Watch Out For Your Withholding Adjustment!

“Ponzi” schemes are fraudulent investment arrangements in which the party perpetrating the fraud receives cash or property from investors, purports to earn income for the investors, and reports to the investors income amounts that are wholly or partially fictitious. Payments, if any, of purported income or principal to investors are made from cash or property that other investors invested in the fraudulent arrangement.  The party perpetrating the fraud criminally appropriates some or all of the investors' cash or property.

The IRS has issued guidance addressing the tax treatment of losses due to criminally fraudulent investment arrangements in the form of "Ponzi" schemes.  The guidance provides that investors in such schemes will be entitled to claim a theft loss under the casualty loss rules, rather than a capital loss, because the perpetrators of such fraudulent schemes actually deprive investors of money by criminal acts.  In addition, since the loss is from a transaction entered into for profit, it is neither subject to the $100 ($500 for 2008) nor the 10% of gross income (AGI) personal loss limitations. 

The theft loss is deductible in the year it is discovered, provided that it is not covered by a claim for reimbursement, or other recovery as to which the investor has a reasonable prospect of recovery.  The amount of the theft loss deduction includes the amount invested in the scheme, less any amounts withdrawn, reimbursements, and claims as to which there is a reasonable prospect of recovery.  The deductible amount also includes any fictitious income that was reported to the investor in years prior to the discovery of the theft that was included in the investor's gross income, and reinvested in the scheme.

To the extent an investor's theft loss deduction exceeds the investor’s income for the year, a net operating loss (NOL) is created which allows the investor to carry that loss back up to three years and forward up to twenty years until used up.  Under a special rule for 2008, an eligible small business with a 2008 NOL can elect a 3-, 4-, or 5-year NOL carryback.

The IRS has provided a safe harbor for taxpayers to enable them to deduct losses from fraudulent investment schemes as theft losses.  The new procedure also provides guidance for taxpayers choosing not to use the safe harbor, but who plan to deduct investment fraud losses under the theft loss provisions of Code Sec. 165.  The procedure applies to investment fraud losses discovered in tax years after 2007.

The IRS procedure and rules related to claiming losses from fraudulent investments is somewhat complicated and includes certain qualifications and disclosure requirements.  Keep in mind that fraud must be involved, not just losses from investments.  If you or someone close to you has been a victim of a “Ponzi” scheme or, for that matter, any other type of investment fraud, please call this office for additional information about the available tax options.

In March, the  IRS announced that a total of 1,391,581 individual income tax returns were audited during FY 2008 (October 1, 2007 through September 30, 2008) out of a total of 137.8 million individual returns that were filed in the previous year.  This works out to about 1.0% of all individual returns filed (about the same as the audit rate for the preceding year).  However, this 1% national average includes large numbers of returns where the income is easily verifiable and the deductions not complicated.  Thus, if you have a more complicated return, your odds increase dramatically.  This is especially true for returns with earned income credit, self-employment income and returns with higher incomes.

If you were involuntarily terminated from you employment between September 1, 2008 and December 31, 2009 and your employer is covered under the COBRA rules, you may qualify for the subsidy.

The American Recovery and Reinvestment Act of 2009, signed into law on February 17, 2009, includes a federally-funded COBRA continuation subsidy of 65%, which lasts up to nine months for workers (and their families) involuntarily terminated between September 1, 2008 and December 31, 2009.

Under the new law, eligible former employees, enrolled in their employer’s health plan at the time they lost their jobs, are required to pay only 35% of the cost of COBRA coverage. Employers must make up the difference, but are entitled to a credit for the other 65% of the COBRA cost on their payroll tax return.

COBRA provides certain former employees, retirees, spouses, former spouses and dependent children the right to temporary continuation of health coverage at group rates. COBRA generally covers health plans maintained by private-sector employers with 20 or more full and part-time employees.  It also covers employee organizations or federal, state or local governments.  It does not apply to churches and certain religious organizations.  The new COBRA subsidy provisions also apply to insurers required to offer continuation coverage under state law similar to the federal COBRA.

This subsidy phases out for individuals whose modified adjusted gross income exceeds $125,000, or $250,000 for those filing joint returns.  Taxpayers with modified adjusted gross income exceeding $145,000, or $290,000 for those filing joint returns, do not qualify for the subsidy.

If you think you may qualify, you should contact your former employer.  Employers are supposed to notify former employees about this benefit no later than April 18, 2009.

To stimulate home sales, Congress first established the first-time homebuyer credit in 2008, then modified it for 2009 (through November 30, 2009), and then extended it again through the middle of 2010 (2011 for certain service members) resulting in some complicated rules.

There are basically two credits, with significantly different sets of rules for each.  In addition, the extension legislation passed in November of 2009 added a new category of home buyer referred to as “long-time residents” and special provisions for U.S. Service Members.  The following is only an overview of these credits and you are encouraged to call this office in advance of a purchase to insure you will qualify for the credit.

2009 -2010 CREDIT HIGHLIGHTS:

• Credit Amount – The credit amount is based upon whether the buyer is a “first-time homebuyer” or a “long-time resident.”  See definition for both below.  The credit is 10% of the purchase price with a maximum credit of $8,000 ($4,000 for those filing married separate) for “first-time homebuyers” or $6,500 ($3,250 if married filing separate) for “long-time residents.” 

• Repayment Required: If the home is sold or ceases to be the taxpayer’s principal residence within 36 months of its purchase

• Purchased: Between January 1, 2009 and before May 1, 2010 (July 1, 2010 if the taxpayer had entered into a binding contract before May 1, 2010.  Note: Credit provisions are extended for one additional year for members of the uniformed services, U.S. Foreign Service, or an employee of the intelligence community (and, if married, the individual's spouse) who serves on qualified official extended duty service outside of the U.S. for at least 90 days during the period beginning after Dec. 31, 2008, and ending before May 1, 2010.

• Home Location: Within the U.S.

• Home Price: For homes purchased after November 6, 2009, no credit is allowed if the home’s purchase price exceeds $800,000.

• Seller: Cannot be purchased from a close relative.

• When Claimed: Credit can be claimed on the taxpayer’s return for the year of purchase or the preceding year

• Financing: Credit can be claimed even if financing is from tax-exempt mortgage revenue bonds

2008 CREDIT HIGHLIGHTS:

• Credit Amount: 10% of the purchase price with a maximum credit of $7,500 ($3,750 for those filing married separate)

• Repayment Required: In 15 equal annual installments beginning in 2010
• Purchased: After April 8, 2008 and before January 1, 2009

• Home Location: Within the U.S

• Seller: Cannot be purchased from a close relative

• When Claimed: Credit can be claimed on the taxpayer’s 2008 return

• Financing: No credit is allowed if the financing for the home is from tax-exempt mortgage revenue bonds.

Details: The following are some additional details that relate to the credit for both 2008 and 2009:

Definition of a First-Time Homebuyer - A taxpayer is considered a first-time homebuyer if he (or spouse, if married) had no present ownership interest in a principal residence in the U.S. during the three-year period before the purchase of the home to which the credit applies. If the individual is married, neither the individual nor his spouse may have had a present ownership interest in a principal residence during that three-year period, even if they file as married taxpayers filing separately. Ownership of a home outside the U.S. during the three-year period will not disqualify the taxpayer.

Definition of a Long-Time Resident - Any individual (and spouse, if married, i.e., both must meet qualifications) who have owned the same principal residence for any 5 consecutive years during the 8-year period ending on the date of purchase of a subsequent principal residence.

Coordination with D.C. First-Time Homebuyer Credit – No District of Columbia First-Time Homebuyer Credit is allowed to a taxpayer in 2009 or 2010 who also qualifies for the national first time homebuyer credit (which gives the taxpayer a greater credit).  If a taxpayer was eligible to claim the D.C. first-time homebuyer credit in 2008, or any prior year, the taxpayer was not eligible to claim the national first-time homebuyer credit for 2008.

Service Members Special Extension and Recapture Waiver - Credit provisions are extended for one additional year for members of the uniformed services, U.S. Foreign Service, or an employee of the intelligence community (and, if married, the individual's spouse) who serves on qualified official extended duty service outside of the U.S. for at least 90 days during the period beginning after Dec. 31, 2008, and ending before May 1, 2010:

• Qualifying Period Extension - Extends the credit provisions one year, through April 30, 2011 (June 30, 2011, in the case of an individual who enters into a written binding contract before May 1, 2010, to close on the purchase of a principal residence before July 1, 2011) for any of the following on qualified official extended duty.

• Recapture Waiver – In the case of a disposition of a principal residence by an individual (or a cessation of use of the residence that otherwise would cause recapture) after Dec. 31, 2008, in connection with Government orders received by the individual (or the individual's spouse) for qualified official extended duty service, no recapture applies by reason of the disposition of the residence, and any 15-year recapture with respect to a home acquired before Jan. 1, 2009, ceases to apply in the tax year of the disposition.

Homes That Qualify - Only the purchase of a main home located in the United States qualifies.  Vacation homes and rental property are not eligible.

Income Limits – The credit is reduced or eliminated for higher-income taxpayers.  The credit is phased out based on the modified adjusted gross income (MAGI).  MAGI is the adjusted gross income plus various amounts excluded from income - for example, certain foreign income.  The MAGI limits are different depending upon the purchase date of the home.

• For homes purchased before November 7, 2009 - The phase-out range is $150,000 to $170,000 for married taxpayers filing a joint return.  For other taxpayers, the phase-out range is $75,000 to $95,000.  This means that the full credit is available for married couples filing a joint return whose MAGI is $150,000 or less and for other taxpayers whose MAGI is $75,000 or less.

• For homes purchased after November 6, 2009 - The phase-out range is $225,000 to $245,000 for married taxpayers filing a joint return.  For other taxpayers, the phase-out range is $125,000 to $145,000.  This means that the full credit is available for married couples filing a joint return whose MAGI is $225,000 or less and for other taxpayers whose MAGI is $125,000 or less.

Who Cannot Take the Credit – In addition to the other qualifications and limitations discussed above, a taxpayer cannot take the credit if the following apply:

• Home is purchased from a close relative. This includes a spouse, parent, grandparent, child or grandchild.

• Home is no longer used as the main home.

• Home is sold before the end of the year in which it was purchased.

• If taxpayer is under the age of 18 (if married, both under the age of 18) on the date of purchase and the home is purchased after November 6, 2009.

• If the taxpayer can be claimed as a dependent of another.

• Taxpayer is a nonresident alien.

• Home financing comes from tax-exempt mortgage revenue bonds.

How and When the 2008 Credit Must Be Repaid - The 2008 credit is similar to a 15-year, interest-free loan. Normally, it is repaid in 15 equal annual installments beginning with the second tax year after the year the credit is claimed.  The repayment amount is included as an additional tax on the taxpayer's income tax return for that year.  For example, if a $7,500 first-time homebuyer credit is properly claimed on the 2008 return, the taxpayer will begin paying it back on his or her 2010 tax return.  Normally, $500 will be due each year from 2010 to 2024.

A taxpayer may need to adjust his or her withholding or make quarterly estimated tax payments to ensure that they are not under-withheld.

However, some exceptions apply to the repayment rule. They include:

• Taxpayer’s Death - If a taxpayer dies, any remaining annual installments are not due.  If a joint return was filed and the taxpayer passes away, the surviving spouse would be required to repay his or her half of the remaining repayment amount.

• Ceases Being Main Home - If a taxpayer stops using a home as the main home, all remaining annual installments become due on the return for the year that happens.  This includes situations where the main home becomes a vacation home or is converted to business or rental property.  There are special rules for involuntary conversions. 

• Home Sold - If a home is sold, all remaining annual installments become due on the return for the year of sale.  The repayment is limited to the amount of gain on the sale, if the home is sold to an unrelated taxpayer.  If there is no gain or if there is a loss on the sale, the remaining annual installments may be reduced or even eliminated.  For example, a home is purchased for $200,000 and the credit of $7,500 is claimed.  Assume that no improvements are made on the home and it is sold for $195,000 after repaying $500 of the credit.  The gain or loss would be measured for purposes of the accelerated credit recapture from $193,000 (the original cost of $200,000 less the $7,500 credit plus the $500 repayment).  In this case, there would be a gain of $2,000 on the sale ($195,000 - $193,000).   Thus, the taxpayer would only be liable for repaying $2,000 of the credit when the home is sold.  Had the home sold for $193,000 or less, there would be no repayment required.

• Divorce - If a home is transferred to a spouse or to a former spouse (as part of a divorce settlement), that person is responsible for making all subsequent installment payments.

• Involuntary Conversion - If the home is involuntarily converted (e.g., it is destroyed in a storm), and the taxpayer buys a new principal residence within a two-year period beginning on the date of the disposition or the date the home ceases to be the principal residence, the accelerated recapture rule does not apply.  However, the regular recapture rule applies to the replacement principal residence during the recapture period in the same way as if the replacement principal residence were the converted residence.

If you or a family member is contemplating on utilizing this credit, it may be appropriate to consult with this office in advance of a home purchase. 

A new provision, enacted as part of the American Recovery and Reinvestment Act of 2009, enables small businesses with a net operating loss (NOL) in 2008 to elect to offset this loss against income earned in up to five prior years.  Typically, an NOL can be carried back for only two years.

This new net operating loss provision could throw a lifeline to struggling businesses, providing them with a quick infusion of cash.  The IRS Commissioner has indicated that the IRS wants to make it as easy as possible for small businesses to take advantage of these key tax benefits.

With the economic downturn and the new law, the IRS expects record numbers of small businesses to be eligible for the refunds.  The IRS is putting in special steps to ensure timely processing of these refunds to help small businesses during this difficult period.  Small businesses with large losses in 2008 may be able to benefit fully from those losses now, rather than waiting until claiming them on future tax returns.

The normal two-year carryback remains available if the small business does not elect the special carryback provision.  If the loss exceeds the income for the carryback period, the taxpayer can continue to carryforward the remaining balance of the NOL for up to 20 years.

For small businesses that use a fiscal year, this special carryback may be used for an NOL in either a tax year that ends in 2008 or a tax year that begins in 2008.  Once a taxpayer makes this election, it may not be changed.

To qualify for the new five-year carryback provision, a small business must have no greater than an average of $15 million in gross receipts over a three-year period ending with the tax year of the NOL.  Businesses with more than $15 million in gross receipts still qualify to carry back their 2008 NOL for two years.

If a small business previously elected to waive the carryback of their 2008 NOL but now wants to elect this special carryback, the small business may revoke its previous election to waive the carryback.  The election revocation must be made on or before April 17, 2009.

Generally, small businesses that are not corporations (including sole proprietorships filing schedule C with their Form 1040) may accelerate a refund by using Form 1045, Application for Tentative Refund.  Corporations with NOLs may also accelerate a refund by using Form 1139, Corporation Application for Tentative Refund.

The IRS will be closely monitoring these filings and will provide additional staff as needed to process these forms.  The IRS will work to issue refunds within 45 days or even earlier to the degree possible.

Accelerated refunds paid via Form 1045 or Form 1139 is described as “tentative” because the applications for refunds are potentially subject to review at a later date.

Please call this office if you would like to determine how this temporary provision can help you.

For vehicles purchased on or after February 17, 2009 and before January 1, 2010, the Recovery Act of 2009 modifies the definition of deductible taxes to include qualified motor vehicle taxes paid or accrued within the tax year.  Thus, the sales tax paid on the purchase of a business vehicle will not be included in the capitalized cost of the vehicle and presumably can be deducted as a tax paid.

The Recovery Act generally allows this deduction to both itemizers and those claiming the standard deduction as an addition to that deduction.  The deduction is subject to two limitations:

• Purchase Price Limitation - Under a purchase price limitation, only taxes on that part of the qualified motor vehicle's purchase price not exceeding $49,500 may be deducted.

• Income Limitation - Under an income limitation, the amount of sales or excise taxes that may be treated as qualified motor vehicle taxes is phased out ratably for a taxpayer with modified AGI (MAGI) between $125,000 and $135,000 ($250,000 and $260,000 on a joint return).

The Recovery Act also extended the 50% bonus depreciation through 2009, thus increasing the first-year deduction for vehicles by $8,000.  This provides the unincorporated small business owner with two extra tax benefits for buying a new business vehicle between now and the end of the year: a sales tax deduction and boosted first-year depreciation.

Example:  Peter, an unincorporated business owner, buys a new $40,000 auto which he uses 100% for business driving.  He paid $3,400 (8.5%) in state sales tax on the car.  If he had purchased the car before February 17, 2009, his business basis in the vehicle would be $43,400 ($40,000 cost plus $3,400 of sales tax), and his first-year depreciation deduction (assuming the luxury auto dollar limits are the same as last year - $10,960 (the regular first-year depreciation allowance of $2,960 plus the $8,000 bonus depreciation amount).  If Peter buys the car on March 1, his basis in the vehicle is only the purchase cost ($40,000).  His first-year depreciation is still $10,960, but he gains a $3,400 deduction for the sales tax.  Counting both tax benefits, Peter ends up deducting $11,400 more than normal for a purchase in 2009.

The sales tax deduction will not apply to C-Corporations, and it is unclear at this time whether it will apply to purchases made by S-Corporations.  Presumably, the deduction must be taken at the individual level either as an itemized deduction or as an add-on to the standard deduction by taxpayers not itemizing.  Watch for further information in the future. 
Please call this office with any questions related to these deductions.

The “American Recovery and Reinvestment Act of 2009” (the 2009 Economic Stimulus Act) expanded the residential energy improvement credit for 2009 and 2010 (this credit was last available in 2007) and extended and expanded the tax credit for residential solar and fuel cell equipment through 2016.  This gives taxpayers who want to “go green” a chance to offset some of the cost of going green with tax credits.  

These are two distinctly different credits with different requirements and limitations.  The following is an overview of these credits.

• Tax Credit for Residential Energy Improvements – Energy property improvements to a principal residence located in the United States and placed in service during 2009 and 2010 qualify for the residential energy improvements credit. The credit is 30% of the cost of:

o Qualified advanced main air circulating fan;
o Qualified natural gas, propane, or oil furnace;
o Qualified natural gas, propane, or oil hot water boiler;
o Qualified energy efficient heat pumps;
o Qualified energy efficient water heaters;
o Qualified energy efficient central air conditioners;
o Qualifying insulation;
o Qualified exterior windows including skylights;
o Qualified exterior doors;
o Qualified metal roofs coated with heat-reduction pigments; and
o Qualified asphalt roofing with appropriate cooling granules. 

This credit is limited to $1,500 for 2009 and 2010 (combined, not each year), which is an increase from the pre-2008 credit cap of $500.  If you claimed pre-2008 credits under this provision, they are not counted toward the new $1,500 limit.

• Tax Credit for Residential Energy Efficient Property (REEP credit) – The 2009 Economic Stimulus Act that the President signed on February 17, 2009 removed the dollar caps for credit for certain energy equipment.  The caps remaining are noted.  A 30% credit applies to the following items placed in service after 2008 and before the end of 2016:

o Qualified solar water heaters; 
o Residential solar electric systems;    
o Fuel cell equipment – with a maximum credit of $500 for each half-kilowatt of capacity;
o Qualified wind energy equipment; and
o Qualified geothermal energy equipment

Labor costs for onsite installation and for piping and wiring connections are qualifying costs for these credits.  However, the credits do not apply to equipment used to heat swimming pools or hot tubs. 

Credit limitations – Although these credits can be used to offset both the regular tax and AMT, they are nonrefundable personal credits that can only reduce a taxpayer’s tax to zero, and any remaining balance is not refundable.  If the amount of the credit for the residential energy efficient property credit (REEP - i.e., the credit for residential solar and fuel cell equipment and wind/geothermal energy equipment) exceeds the taxpayer’s tax after subtracting other nonrefundable personal credits, the excess can be carried to the next tax year and is added to that year’s allowable credit.

Caution - Before entering into a contractual arrangement to install any of the energy-efficient equipment listed above, please contact this office to first verify what your tax benefit might be.