolage structured an investment vehicle, called FOCus, which consisted of a three-tiered set of partnerships. Through a complicated series of pre-planned steps, Bricolage and KPMG explicitly intended for FOCus to generate artificial losses for their high net-worth clients such as Sarma. At a meeting with Sarma in 2001, KPMG demonstrated to Sarma that by using the FOCus vehicle, he could offset his $80 million capital gain from the sale of American Megatrends with an artificial $80 million capital loss, thereby saving $16 million in taxes. In October of 2001, Sarma decided to buy a FOCus investment vehicle, which consisted of the following three partnerships: Kearney Partners Fund, LLC, Nebraska Partners Fund, LLC, and Lincoln Partners Fund, LLC (NLK FOCus).
In early 2002, the IRS released Announcement 2002-2, an amnesty provision which provided that if a taxpayer properly disclosed his involvement in a tax shelter, the IRS would waive certain accuracy-related penalties. Sarma decided to make a disclosure of his involvement in the NLK FOCus pursuant to the Announcement.
The IRS issued Notices of Final Partnership Administrative Adjustment (FPAA) to the three partnerships in the NLK FOCus. In the FPAAs, the IRS concluded that the partnerships' transactions lacked economic substance. The IRS disallowed all items claimed on the partnership returns on the ground that the partnerships constituted an abusive tax shelter designed to generate artificial, noneconomic tax losses. The IRS also assessed accuracy-related penalties due to the alleged misstatements on the tax returns. The partnerships challenged the FPAAs in a district court.
The U.S. District Court for the Middle District of Florida held that the partnerships lacked economic substance and the FPAAs properly made adjustments accordingly. However, the court held that the imposition of penalties was improper. The purpose of Announcement 2002-2, the court said, was to call out questionable behavior for scrutiny. According to the court, it was disingenuous for the IRS to turn around and apply penalties for a shelter pursuant to an Announcement that prompted the uncovering of the shelter in the first place. The court said the IRS needed to be held to the terms of its bargain and waived the accuracy-related penalties because Sarma's disclosure, made on behalf of the partnerships, was compliant with Announcement 2002-2.
The partnerships appealed the decision, questioning whether the district court had jurisdiction to determine all partnership and nonpartnership items for the tax periods in question, and, if it had jurisdiction, whether it erred in determining that the transactions at issue lacked economic substance and therefore had to be disregarded for tax purposes.
The Eleventh Circuit affirmed the lower court's decision without comment.
For a discussion of when accuracy-related penalties apply, see Parker Tax ¶262,120.
IRS Issues Proposed Regs Applying Supreme Court Decisions on Same-Sex Marriage
The IRS has issued proposed regulations that reflect the holdings of Obergefell v. Hodges, Windsor v. United States, and Rev. Rul. 2013-17. The proposed regs define terms in the Code describing the marital status of taxpayers in a gender-neutral way. The IRS also reiterates that domestic partnerships, civil unions, or other similar relationships are not considered "marriage" for federal tax purposes. REG-148998-13 (10/23/15).
Background
On June 26, 2013, the Supreme Court in United States v. Windsor, 2013 PTC 167 (S. Ct. 2013), held that Section 3 of the Defense of Marriage Act, which generally prohibited the federal government from recognizing the marriages of same-sex couples, was unconstitutional because it violated the principles of equal protection and due process.
Rev. Rul. 2013-17 provided guidance on the Windsor decision's effect on the IRS's interpretation of Code sections that refer to taxpayers' marital status. In the revenue ruling, the IRS ruled that if a same-sex couple is married in a state that recognizes such marriages, that marriage will be recognized for all federal purposes, no matter where the couple lives.
On June 26, 2015, the Supreme Court in Obergefell v. Hodges, 2015 PTC 380 S. Ct. (2015), held that state laws are "invalid to the extent they exclude same-sex couples from civil marriage on the same terms and conditions as opposite-sex couples" and "that there is no lawful basis for a
State to refuse to recognize a lawful same-sex marriage performed in another State on the ground of its same-sex character."
In light of the holdings of Windsor and Obergefell, the IRS determined that, for federal tax purposes, marriages of couples of the same-sex should be treated the same as marriages of couples of the opposite-sex and that, for reasons set forth in Rev. Rul. 2013-17, terms indicating sex, such as "husband," "wife," and "husband and wife," should be interpreted in a neutral way to include same-sex spouses as well as opposite-sex spouses.
The proposed regulations are effective when finalized. Once the proposed regulations are published as final regulations, Rev. Rul. 2013-17 will be obsolete, but taxpayers may continue to rely on the ruling's guidance until then.
Proposed Regs Define Terms Relating to Marital Status
The proposed regs amend the current regulations under Code Sec. 7701 to provide that, for federal tax purposes, the terms "spouse," "husband," and "wife" mean an individual lawfully married to another individual, and the term "husband and wife" means two individuals lawfully married to each other. These definitions apply regardless of sex.
In addition, the proposed regs provide that a marriage of two individuals will be recognized for federal tax purposes if that marriage would be recognized by any state, possession, or territory of the U.S. Under this rule, whether a marriage conducted in a foreign jurisdiction will be recognized for federal tax purposes depends on whether that marriage would be recognized in at least one state, possession, or territory of the U.S.
Although the proposed regulations define terms relating to marital status for federal tax purposes, the IRS may provide additional guidance as needed. For example, in Notice 2014-19 the IRS issued more particular guidance for employers regarding the application of Rev. Rul. 2013-17 to qualified retirement plans, and that guidance remains in effect.
Registered Domestic Partnerships, Civil Unions, or Other Similar Relationships Are Not Denominated as Marriage
The IRS noted that some couples choose to enter into a civil union or registered domestic partnership even when they could have married, and some couples who are in a civil union or registered domestic partnership choose not to convert those relationships into a marriage even when they have had the opportunity to do so. In many cases, such choices are deliberate, and couples who enter into civil unions or registered domestic partnerships may have done so with the expectation that their relationship will not be treated as a marriage for purposes of federal law.
The IRS observed that, for some of these couples, there are benefits to being in a relationship that provides some, but not all, of the protections and responsibilities of marriage. For example, some individuals who were previously married and receive Social Security benefits as a result of their previous marriage may choose to enter into a civil union or registered domestic partnership (instead of a marriage) so that they do not lose their Social Security benefits. More generally, the rates at which some couples' income is taxed may increase if they are considered married and thus required to file a married-filing-separately or married-filing-jointly federal income tax return.
The IRS said that treating couples in civil unions and registered domestic partnerships the same as married couples who are in a relationship denominated as marriage under state law could undermine the expectations certain couples have regarding the scope of their relationship. Further, no provision of the Code indicates that Congress intended to recognize as marriages civil unions, registered domestic partnerships, or similar relationships.
Accordingly, the IRS has stated that for federal tax purposes, the term "marriage" does not include registered domestic partnerships, civil unions, or other similar relationships recognized under state law that are not denominated as a marriage under that state's law, and the terms "spouse," "husband and wife," "husband," and "wife" do not include individuals who have entered into such a relationship.
Taxpayer's Cancer Doesn't Negate Liability for Tax on Discharged Debt Income
Where a taxpayer's debt was discharged, he could not rely on statements from the lender and IRS employees that such discharge was excludible from income; nor was there was there any hardship provision that excluded such discharge from income because of the taxpayer's cancer. Dunnigan v. Comm'r, T.C. Memo. 2015-190.
Donald Dunnigan was the sole proprietor of Donald Dunnigan Period House Appraisal (Dunnigan Appraisal). In 2008, Dunnigan Appraisal received a business line of credit for $50,000 from Swift Financial/M&I Bank FSB (Swift). The credit agreement provided that Dunnigan, both individually and on behalf of Dunnigan Appraisal, was liable for repayment. In 2009, Dunnigan was unable to pay back the borrowed funds in full. He negotiated with Swift to pay approximately $16,000 in settlement of the debt and Swift later reported on Form 1099-C, Cancellation of Debt, that it had canceled Dunnigan's debt of approximately $34,000 on September 28, 2009. It further indicated in Box 5 of Form 1099-C that Dunnigan was not personally liable for repayment of the debt.
On his Form 1040 for 2009, Dunnigan reported cancellation of debt income of approximately $68,000, consisting of three discharges of indebtedness from entities other than Swift. He did, however, include with his return a copy of the Form 1099-C issued by Swift and handwrote on it the following:
"Please note: Swift Financial indicated to me that I am not liable for repayment of cancelled debt. I had explained to them that I have a serious cancer problem, and that Im [sic[ 76 years old. Thus they marked Box 5 No'. The local IRS office suggested I explain the situation at time of filing, and felt it would likely come under Hardship' rules for approval."
The IRS determined that the discharge by Swift was taxable income to Dunnigan and assessed a deficiency. Before the Tax Court, Dunnigan argued that Swift and IRS employees told him that "hardship" rules could apply in his case and, thus, the discharged debt was not taxable income to him.
While expressing sympathy for Dunnigan's situation, the Tax Court held that Dunnigan was taxable on the discharged debt. The court noted that there is no hardship exception to the taxability of discharge of indebtedness income. While there are exceptions to recognizing such income, none applied to Dunnigan's situation. The court also found Dunnigan's reliance on alleged statements by Swift and IRS employees unpersuasive, noting that administrative guidance by the IRS is not binding, nor can it change the plain meaning of tax statutes.
For a discussion of the exceptions to the taxability of discharge of indebtedness income, see Parker Tax ¶72,315.
IRS Goes After Law Firm for Tax Shelter Transactions, Assesses Over $11 Million in Penalties
The IRS assessed $11.28 million in fines under Code Sec. 6708 for a law firm's failure to register transactions the IRS deemed were tax shelters, and to turn over a list of participants. A district court needed additional fact finding to determine whether the fines were excessive and whether the firm had reasonable cause to withhold the list and, thus, judgment could not be entered at this stage. Callister Nebeker & McCullough v. U.S., 2015 PTC 365 (D. Utah 2015).
According to the IRS, in 2001, certain attorneys with the law firm of Callister Nebeker & McCullough (CNM) began to promote a tax avoidance scheme designed to shelter certain clients' business income from tax through the acceleration of deductions for employer contributions to certain compensation plans. CNM's 2001 "scheme," the IRS said, involved contributions to nonqualified deferred compensation plans (NQDCPs). In 2004, after the IRS issued a new regulation targeting abuses arising out of transactions similar to the 2001 scheme, CNM implemented what the IRS deemed an "unwinding scheme" for clients (individual business owners).
According to the IRS, the unwinding scheme created a potentially abusive tax shelter that triggered reporting and disclosure obligations under Code Secs. 6111 and 6112. Under Section 6111, a tax shelter organizer must register the tax shelter with the IRS. Failure to do so results in penalties under Code Sec. 6707. In addition, Code Sec. 6112 requires a tax shelter organizer to maintain a list of participants in any potentially abusive tax shelter and to provide that list to the IRS upon request. Failure to do so results in penalties under Code Sec. 6708, unless the tax shelter organizer establishes reasonable cause for the failure.
Part of the unwinding process caught the IRS's attention and the IRS demanded that CNM disclose a list of the participants in the transactions. CNM refused. As a result, in 2010, the IRS assessed two penalties against the law firm: $195,081 for violating Code Sec. 6707 (i.e., failing to furnish information regarding reportable transactions); and $11.28 million for violating Code Sec. 6708 (i.e., failing to maintain lists of advisees with respect to reportable transactions).
CNM said it was not obligated to disclose the requested information because it was not a "tax shelter organizer" and because the unwinding scheme was not a "potentially abusive tax shelter." Alternatively, CNM argued that even if the transaction implementing the unwinding scheme fell within the statutory definition of a "potentially abusive tax shelter," CNM was not required to produce the requested information because doing so would violate attorney-client privilege under the Utah Rules of Professional Conduct. According to CNM, it refused to provide the list of participants based on advice of counsel, and cited the "reasonable cause exception" in Code Sec. 6708, which, if satisfied, would allow CNM to escape the disclosure requirements and penalties.
CNM filed a motion for judgment with a Utah district court. CNM requested, among other things a finding that the IRS's assessment of the $11.28 million penalty was an abuse of discretion and was an unconstitutionally excessive fine under the Eighth Amendment. CNM asserted that the IRS's admissions to allegations in the documents filed with the court established ample, undisputed facts to decide the issues as a matter of law.
The District Court noted that Code Sec. 6111 defines "tax shelter" as any investment with respect to which any person could "reasonably infer" from the representations made, or to be made, in connection with the offering for sale of interests in the investment that the tax shelter ratio for any investor may be greater than 2 to 1 and is "substantial." The "reasonably infer" test, the court said, and calculation of the "tax shelter ratio" were key to determining whether the transactions by CNM's clients should have been registered as tax shelters. The court agreed with the IRS that the phrase "any person could reasonably infer" required a factual determination of fact. The court also agreed with the IRS that the "reasonable cause" exception to the penalties assessed against CNM required a fact intensive determination that could not be hashed out in CNM's motion for judgment.
The court also stated that whether the Eighth Amendment applied required it to determine whether the Code Sec. 6708 penalty was punitive (which required an assessment of the penalty imposed and its purpose), and for it to consider whether the penalty was excessive. The court noted it could not decide at the time whether the $11.28 million fine was excessive, because it needed a fully developed record to determine whether the fine was proportionate to the gravity of the offense.
For a discussion of the penalties associated with tax shelters, see Parker Tax ¶253,170.
