Pension and Retirement Income

Transcription

1 TDB 2/ Pension and Retirement Income 5 TABLE OF CONTENTS KEY ISSUE DESCRIPTION PAGE Introduction A Calculating Taxable Social Security Benefits General Rules Lump-sum Social Security Payments Repayment of Social Security Benefits Interaction of Taxable Social Security Benefits with IRA Deduction B Distributions from Traditional IRAs Only Deductible Contributions Made to Traditional IRAs Nondeductible Contributions Made to Traditional IRAs C Distributions from Roth IRAs Taxation of Distributions Application of Required Minimum Distribution Rule Distributions Following Roth IRA Conversions Roth IRA Rollovers D Converting Traditional IRAs into Roth IRAs Conversion Requirements Tax Consequences of Conversion Reversing a Rollover or Conversion E Simplified Methods for Taxing Annuity Payments from Qualified Plans F Rolling Over Qualified Retirement Plan and IRA Distributions Rolling Over Distributions from Qualified Retirement Plans Rolling Over Distributions from IRAs Spousal Rollovers Nonspouse Beneficiary Rollover Invalid Rollovers G Reporting Income from Withdrawal of Excess IRA Contributions Taxation of Excess Contributions Reporting the Withdrawal H Divorce-related Transfers of Retirement Plan Assets Qualified Retirement Plan Benefits Table of Contents

2 5-2 TDB 2/18 IRAs I Distributions from a SIMPLE IRA Plan Two-year Period Rules J Required Minimum Distribution Rules for Retirement Accounts Required Beginning Date Calculating the Required Minimum Distribution (RMD) RMDs during the Owner s Life RMDs after the Owner s Death Rollovers to Nonspouse Beneficiaries and the RMD Rules IRA Distributions to Charities Qualify under the RMD Rules K Distributions from Commercial Variable Annuities General Tax Considerations Taxation of Annuity Payments Taxation of Nonannuity Payments Premature Distributions Annuity and Partial Annuity Exchange L Special Retirement Account Disaster Relief Rules for 2017 Hurricane and California Wildfire Victims and 2016 Disaster Areas Penalty-free Treatment for Qualified Distributions Three-year Recontribution Period for Qualified Distributions No Mandatory Federal Income Tax (FIT) Withholding on Qualified Distributions Three-year Income Averaging for Qualified Distributions Tax-free Recontributions for Retirement Account Withdrawals Taken for Canceled Home Purchases in Hurricane Disaster Area or California Wildfire Area Larger Plan Loans Allowed for Hurricane and California Wildfire Victims Hurricane and California Wildfire Victims Can Delay Plan Loan Repayments Introduction This chapter covers the taxation of pension and retirement income (including social security benefits and the required minimum distribution rules for IRAs and qualified plans). Other key issues dealing with pension and retirement income are discussed in Chapter 33 (lump-sum distributions), Chapter 34 (excise and other taxes), and Key Issue 26I (charitable contributions distributed from IRAs). Select inflation-adjusted data can be found at Table T1001. References IRS Anns , IRB 973; , IRB 907; , IRB 255; and , IRB 271. IRS Notices 87-16, CB 446; 88-38, CB 524; 89-25, CB 662; 97-11, CB 379; 98-4, CB 269; , CB 1266; , CB 132; , IRB 395; , IRB 638; , IRB 436; , IRB 872; , IRB 819; , IRB 670; and , IRB Rev. Procs , CB 359; , IRB 66; , IRB 1160; and , IRB 346. Rev. Ruls , CB 46; , CB 157; , CB 29; 87-77, CB 115; 92-47, CB 198; and , CB 347. Bobrow, Alvan L., TC Memo (2014). Brady, James, TC Memo (2013). Campbell, George, 108 TC 54 (1997). Introduction

3 TDB 2/ Observation: The 180-day safe harbor provides an important opportunity for taxpayers with large deferred annuities who might benefit by restructuring the annuity into smaller contracts. However, the taxpayer should recognize that the new annuity contract or contracts received in the partial exchange typically will have a fresh surrender charge period (generally five to seven years), during which time a surrender of the contract incurs a penalty from the insurance company. For this reason, in Example 5K-4 Betty Lou should surrender the old annuity first rather than the new annuity subject to a penalty. Example 5K-5 Annuity exchange for long-term care insurance. Willy, who is 72 years old, invested $50,000 in a life insurance policy many years ago with the purpose of covering his debts and other obligations. Now that he is retired, he no longer has a need for the death benefit protection, but is concerned about the possibility of incurring long-term care costs. The cash surrender value of his policy is currently $150,000. If he were to cash in the policy, this would trigger $100,000 in ordinary income. Alternatively, Willy is able to initiate a Section 1035 tax-deferred exchange of his life insurance policy for a long-term care policy and have no current income recognition. KEY ISSUE 5L Special Retirement Account Disaster Relief Rules for 2017 Hurricane and California Wildfire Victims and 2016 Disaster Areas. A special set of liberalized retirement account rules applies to qualified 2017 hurricane victims under the Disaster Tax Relief and Airport and Airway Extension Act of 2017 (2017 Disaster Relief Act), to California wildfire victims under the Bipartisan Budget Act of 2018 (2018 Budget Act), and partially to qualified 2016 disaster distributions under the 2017 Tax Cuts and Jobs Act. In addition, the 2018 Budget Act extended some of the dates in the 2017 Disaster Relief Act. These special rules are summarized in this key issue. Practice Tip: Taxpayers affected by the 2016 disaster areas may file amended returns to receive these benefits for distributions received in Penalty-free Treatment for Qualified Distributions The 2017 Disaster Relief Act exempts up to $100,000 of qualified hurricane distributions, the 2017 Tax Cuts and Jobs Act exempts up to $100,000 of qualified 2016 disaster distributions (including distributions received in 2017), and the 2018 Budget Act exempts up to $100,000 of qualified wildfire distributions from the Section 72(t) 10% premature withdrawal penalty tax (see Key Issue 34B). A qualified hurricane distribution is any distribution from most types of tax-favored retirement plans made on or after August 23, 2017, for Hurricane Harvey victims; on or after September 4, 2017, for Hurricane Irma victims; and on or after September 16, 2017 for Hurricane Maria victims. All qualified hurricane distributions must be received before January 1, The recipient must have had a principal place of abode located in the applicable hurricane disaster area on the beginning date for that disaster and sustained an economic loss due to the hurricane [Sec. 502(a) of the 2017 Disaster Relief Act]. A qualified 2016 disaster distribution must be received before January 1, The recipient must have had a principal place of abode located in a 2016 federally declared disaster area and have sustained an economic loss due to the disaster [Sec (b)(1)(A) of the 2017 Tax Cuts and Jobs Act]. A qualified wildfire distribution must be received after October 7, 2017, and before January 1, The recipient must have a principal place of abode in a California wildfire disaster area at some time from October 8, 2017, through December 31, 2017, and sustained a loss due to the wildfires in that area [Sec (a) of the 2018 Budget Act]. Warning: The aggregate amount that can be treated by an individual as qualified hurricane distributions for any year cannot exceed $100,000 reduced by the aggregate amount treated as such in any earlier year [Sec. 502(a)(2)(A) of the 2017 Disaster Relief Act]. Similar provisions apply for qualified 2016 disaster distributions [Sec (b)(1)(B) of the 2017 Tax Cuts and Jobs Act] and qualified wildfire distributions [Sec (a)(2)(A) of the 2018 Budget Act]. Three-year Recontribution Period for Qualified Distributions The 2017 Disaster Relief Act permits qualified hurricane distributions (as previously defined) to be recontributed to eligible retirement plans or IRAs tax-free. This amounts to tax-free rollover treatment, and it can be done any time during the three-year period beginning on the day after the date of the distribution. Taxpayers who treat qualified Key Issue 5L

4 5-38 TDB 2/18 hurricane distributions as taxable can file amended returns to get federal income tax refunds after taking advantage of the tax-free rollover rule [Sec. 502(a)(3) of the 2017 Disaster Relief Act]. Similar provisions apply to qualified 2016 disaster distributions [Sec (b)(1)(C) of the 2017 Tax Cuts and Jobs Act] and qualified wildfire distributions [Sec (a)(3) of the 2018 Budget Act]. No Mandatory Federal Income Tax (FIT) Withholding on Qualified Distributions Mandatory 20% FIT withholding is required for an eligible rollover distribution (see Key Issue 5F), unless the rollover is accomplished via a direct trustee-to-trustee transfer (IRC Sec. 3405). The 2017 Disaster Relief Act removes this withholding requirement for qualified hurricane distributions (as previously defined) [Sec. 502(a)(6)(A) of the 2017 Disaster Relief Act]. Similar provisions apply for qualified 2016 disaster area distributions, although practically only distributions from December 22, 2017, through December 31, 2017, will be affected by this provision since earlier distributions would have already had withholding [Sec (b)(1)(F) of the 2017 Tax Cuts and Jobs Act] and for qualified wildfire distributions [Sec (a)(6)(A) of the 2018 Budget Act]. Three-year Income Averaging for Qualified Distributions The 2017 Disaster Relief Act provides that a qualified hurricane distribution (as previously defined) is taken into the recipient taxpayer s gross income ratably over three years using Form 8915B, beginning with the year the distribution is received [Sec. 502(a)(5)(A) of the 2017 Disaster Relief Act]. This three-year averaging rule automatically applies unless the taxpayer elects out of such treatment (or unless the taxpayer rolls the money back into an account tax-free as previously explained). Similar provisions apply to qualified 2016 disaster distributions using Form 8915A [Sec (b)(1)(E) of the 2017 Tax Cuts and Jobs Act] and qualified wildfire distributions [Sec (a)(5)(A) of the 2018 Budget Act]. Note: Drafts, including instructions, for Form 8915A (Qualified 2016 Disaster Retirement Plan Distributions and Repayments) and Form 8915B (Qualified 2017 Disaster Retirement Plan Distributions and Repayments) are available at While the instructions for draft Form 8915B currently only refer to qualified hurricane distributions, presumably they will be revised to include qualified wildfire distributions. Tax-free Recontributions for Retirement Account Withdrawals Taken for Canceled Home Purchases in Hurricane Disaster Area or California Wildfire Area Under the 2017 Disaster Relief Act, any individual who took out a qualified distribution to buy or build a home can at any time during the period beginning on August 23, 2017, and ending on February 28, 2018, roll the money back into an eligible retirement plan (including an IRA) with no tax consequences (i.e., tax-free rollover treatment will apply see Key Issue 5F). For this purpose, a qualified distribution means a hardship distribution from a retirement plan or a qualified first-time homebuyer distribution from an IRA that was: (1) received after February 28, 2017, and before September 21, 2017, and (2) intended for the purchase or construction of a principal residence within a hurricane disaster area when such transaction did not take place due to the hurricane [Sec. 502(b) of the 2017 Disaster Relief Act]. Similar provisions apply to California wildfire victims who received distributions after March 31, 2017, and before January 15, 2018, and repaid the contributions after October 7, 2017, and before June 30, 2018 [Sec (b) of the 2018 Budget Act]. Larger Plan Loans Allowed for Hurricane and California Wildfire Victims The 2017 Disaster Relief Act increases the amount that can be taken out as a tax-free loan from a qualified plan to the lesser of $100,000 or the present value of the nonforfeitable accrued benefit in the participant s account. This special rule applies to plan loans made to any qualified individual after September 28, 2017, and before January 1, Under the normal rules, plan loans generally cannot exceed $50,000 or one-half of the accrued benefit. For this purpose, qualified individual means any person whose principal place of abode was in the Hurricane Harvey disaster area on August 23, 2017; whose principal place of abode was in the Hurricane Irma disaster area on September 4, 2017; or whose principal place of abode was in the Hurricane Maria disaster area on September 16, 2017; and who sustained an economic loss due to the applicable hurricane [Sec. 502(c)(1) of the 2017 Disaster Relief Act]. Similar provisions apply to California wildfire victims who receive qualified loans after February 8, 2018, and ending on December 31, 2018, if their principal place of abode was in a California wildfire disaster area at any Key Issue 5L

5 TDB 2/ time from October 8, 2017, through December 31, 2017, and sustained a loss because of the wildfires [Sec (c) of the 2018 Budget Act]. Hurricane and California Wildfire Victims Can Delay Plan Loan Repayments In general, retirement plan loans must be repaid within five years to be tax-free (home loans can have longer terms). The 2017 Disaster Relief Act created an exception for any qualified individual who has a loan outstanding on or after August 23, 2017 (for Hurricane Harvey), on or after September 4, 2017 (for Hurricane Irma), or on or after September 16, 2017 (for Hurricane Maria) for any repayment of the loan that is otherwise due during the period beginning on the applicable date and ending on December 31, The due date can be delayed for one year, and subsequent loan repayments will be adjusted to reflect the delay. In determining whether the loan term complies with applicable tax rules, the one-year delay will be disregarded. For this purpose, qualified individual means any person whose principal place of abode was in the applicable hurricane disaster area on its applicable starting date and who sustained an economic loss due to the hurricane [Sec. 502(c)(2) of the 2017 Disaster Relief Act]. Similar provisions apply to plan loan repayments of California wildfire victims, using October 8, 2017, as the beginning date. The ending date is still December 31, 2018 [Sec (c)(2) of the 2018 Budget Act]. Key Issue 5L

6 5-40 TDB 2/18 Key Issue 5L

7 TDB 2/ Law Change Alert: The 2017 Tax Cuts and Jobs Act has added the Sinai Peninsula of Egypt as a qualified hazardous duty area if the servicemember is entitled to special pay, duty subject to hostile fire, or imminent danger, effective December 22, 2017 [Sec (b) of the 2017 Tax Cuts and Jobs Act]. For more information on these and other special issues that apply to members of the Armed Forces, see IRS Publication 3, Armed Forces Tax Guide, in general, Notice for specific guidance on the tax relief provided for U.S. military and support personnel involved in military operations in Afghanistan, and Notice for tax relief guidance for military and support personnel involved in Operation Iraqi Freedom. In addition, the IRS website at has a page called Tax Information for Members of the Military covering various tax-related military topics. Also, see Key Issue 22B for relaxed rules for excluding gain on the sale of a principal residence. Mortgage Assistance Payments Federal and state payments made to or on behalf of financially distressed homeowners under programs designed by state housing finance agencies (SHFAs) and the Department of Housing and Urban Development s Emergency Homeowners Loan Program (EHLP) are excludable from income under the general welfare exclusion. The general welfare exclusion refers to the consistent standpoint of the IRS that payments made by governmental units under legislatively provided social benefit programs for the general welfare are not includible in gross income of the recipient (IRS Notice ). Homeowners must meet certain eligibility criteria to receive payments, the purpose of which is to provide assistance to homeowners who are at risk of foreclosure and have experienced a substantial reduction in income as a result of involuntary unemployment or underemployment due to adverse economic or medical conditions. In addition to the previously mentioned programs, the income exclusion applies to payments from any existing state program receiving funding from the EHLP, referred to as a substantially similar state program. Programs approved by the Treasury Department are listed in the Appendix to IRS Notice Payors of payments made under the state programs, the EHLP, or an SSSP are not required to file information returns for these payments. However, a homeowner receiving payments should not report the amount as interest received on a mortgage. A safe harbor is provided for tax years 2010 through 2021 under which a homeowner may deduct the total payments actually made during the year to the mortgage servicer, HUD, or the SHFA toward the home mortgage (IRS Notice amplified by IRS Notice ). The total deductible may not be in excess of the dollar amount shown on the Form 1098 (Mortgage Interest Statement). The safe harbor may be used by any homeowner that meets the requirements for deducting mortgage interest and participates in one of the listed programs (IRS Notice ). Damages from Wrongful Incarceration Generally, damages are excludable from gross income if received on account of personal physical injuries or physical sickness, except for punitive damages (see Key Issue 6C). However, an individual is allowed to exclude from gross income civil damages, restitution, or other monetary awards, including compensatory or statutory damages and restitution imposed in a criminal matter, for wrongful incarceration (IRC Sec. 139F). A wrongfully incarcerated individual is an individual convicted of a criminal offense under federal or state law and who served all or part of a sentence of imprisonment for that offense if either: (1) the individual was pardoned or granted clemency or amnesty for such offense because the individual was innocent of that offense, (2) the individual s conviction for such offense was reversed or vacated, after which the indictment, information, or other accusatory instrument for such offense was dismissed, or (3) the individual was found not guilty at a new trial [IRC Sec. 139F(b)]. The covered offense includes any criminal offense arising from the same course of conduct as that criminal offense [IRC Sec. 139F(c)]. Essentially, to qualify for the exclusion, the individual must have been exonerated of all criminal charges arising from the same course of conduct. The exclusion applies only to the wrongly incarcerated individual and does not apply to derivative claims paid to a spouse, child, parent, or other individual, such as for loss of consortium or loss of companionship (Elkins). Key Issue 6K

8 6-32 TDB 2/18 There are no reporting requirements for receipt of an award qualifying for the wrongful incarceration exclusion. This means for the year an award is received, recipients need not report the award on their return or submit documentation to the IRS. Law Change Alert: A taxpayer now has until the later of December 28, 2019, or the normal statute of limitations in which to file a refund claim [Sec. 304(d) of the Protecting Americans from Tax Hikes Act of 2015, as amended by the Bipartisan Budget Act of 2018 (2018 Budget Act)]. To claim a refund of an overpayment of tax in previous years, the wrongfully incarcerated individual must file for refund within three years from the date the individual filed the income tax return that reported the award, two years from the date the individual paid the tax on the award, or December 28, 2019, whichever is later. To take advantage of the wrongful incarceration exclusion reported on amended returns, the IRS has established a special filing address for any federal Form 1040X claiming the wrongful incarceration exclusion. Write Incarceration Exclusion PATH Act at the top of Form 1040X and send along with any supplemental documentation (award was included in income and establishing award was made on account of wrongful incarceration) to IRS, 333 W. Pershing, Stop th Floor, Kansas City, MO Payments from Certain Work-learning-service Programs Payments from certain work-learning-service programs operated by a work college are exempt from gross income [IRC Sec. 117(c)(2)(C)]. Work colleges are public or private nonprofit, four-year, degree-granting institutions committed to community service that have operated a comprehensive work-learning-service program for at least two years. Students are required to participate in a comprehensive work-learning-service program. Key Issue 6K

9 TDB 2/ OID, to the extent of the OID that has accrued as of the date the payment is due (under Reg ) and that has not been allocated to prior payments, and second as a principal payment [Reg (f)(4), Ex. 2]. Lenders are required to include loan origination fees and/or capitalized interest computed under the OID rules on Form 1098-E (in box 1). Dependent Not Eligible for Deduction. An individual who is a dependent of another taxpayer for the year cannot claim an interest deduction [IRC Sec. 221(c)]. Example 7H-4 Interest deduction for child when dependency exemption is not allowed. Tyler is legally obligated on certain education loans and pays $750 of interest on those loans during the current year. Because their AGI is too high, his parents are not allowed a dependency exemption for Tyler in the current year. Thus, assuming Tyler meets all of the relevant requirements for deducting education loan interest, he can deduct the $750 of interest on his own return [Reg (b)(2)(ii), Ex. 1]. Observation: The example in the regulations does not say why Tyler s parents cannot claim a dependency exemption for him. However, IRC Sec. 221(c) says that no education loan interest deduction is allowed to an individual if a deduction under IRC Sec. 151 is allowed to another taxpayer with respect to that individual. Because the phase-out of the dependency exemption is part of IRC Sec. 151 [see IRC Sec. 151(d)(3)], the fact that the income of Tyler s parents is too high to allow them any dependency exemption for him should be sufficient reason to allow the interest deduction to Tyler (assuming all other requirements for the deduction are met). Of course, for Tyler to benefit from this deduction, he has to have taxable income. KEY ISSUE 7I Tuition and Fees Deduction. Law Change Alert: The deduction for tuition and fees has been extended through December 31, 2017 [IRC Sec. 222(e), as amended by the Bipartisan Budget Act of 2018 (2018 Budget Act)]. Taxpayers whose modified AGI does not exceed certain thresholds can claim an above-the-line deduction of up to $4,000 for qualified tuition and related expenses (IRC Sec. 222). No deduction may be claimed by taxpayers with a filing status of married filing separately or if another person can claim a dependency exemption on his or her tax return for the individual [IRC Sec. 222(c)(3)]. The deduction is claimed on Form 8917 (Tuition and Fees Deduction). Qualified Tuition and Related Expenses Qualified tuition and related expenses are defined the same as for the education credits(see Key Issue 35D)and include out-of-pocket costs for tuition and fees required for the enrollment or attendance of the taxpayer, the taxpayer s spouse, or a dependent (if the taxpayer claims a dependency exemption for that person) at an eligible educational institution [IRC Sec. 25A(f)(1)]. Prepaid expenses qualify if the academic term they relate to begins no later than three months into the following tax year [IRC Sec. 222(d)(3)(B)]. The education need not be work-related. Eligible Educational Institution. The qualified tuition and expenses do not have to be incurred in connection with a postsecondary degree program but must be paid to an eligible educational institution, defined by reference to Section 481 of the Higher Education Act of These institutions generally are accredited post-secondary educational institutions (including certain proprietary and vocational schools) offering credit toward a bachelor s degree, an associate s degree, or another recognized post-secondary credential. The institution must be eligible to participate in Department of Education student aid programs. For a list of institutions eligible for the federal financial aid program, see the school code search section on the U.S. Department of Education s Federal Student Aid website at Books, Supplies, and Equipment. Student activity fees and charges for course-related books, supplies, and equipment are qualified tuition and related expenses if the fee must be paid to the eligible educational institution as a condition of the enrollment or attendance of the student at the institution [Reg. 1.25A-2(d)(2)]. Observation: This implies that books or supplies cannot be purchased from off-campus sources and still qualify. Although not authoritative, an example provided in IRS Publication 970 suggests that books and supplies Key Issue 7I

10 7-34 TDB 2/18 purchased from a university bookstore are not qualified expenses unless it is required upon enrollment that the student purchases the items from the university. However, this requirement does not appear to be consistent with the Tax Reform Act of 1997 Committee Reports, which state that books must be required for enrollment or attendance, without any mention of where they are purchased. Room and Board and Other Expenses. Costs associated with room and board; medical expenses (including student health fees); athletics; insurance; transportation; and similar personal, living, or family expenses are not qualified tuition and related expenses even when required for enrollment. The sameistrueforexpensesinvolving sports, games, or hobbies or any noncredit course, unless thiseducationispartofthe student s degree program [IRC Secs. 25A(f)(1)(B) and (C); Reg. 1.25A-2(d)]. Limitations on AGI and Maximum Deduction Taxpayers with modified AGI that does not exceed $65,000 ($130,000 in the case of married taxpayers filing joint returns) can claim a maximum deduction of $4,000. Furthermore, taxpayers with adjusted gross income that does not exceed $80,000 ($160,000 in the case of married taxpayers filing joint returns) can claim a reduced deduction of up to $2,000 [IRC Sec. 222(b)(2)(B)]. Observation: There are no phase-out ranges for the maximum $4,000 deduction. Taxpayers with modified AGI above the applicable threshold are at best entitled to the reduced $2,000 deduction. For example, a married taxpayer who had $4,500 of qualifying educational expenses and $130,000 of modified AGI would be entitled to a $4,000 above-the-line deduction. The same taxpayer with only $1 of additional gross income would be entitled to only a $2,000 deduction. Modified AGI. Modified AGI is AGI computed without regard to the qualified tuition deduction and is increased by the income exclusions for income earned in a foreign country, Puerto Rico, and certain U.S. possessions and by the deduction for domestic production activities [IRC Sec. 222(b)(2)(C)]. Adjustment for Refunds and Tax-free Education Benefits The amount of qualified tuition and related expenses for purposes of the education benefits must be out-of-pocket costs. Therefore, the otherwise qualified tuition and related expenses for the tax year are reduced by refunds or other tax-free educational assistance allocable to the tax year and paid for the benefit of the student [IRC Sec. 25A(g)(2)]. These benefit reductions include the following: 1. A qualified scholarship excludable from gross income under IRC Sec A payment (other than a gift, bequest, devise, or inheritance) for the student s educational expenses, or attributable to the student s enrollment at an eligible educational institution that is excludable from gross income (such as employer-provided educational assistance under IRC Sec. 127). 3. A veteran s educational assistance allowance under Chapters 30, 31, 32, 34, or 35 of Title 38 of the United States Code. 4. An educational assistance allowance for members of the Selected Reserve under Chapter 1606 of Title 10 of the United States Code. No Double Benefit An expense cannot be claimed as an above-the-line qualified tuition deduction if it is deducted under some other provision, such as a deduction for business continuing education [IRC Sec. 222(c)(1)]. No Deduction If the American Opportunity or Lifetime Learning Credit Is Claimed Taxpayers are not eligible to claim a tuition deduction and the American Opportunity or Lifetime Learning Credit in the same year for the same student [IRC Sec. 222(c)(2)(A)]. Key Issue 7I

11 TDB 2/ Observation: Generally, personal use of an employer-provided cell phone will be considered a de minimis fringe benefit under IRC Sec. 132(e)(1) (Notice ). Computers A computer and any related equipment (such as a printer or modem) are 100% deductible if used solely for business purposes in an area of the home that qualifies for home office deductions under IRC Sec. 280A(c)(1) [IRC Sec. 280F(d)(4)(B), before amended by the 2017 Tax Cuts and Jobs Act]. (See Key Issue 8C.) The cost recovery is claimed through regular MACRS depreciation (using a five-year life), Section 179 deduction, or a combination of both (i.e., Part I or II of Form 4562). Note: By definition, a computer in an area of the home that qualifies for home office deductions is not listed property. Thus, a return that includes a computer as listed property (in Form 4562, Part V) generally should not also include a home office deduction (unless the computer is kept somewhere other than the home office). In addition, the Tax Court has held that the substantiation requirements of IRC Sec. 274(d)(4) do not apply to a computer the taxpayers used in a home office that qualifies for the home office deduction under IRC Sec. 280A (Zeidler). If a taxpayer s computer is used in a space that does not qualify for home office deductions, it is automatically treated as listed property [IRC Sec. 280F(d)(4)(A), before amended by the 2017 Tax Cuts and Jobs Act]. This means the property s business use must be more than 50% before the computer is eligible for a Section 179 deduction or regular MACRS depreciation [IRC Secs. 280F(b) and (d)(1)]. If such use is 50% or less, IRC Sec. 179 does not apply and depreciation is claimed on an SL basis over five years. In addition, the recapture rules discussed earlier also apply when business use of the computer drops to 50% or less. (See Key Issue 15E.) Observation: Laptops, notebooks, and other portable computers that are used in many areas because of their portability and are not used exclusively at a regular business establishment (or home office) would be considered listed property and subject to the strict substantiation rules (even if used 100% for business) and the stricter depreciation rules previously mentioned. Employee Use. A taxpayer can qualify for a home office deduction (and thus favorable home computer write-offs) even if not self-employed. (See Key Issue 8C for discussion of home office deductions.) However, when the taxpayer is an employee, the business use of the home and the computer must be for the convenience of the employer [IRC Secs. 280A(c)(1) and 280F(d)(3)]. If the home office does not qualify under IRC Sec. 280A, the computer must also be required as a condition of employment before it can be depreciated [IRC Sec. 280F(d)(3)]. The IRS holds that the convenience (and condition of employment) test means the employer has to specifically require employees to buy a computer to keep their job. However, the Tax Court ruled in the case of a university professor that the test is satisfied when the computer purchase spares the employer the cost of providing the employee with suitable computer equipment with which to fulfill job responsibilities (Cadwallader). Observation: Even under the Tax Court s liberal interpretation, it generally is difficult for employees to claim home office or computer deductions. In addition, any deduction allowed is claimed as a miscellaneous itemized deduction, subject to the 2% of AGI and other itemized deduction limitations. Investment or Income-producing Use. A home computer is automatically listed property if used for any of the following purposes [IRC Secs. 212 and 280F(d)(4), before amended by the 2017 Tax Cuts and Jobs Act]: 1. Assist in the production or collection of income (e.g., tracking investments). 2. Manage, conserve, or maintain property held for the production of income (e.g., manage rental properties). 3. Assist in determining a tax liability (e.g., used in preparing the taxpayer s income tax return). A computer used for one of these purposes is subject to the depreciation rules discussed earlier for a taxpayer not qualifying for home office deductions (i.e., no Section 179 deduction available, SL depreciation required, and depreciation claimed as a miscellaneous itemized deduction). In addition, investment/income-producing use cannot be combined with business use to qualify for regular MACRS and the Section 179 deduction [Regs F-6(d)(2)(i) and (3)(i)]. Key Issue 15G

12 15-24 TDB 2/18 Example 15G-2 Home computer used for both business and investment. Scott uses a home computer 35% of the time to manage his investments and 40% in a business activity operated as a sole proprietorship. Because the computer s business use percentage is not more than 50%, it does not qualify for a Section 179 deduction and it must be depreciated on a SL basis. However, to determine the depreciable basis, the business and investment percentages are added so that SL depreciation can be claimed on 75% (35% plus 40%) of the cost. The depreciation is reported on Form 4562 and then deducted on Schedule C (for the business portion) and Schedule A (for the investment-related portion). See Key Issue 14H for a discussion of the rules regarding deductions for computer software costs. KEY ISSUE 15H Electric Vehicles and Alternative Motor Vehicle Issues. Claiming the New Qualified Plug-in Electric Drive Motor Vehicle Credit (NQPEDMV) Law Change Alert: The NQPEDMV credit for qualified two-wheeled plug-in vehicles has been extended through December 31, 2017 [IRC Sec. 30D(g)(3)(E)(ii), as amended by the Bipartisan Budget Act of 2018 (2018 Budget Act)]. The credit remains available for four-wheeled vehicles indefinitely. A tax credit is available for certain plug-in electric vehicles (IRC Sec. 30D). Qualifying vehicles must draw propulsion using a battery with at least four kilowatt hours of capacity; use an external source of energy to recharge the battery (hence the name plug-in); be used primarily on public streets, roads, and highways; have four wheels (in certain cases, two wheels); meet certain federal emission and clean air standards based upon the gross vehicle weight rating (GVWR) of the vehicle; and the use must originate with the taxpayer [IRC Secs. 30D(d)(1), 30D(d)(2), and 30D(f)(7)]. The credit is subject to various limitations discussed later in this key issue. The credit is available for tax years beginning after December 31, Note: There could be some argument that golf carts modified for use on public roads (i.e., with seat belts, turn signals, brake lights, etc.) can qualify for the NQPEDMV. However, in a response letter written to Senator Richard Lugar dated November 30, 2009, the IRS stated emphatically that golf carts do not qualify for the credit. The IRS reasoned that golf carts are not manufactured primarily for use on public streets (one of the specific criteria for the credit). They are manufactured primarily for off-road use; i.e., a golf course (INFO ). The IRS has provided interim guidance on the certification procedures for manufacturers (and domestic distributors of foreign vehicles) of qualifying vehicles and has stated that purchasers may rely on the manufacturer s (or in the case of a foreign vehicle, its domestic distributor s) certification of a vehicle and the amount of the credit allowable with respect to that vehicle (Notice ) A list of manufacturers that have completed the certification process arranged by manufacturer, model year, vehicle description, and credit amount can be accessed at businesses/qualified-vehicles-acquired-after Amount of the Credit. The per-vehicle credit amount is $2,500 for vehicles powered by a four kilowatt-hour battery, with an additional $417 for each kilowatt hour of capacity beyond that. The maximum credit per vehicle is $7,500 [IRC Sec. 30D(b)]. Phase-out Rules. The NQPEDMV will begin phasing out over a period of four calendar quarters once the total number of qualifying vehicles sold by a manufacturer for use in the United States is at least 200,000. The phase-out period begins with the second calendar quarter following the quarter in which the 200,000 milestone is reached. During the first two quarters of the four-quarter phase-out period, the credit is reduced to 50% of the otherwise allowable amount. During the last two quarters of the phase-out period, the credit is reduced to 25% of the otherwise allowable amount. Consequently, starting with the sixth quarter after the 200,000 milestone is reached, phase-out of the credit is complete and no further credit is allowed [IRC Sec. 30D(e)]. Quarterly sales by manufacturer can be found at Limitations and Special Rules. The tax liability limit for the NQPEDMV depends on whether it is claimed on personal vehicles or depreciable vehicles used in a trade or business. The credit claimed on personal vehicles is treated as part of the taxpayer s nonrefundable personal credits. The total amount of nonrefundable personal credits cannot Key Issue 15H

13 TDB 2/ exceed the sum of: (1) the taxpayer s regular tax liability, reduced by any foreign tax credit allowable and (2) AMT for the tax year [IRC Sec. 26(a)]. This means that the credit can be used to offset both regular tax and AMT. The credit claimed on depreciable business vehicles becomes part of the taxpayer s general business credit and is applied under those rules [IRC Sec. 30D(c)(1)]. Note: The credit is not available to offset the 3.8% net investment income tax (3.8% NIIT) of IRC Sec (see Key Issue 34E for information on the 3.8% NIIT). The basis (depreciable or personal) of property for which the credit is allowed is reduced by the amount of the credit allowed [IRC Sec. 30D(f)(1)]. The Treasury Department is authorized to issue regulations that provide for the recapture of the credit for vehicles that cease to be eligible for the credit [IRC Sec. 30D(f)(5)]. Any credit recaptured should be reported on Form 1040, line 62. Box c should be checked and 8936R entered in the space provided. Observation: The NQPEDMV is not phased out for high income taxpayers. Election Not to Claim the Credit. Taxpayers may choose not to claim the NQPEDMV [IRC Sec. 30D(f)(6)]. No formal election is required. Preparation Pointer: The credit is claimed using Form 8936 (Qualified Plug-in Electric Drive Motor Vehicle Credit). The total tentative credit is computed in Part I. The business use portion of the credit is computed in Part II and carried to Form The personal use portion of the credit is computed in Part III and carried to Form 1040, line 54. Box c should be checked and 8936 entered in the space provided next to that box. Claiming the Alternative Motor Vehicle Credit Law Change Alert: The alternative motor vehicle credit has been extended through December 31, 2017 [IRC Sec. 30B(k)(1), as amended by the 2018 Budget Act]. The alternative motor vehicle credit (IRC Sec. 30B) is available for new (not used) vehicles that are either purchased or leased by the taxpayer and for both business and personal vehicles before January 1, For qualifying property purchased in 2017, the alternative motor vehicle credit consists solely of the Qualified Fuel Cell Motor Vehicle Credit [IRC Sec. 30B(b)]. Qualified Fuel Cell Motor Vehicle Credit. A qualified fuel cell motor vehicle is propelled by power derived from one or more cells that convert chemical energy directly into electricity by combining oxygen with hydrogen fuel that is stored on board the vehicle and may or may not require reformation prior to use [IRC Sec. 30B(b)]. Original use must begin with the taxpayer. These vehicles must also meet certain federal emission standards. The fuel cell motor vehicle credit consists of two parts: (1) a base credit amount depending upon the GVWR of the qualifying vehicle and (2) an additional credit amount based on fuel efficiency improvements compared to 2002 models. The credit applies to qualified vehicles purchased before Taxpayers may rely on the certification by a domestic manufacturer (or, in the case of a foreign manufacturer, its domestic distributor) that a make, model, and model year of a vehicle qualifies as fuel cell motor vehicle, and the amount of the credit allowable for that vehicle (Notice ). Limitations and Special Rules. The tax liability limitation of the alternative motor vehicle credit is limited based on whether it is claimed on personal vehicles or depreciable vehicles used in a trade or business. The credit claimed on personal vehicles is treated as part of the taxpayer s nonrefundable personal credits. The total amount of nonrefundable personal credits cannot exceed the sum of: (1) the taxpayer s regular tax liability, reduced by any foreign tax credit allowable and (2) AMT for the tax year [IRC Sec. 26(a)]. This means that the credit can be used to offset both regular tax and AMT. The credit claimed on depreciable business vehicles becomes part of the taxpayer s general business credits and, therefore, if unused in the current year is available for carryback and carryover under the rules for general business credits [IRC Sec. 30B(g)(1)]. Also, any vehicle that is eligible for the new qualified plug-in electric drive motor vehicle credit (see later discussion in this key issue) is not eligible for the alternative motor vehicle credit [IRC Sec. 30B(d)(3)(D)]. Key Issue 15H

14 15-26 TDB 2/18 Note: The credit is not available to offset the 3.8% net investment income tax (3.8% NIIT) of IRC Sec (see Key Issue 34E for information on the 3.8% NIIT). The basis (depreciable basis or personal basis) of property for which a credit is claimed must be reduced by the amount of the credit allowed, computed without regard to the tax limitation mentioned in the previous paragraph [IRC Sec. 30B(h)(4)]. The Treasury Department will be issuing regulations providing for the recapture of the credit for vehicles that cease to be eligible for the credit (except by reason of conversion to a qualified plug-in electric drive motor vehicle), including recapture in the case of a lease period that is less than the economic life of the vehicle [IRC Sec. 30B(h)(8)]. Any credit recaptured should be reported on Form 1040, line 62. Box c should be checked and AMVCR entered in the space provided. Note: The alternative motor vehicle credit is not phased out for high-income taxpayers. Observation: In general, taxpayers (and practitioners) will not be able to calculate the credit on their own. They must rely on information provided by vehicle manufacturers. Preparation Pointer: The credit is claimed using Form 8910(Alternative Motor Vehicle Credit). The total tentative credit is computed in Part I. The business use allocation is computed in Part II and carried to Form The personal use allocation is computed in Part III and carried to Form 1040, line 54. Box c should be checked and 8910 entered in the space provided. Key Issue 15H

15 TDB 2/ Example 21B-6 Application of real property business debt limitations. Joan owns a building used in her business. Its FMV is $150,000 (adjusted basis $175,000). The building secures a first mortgage of $110,000 and a second mortgage of $90,000. None of the debt is qualified farm indebtedness. Joan is not insolvent or bankrupt and owns no other depreciable real property. On July 1, 2017, the second mortgagee agrees to reduce its debt from $90,000 to $30,000, resulting in debt discharge income of $60,000. The FMV rule limits the total amount of debt discharge income that can be excluded to $50,000, the amount by which the principal of the debt ($90,000) exceeds the FMV of the collateral property, reduced by other qualified real property business debt securing the property ($150,000 $110,000 = $40,000). Therefore, Joan can exclude $50,000 of debt discharge income if she files an election to do so with her 2017 return. The remaining $10,000 of debt discharge income is included in her 2017 income. See Election E904. Client Advice: Because the FMV of the secured property plays a key role in determining the amount of excludable debt discharge income, taxpayers will often benefit from an appraisal that minimizes the property s FMV (if more than one appraisal has been obtained from qualified appraisers and one of the appraisals gives heavier weight to factors that would minimize the FMV of the property appraising property is not a perfect science and thereforeappraisalsofthesamepropertybydifferent appraisers may have different results). Basis Adjustment Requirement. Income excluded for the discharge of qualified real property business debt reduces the basis of the taxpayer s depreciable real property [IRC Sec. 108(c)(1)]. [The reduction is made under IRC Sec. 1017, except the election to treat real property inventory as depreciable property is not available IRC Sec. 1017(b)(3)(F).] The basis reduction is made first to the adjusted depreciable basis of the real property securing the discharged debt. Any excess reduces the depreciable bases of the taxpayer s other depreciable real property proportionately, based on each property s relative adjusted basis. The basis reduction is deemed to occur at the beginning of the tax year following the tax year during which the discharge occurs. However, if the property is disposed of before the beginning of the tax year following the discharge, the basis reduction occurs immediately before the disposition. Example 21B-7 Reducing the basis of depreciable real property. Bill owns Garden Apartments. On July 1, 2017, the property has an adjusted basis of $2.2 million and outstanding nonrecourse debt of $2.5 million. The property s FMV is $2 million. On that day, the mortgage holder reduces the principal amount of the outstanding mortgage to $2 million, resulting in debt discharge income of $500,000. Bill elects to exclude this $500,000 of income under the qualified real property business debt rules. Therefore, his depreciable basis in the apartments is reduced by $500,000 as of January 1, 2018, and depreciation calculated for periods subsequent to that date will take the $500,000 basis reduction into account. Preparation Pointer: If the basis of depreciable real property is reduced under the qualified real property rules, and the property is subsequently disposed of, the basis reduction is treated as a depreciation deduction in calculating ordinary income from depreciation recapture. The calculation of the amount of straight-line depreciation that would have been allowed is made as if no basis reduction had occurred [IRC Sec. 1017(d)(2)]. Thus, the amount of the basis reduction recaptured as ordinary income is reduced over time as the taxpayer forgoes depreciation deductions (because of the basis reduction). Partnership Debt Reduced. For a discharge of partnership debt, the determination of whether debt is qualified real property business debt and the application of the FMV limitation is made at the partnership level (Ltr. Rul ). The election to apply the exclusion is made at the partner level on a partner-by-partner basis. When an election causes a basis reduction to the partner s allocable share of the partnership s depreciable real property, the partner s basis of his interest in the partnership and the partnership s basis of the depreciable realty allocated to the partner are reduced by such amount [IRC Sec. 1017(b)(3)(C) and (F)]. S Corporations Apply Rules at the Entity Level. The income exclusion under IRC Sec. 108 and any resulting reduction in tax attributes are applied at the S corporation level [IRC Sec. 108(d)(7)]. IRC Sec. 108(d)(7)(A) clarifies Key Issue 21B

16 21-16 TDB 2/18 that income excluded under IRC Sec. 108 does not increase a shareholder s basis in S corporation stock. See also Key Issue 17C for additional discussion. Special Rules for Certain Student Loans Cancellations of all or part of certain student loans obtained to attend qualified educational institutions do not result in gross income to the borrower. This special rule applies only to student loans that contain a provision stating that all or part of the loan will be cancelled if the borrower works for a certain period of time in certain professions for any of a broad class of employers (i.e., a public service requirement), and the borrower satisfies such requirement. To qualify, the loan must be made by either [IRC Sec. 108(f)(2)] 1. a federal, state, or local government unit, or instrumentality, agency, or subdivision thereof; 2. a tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, and whose employees are considered public employees under state law; or 3. an educational institution that makes the loan under (a) an agreement with an entity described in item 1 or 2, or (b) a program of the institution to encourage students to serve in occupations or in areas with unmet needs and under which the services provided are for or under the direction of a governmental unit or other tax-exempt organization. Loans made by educational institutions and tax-exempt organizations to refinance loans that assist individuals in attending such educational institution also qualify, provided the refinancing is pursuant to a program as described in item 3 above. Loans from educational institutions and tax-exempt organizations do not qualify if the discharge is on account of services the individual performs for the lender organization [IRC Sec. 108(f)(3)]. Observation: Congress enacted this special rule for certain student loans to encourage students to go into such occupations as medicine, nursing, and teaching in rural and low-income areas. See Rev. Rul for a discussion of the application of IRC Sec. 108(f)(1) to a law school s loan repayment assistance program. In addition to federal loan programs, some families seek funds from other sources. Most states have college loan programs for their residents. Many colleges have their own loan programs that they fund out of their endowments. Banks and other private lenders offer loans that can be used for educational expenses. And individuals can borrow from insurance policies and various retirement plans, or tap into their home equity, as a source for college funding. Observation: The IRS ruled that taxpayers whose college loans were originally taken out to finance attendance at schools owned by Corinthian Colleges, Inc. and later discharged will not realize taxable income or recapture of tax credits and tax benefits as result of said discharges (Rev. Proc ). In addition, taxpayers whose college loans were taken out to finance attendance at schools owned by American Career Institutes, Inc. and later discharged will not realize taxable income or recapture of tax benefits as a result (Rev. Proc ). Special Rules for Principal Residence Debt Law Change Alert: The ability to exclude the discharge of indebtedness on a principal residence from taxable income has been extended through December 31, 2017 [IRC Sec. 108(a)(1)(E), as amended by the Bipartisan Budget Act of 2018 (2018 Budget Act)]. Taxpayers can exclude up to $2 million from gross income for a discharge (in whole or in part) of qualified principal residence indebtedness before January 1, 2018 [IRC Sec. 108(a)(1)(E), as amended by the 2018 Budget Act]. In addition, certain qualified debt may be excluded in 2018 if the discharge is subject to an arrangement that is entered into and evidenced in writing prior to January 1, This exclusion applies where a taxpayer restructures his or her acquisition debt on a principal residence, loses his or her principal residence in a foreclosure, or sells a principal residence in a short sale (where the sales proceeds are insufficient to pay off the mortgage and the lender cancels the balance). The exclusion does not apply if the discharge is on account of services performed for the lender (for example, an employee of the lender and the discharge relates to employment services performed) or any other factor not directly related to a decline in the value of the residence or to the taxpayer s financial condition [IRC Sec. 108(h)(3)]. The exclusion also does not apply to a taxpayer in a Title 11 bankruptcy case; the regular Title Key Issue 21B