WASHINGTON TAX UPDATE

Transcription

1 WASHINGTON TAX UPDATE August 1, 2012 Welcome to Washington Tax Update, where you will find useful information about taxes, including current events in our nation s capital, as well as informed opinions and predictions about what is expected to happen. Tax Look Inside Tax Planning Tip of the Week IRS Courts What s New from the IRS What s New from the Courts It Bears Repeating Tax Laughs Congress

2 tax planning tip of the week When is a health insurance rebate taxable? You receive a rebate from your health insurance company great news, right? The sticky wicket is the possible tax consequences. The Affordable Care Act requires health insurance companies to disclose the amount of premium dollars they actually spend on health care and the amount they spend on administration, such as salaries and marketing. If an insurance company spends less than 80 percent of premiums on medical care, it must rebate the portion of premium dollars that exceeded this limit. This rule is commonly known as the Medical Loss Ratio (MLR) or the 80/20 rule. For the large group market, which is typically insurance provided through large employers, spending less than 85 percent requires rebates.

3 On June 1, 2012, insurance companies submitted their annual MLR reports for coverage provided during 2011 to the Department of Health and Human Services (HHS). Based on this data, HHS has announced that insurance companies that did not meet the 80/20 rule will be issuing more than $1.1 billion in rebates to nearly 12.8 million insured policyholders. These Americans may see rebates ranging up to approximately $800, with the average being about $150. However, the choice may depend on their employers, if applicable. tax planning tip of the week

4 tax planning tip of the week Rebates must be paid by Aug. 1 each year, using one of four methods: 1. A rebate check 2. A lump-sum reimbursement to the same account that was used to pay the premium if it was paid by credit card or debit card 3. A direct reduction in future premiums 4. A rebate to an employer using one of these methods, with the employer applying the rebate in a manner that benefits its employees If you receive a rebate, whether that rebate represents taxable income to you or not depends on a number of factors. The tax principle involved is called the tax benefit rule. The notion behind the tax benefit rule is that, if you received a tax reduction for money you spent in 2011 and you get some of that money back in 2012, the IRS wants to recover some of the tax benefit you received last year. Self-employed If you claimed the premium as a page 1 deduction on your 2011 return because you were self-employed, the rebate will be taxable. Itemized vs. standard deduction If you have an individual policy or you paid premiums on an employer-provided policy with after-tax dollars, the tax status of any rebate will depend on whether you deducted the premiums on your 2011 return: If you claimed the standard deduction rather than itemizing, the rebate will be tax-free.

5 If you itemized and did not claim a medical deduction because your qualifying expenses, including you medical insurance premium, did not exceed 7.5 percent of your adjusted gross income, your rebate will be tax-free. If you deducted any medical expenses, all or part of the rebate will be taxed. The taxable amount depends on how much your total itemized deductions exceeded the standard deduction for your filing status. Group plans If you get your health insurance at work and your employer has a program that lets you pay your healthcare premium with pretax dollars, the rebate will be taxable. Your employer may choose either to give you your share of the rebate in cash or to use the rebate to reduce your health premium in The choice made by your employer will not affect the taxation of your rebate in If you purchase medical insurance at work, you may not actually receive a check even if you are entitled to a rebate. If your employer opts to reduce your future premium payments, your rebate will come in the form of higher take-home pay because a lower insurance premium will be withheld from your pay. tax planning tip of the week

6 what s new from the IRS Health insurance deduction: Self-employed catch a break If you have self-employment income, you may be able to claim a deduction for health insurance expenses incurred for yourself, your spouse and your dependents. You will claim the health insurance deduction on page 1 of Form 1040, whether or not you itemize your deductions. Any health insurance premiums that you cannot deduct directly on Form 1040, you may be able to consider if you itemize your deductions. Self-employed people include farmers reporting income on Schedule F or others reporting income on Schedule C. General partners in a partnership and actively participating members in an LLC treated as a partnership may also have income from self-employment. Likewise, employees of an S corporation who own 2 percent or more of the S corporation s stock may be entitled to the deduction. The deduction cannot exceed your net self-employment income. This limit is calculated by subtracting from your self-employment income 50 percent of your self-employment taxes and any retirement contributions you make to a SEP-IRA, SIMPLE-IRA or Keogh plan. If you report a loss from your self-employment activity, you re not eligible for this deduction. However, you can still claim the health insurance expenses as an itemized medical deduction.

7 In addition, you cannot deduct the insurance premiums for any months you were eligible to participate in a group health insurance plan through your or your spouse s employer. In recent advice, the IRS Chief Counsel has concluded that a self-employed individual can deduct Medicare insurance premiums in computing adjusted gross income (CCA ). The Chief Counsel also advised that: The premiums for all Medicare parts, not just Part B, are eligible for the deduction. A self-employed individual can pay the premiums directly and be reimbursed by the employer, or the premiums may be paid by the employer (the partnership or S corporation). Sole proprietors must pay the premiums directly. Medicare premiums can be deducted for coverage of the self-employed individual s spouse, dependent or child (assuming the child is not age 27). Self-employed individuals who failed to deduct Medicare premiums for prior years may file an amended return to claim the deduction. Prior to 2010, the IRS instructions for Form 1040 specifically said, Medicare premiums cannot be used to figure the [self-employed health insurance] deduction. For 2010 and 2011, the instructions were changed to say, Medicare Part B premiums can be used to figure the deduction. Now the IRS has clarified that all Medicare premiums qualify for the deduction. what s new from the IRS

8 what s new from the courts Child of U.S. citizen doesn t necessarily mean tax exemption Parents who move to the United States and leave their children in their home country and U.S. citizens living abroad with their families should be knowledgeable about the U.S. dependency tax exemption rules. A recent Tax Court case emphasized that a child who does not reside in the United States, Canada or Mexico must be a U.S. citizen at some time during the relevant tax year. The case involved Leah Carlebach, a U.S. citizen living in Israel with her husband, who was not a U.S. citizen, and their children, who were all born in Israel.

9 The couple filed joint federal income tax returns for three years, claiming some of the children as dependents and also claiming child tax credits and a child care credit. In later years, Leah filed a separate federal income tax return claiming the children as dependents. Eventually, the Director of the U.S. Citizen and Immigration Services granted certificates of citizenship to the children. The children also applied for, and were issued, Social Security cards. The IRS denied the dependency exemptions and the child credits claimed during years prior to the years in which the children were granted certificates of citizenship. The parents argued that the children should be considered U.S. citizens by virtue of derivative citizenship. Under the Child Citizenship Act of 2000, a child born outside the United States to a parent who is a U.S. citizen automatically becomes a U.S. citizen if the child permanently resides in the United States.

10 what s new from the courts However, if the child permanently resides outside the country as was the situation in this case, the child is entitled to become a U.S. citizen by filing an application and receiving a certificate of citizenship. The court concluded that, although the children s status as U.S. citizens derived from their mother s U.S. citizenship, they did not actually become U.S. citizens until they applied for and received certificates of U.S. citizenship. Prior to the years in which this process was completed, the children could not be claimed as dependents on their parents federal income tax return (Leah M. Carlebach and Uriel Fried v. Commissioner, 139 TC No. 1, July 19, 2012).

11 it bears repeating Taxpayer takes a $23,000 hit on commuting costs So you think your commute is expensive? The costs of commuting between your home and your place of business are generally considered nondeductible personal expenses. However, in some cases you can deduct travel expenses between your home and a temporary work location, if the temporary work location is outside the metropolitan area where you normally live and work. A recent Tax Court case addressed a common fact pattern. Kristopher Saunders performed construction services as an employee of Valley Interior Systems in Cincinnati, Ohio. During 2007, he traveled to five temporary work sites. He did not travel to the Valley Interior offices in Cincinnati. None of the jobs lasted more than a few months. The temporary work sites ranged in distance from 74 to 96 miles from Saunders home. Each workday, Saunders drove from his home to the temporary work location, returning home at the end of each day.

12 it bears repeating For reasons not explained in the case, Valley Interiors did not reimburse the travel costs, which exceeded $23,000. Saunders claimed an itemized deduction for unreimbursed employee business expenses, which was disallowed by the IRS. The Tax Court noted that it takes a facts-and-circumstances approach in deciding whether a particular work site is unusually distant from the area where the taxpayer lives and normally works. The court found that Saunders temporary work sites could not be considered outside the Cincinnati metropolitan area. The court also found that the travel expenses would be deductible if the residence was Saunders principal place of business. However, Saunders did not claim that his residence was his principal place of business. Finally, travel expenses between his residence and a temporary work location may have been deductible if Saunders had shown that he had a regular work location away from his residence. The court found no evidence to establish that Saunders had a regular work location in The court concluded that all of Saunders travel expenses were nondeductible commuting costs (Kristopher R. Saunders and Jessika R. Saunders v. Commissioner, TC Memo , July 17, 2012).

13 tax laughs Isn t art supposed to lift the human spirit? You ve probably read horror stories about family businesses sold to pay estate taxes. Now Forbes magazine is reporting a strange case the IRS is pursuing against the estate of art dealer Ileana Sonnabend, who died in Among the many works of art included in the estate is one called Canyon, a sculptural combine created by artist Robert Rauschenberg. According to Forbes, the IRS wants to value this particular piece at $65 million and collect some $29.2 million in estate taxes, plus $11.7 million in penalties. Not the least of the problems facing Sonnabend s heirs is that, if they sell Rauschenberg s creation to pay the estate taxes, they will go to jail along with any art connoisseur foolish enough to buy it! Both will have committed a felony. It seems that this particular work of art includes within its composition a stuffed bald eagle. The 1940 Bald and Golden Eagle Protection Act and the 1918 Migratory Bird Treaty Act make it a crime to possess, sell, purchase, barter, transport, import or export any bald eagle dead or alive.

14 tax laughs Apparently, Sonnabend had received some sort of informal exemption from the United States Fish and Wildlife Service allowing her to possess Canyon. The artist himself had to send a notarized statement attesting that the eagle had been killed and stuffed by one of Teddy Roosevelt s Rough Riders long before the 1940 act went into effect. The government then allowed Sonnabend to retain ownership of the work so long as it remained on exhibit in a public museum. The Sonnabend estate used the IRS s own valuation guidelines: the amount at which the item would change hands between a willing buyer and a willing seller, both fully knowledgeable of all relevant facts. Since Canyon cannot be legally sold, the estate valued the work at zero. The estate even hired three appraisers, including the auction house Christie s, to support its zero valuation. In prior cases, the IRS has successfully argued that assets like farmland should be valued at highest and best use, such as commercial development instead of growing corn. But this may be the first time the IRS has proposed that highest and best use is an illegal activity like arguing that farmland could be cultivated for marijuana plants. Only put off until tomorrow what you are willing to die having left undone. Pablo Picasso

15 Courts Tax IRS Congress The technical information in this newsletter is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the information contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS CPAmerica International