- Written by: Sidney Kess, CPA, J.D., LL.M.
A handful of important changes impact relations between the IRS and taxpayers. The IRS has ended some of its programs while starting a new one; new laws have changed the rules affecting some dealings with the IRS. Here is a roundup of some of those changes.
Six-Year Statute of Limitations
While the IRS usually has three years from the due date of the return to commence an audit (Code Sec. 6501(a), the IRS has six years in which to act when a taxpayer omits 25% from gross income, provided the omission is more than $5,000 (Code Sec. 6501(e)(1)), the question of what constitutes “gross income” for this purpose may not always be clear.
[This article is course content for the Tax Season 2016 CPE quiz, worth 3 CPE credits! Reach the quiz and additional content HERE.]
In 2012, the U.S. Supreme Court held that the overstatement of basis, which results in an understatement of gain on the sale of property, is not an omission from gross income for purposes of the six-year statute of limitations (Home Concrete
& Supply, LLC, 132 S. Ct. 1836 (2012)). Now, however, the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (P.L. 114-41) has effectively reversed the Court’s ruling. Under the new law, which became effective on July 31, 2015, an overstatement of basis that produces an understatement of gain constitutes an omission from gross income triggering the six-year statute of limitations.
Thus, the change applies to tax returns filed after July 31, 2015. However, it also applies to any returns filed prior to this date that are not closed by the statute of limitations or by consent of the taxpayer. It also applies to cases before the Tax Court that were docketed before July 31, 2015, if the tax year is still open.
In 2000, the IRS directed the IRS to start a pilot program offering arbitration to resolve taxpayer disputes (Code Sec. 7123(b) (2)). The IRS followed up with a number of such pilot programs and, in 2006, made the Appeals arbitration program permanent. Now the IRS announced it was terminating the program, effective September 21, 2105 (Rev. Proc. 2015-55, IRB 2015-ADD). The reason for the end to the program was simply lack of interest on the part of taxpayers. In the 14 years that the program was operational, only two cases were settled through arbitration.
Alternative dispute resolution with the IRS can still be done through mediation under certain conditions. There are different mediation programs for large corporations, small businesses and self-employed individuals, and tax-exempt organizations; see www.irs.gov/Individuals/Appeals-Mediation-Programs for details.
About 23 million taxpayers used the online Get Transcript service from the IRS in the past tax return season (http://www.irs.gov/uac/Newsroom/Get-Transcript-Application-Questionsand-Answers). This service enabled taxpayers to obtain their tax account information, a tax return transcript, and certain other information online by providing personal information (e.g., Social Security number, date of birth, street address). In May, the IRS announced that its computers had been breached through its Get Transcript online service (http://www.irs.gov/uac/Newsroom/IRS-Statement-on-the-Get-Transcript-Application). The IRS first reported that about 100,000 taxpayers’ accounts were accessed illegally; the number of affected taxpayers was later expanded to about 330,000 (http://www.irs.gov/uac/Newsroom/Additional-IRS-Statement-on-the-Get-Transcript-Incident) and many believe the number is much higher. As a result of the breach, the IRS has suspended the online program (http://www.irs.gov/uac/Newsroom/IRS-Statement-on-the-Get-Transcript-Application).
Taxpayers can get a transcript by mail (http://www.irs.gov/Individuals/Get-Transcript); it takes five to 10 days to receive the transcript in this way. Alternatively taxpayers can obtain copies of their returns by filing Form 4506, Request for Copy of Return, through the mail. Obviously, transcripts by mail take more time than the online option.
Note: As a result of this breach, a class action lawsuit has been filed against the IRS by taxpayers who claim their identities were stolen (Wellborn v. IRS, DC DC, filed 8/20/15). They argue that the IRS should have known their computers were vulnerable to cyber-criminals. The complaint references reports from the Government Accountability Office (GAO) and the Treasury Inspector General for Tax Administration that warned the IRS about its lax computer security.
Other fallout from the Get Transcript hacking:
• The IRS has ruled that identity theft protection services offered to consumers, employees, and others whose personal information may have been compromised by a data breach of a business, government agency, or other organization will not be taxed because the IRS will not claim it is taxable income (Announcement 2015-22, IRB 2015-35, 288). Such services include credit reporting and monitoring services, identity theft insurance policies, identity restoration services, or other similar services. The tax-free treatment does not extend to employees who receive this fringe benefit as part of their compensation package rather than because of the company having experienced a data breach.
• The IRS has ended the automatic extension for filing Form W-2, Wage and Tax Statement (T.D. 9730, 8/15/15). According to the preamble in temporary regulations, the change is due to incidents of falsified statements filed by identity thieves using stolen taxpayer information. Until these new temporary regulations go into effect, the old rules apply, which allow for an automatic 30-day extension, with another non-automatic 30-day extension that can be granted by requesting it from the IRS. The temporary regulations making this change apply to all forms within the W-2 series other than Form W-2G, Certain Gambling Winnings. As a result of the change, the IRS will grant an extension of up to 30 days only in limited cases where the extension is warranted because of extraordinary circumstances or catastrophe (e.g., destruction of records in a fire or natural disaster). The change takes effect for returns filed in 2017 (i.e., W-2s reporting compensation earned in 2016).
Form 5500-EZ late filer program
The IRS has created a penalty relief program for late filers of Form 5500-EZ. This return covers qualified retirement plans where the only participants are owners and their spouses; there are no common law employees (other than these participants) (Rev. Proc. 2015-32, IRB 2015-24, 1063). The purpose of the program is to get these plans into compliance without having to pay the $25 per day penalty (up to $15,000 for each delinquent return), plus interest (Code Sec. 6652(e)). Instead, delinquent filers only have to pay $500 per delinquent return (up to $1,500 per plan).
To use the program, each delinquent return must be submitted separately on paper (no electronic filing). The top of the return should be marked “Delinquent Return Filed under Rev. Proc. 2015-32, Eligible for Penalty Relief.” Form 14704, Transmittal Schedule—Form 5500-EZ Delinquent Filer Penalty Relief Program, should also be completed and attached to the oldest delinquent return being submitted, along with the required fee.
The program cannot be used if the IRS has already sent a delinquency notice called CP 283, Penalty Charged on Your 5500 Return, for an overdue return. Instead of relying on this program to escape severe penalties, delinquent filers can come into compliance arguing reasonable cause for the late filing. The taxpayer attaches his or her own statement about reasonable cause to the delinquent return; the IRS may or may not accept the explanation. If it does, the penalties are waived. If it does not, the IRS will send a penalty notice (CP 283), making the late filer program option no longer available.
Plans that have assets under $250,000 usually are not required to the annual return. However, this filing exception does not apply to the final year of the plan. Small business owners who did not file a return for the final year of their plans because they thought the $250,000 exception exempted them should take advantage of the penalty relief program.
The rules regarding IRS-taxpayer relations are constantly changing. With changes in technology, a reduced IRS budget despite increasing responsibilities, and the need to implement new tax rules, expect to see more developments in IRS-taxpayer relations to come.
Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is counsel at Kostelanetz & Fink and is consulting editor to CCH.Write comment (0 Comments)
- Written by: Sidney Kess, CPA, J.D., LL.M.
Today, there are a growing number of primary and secondary students who are being educated outside of the public school system. Alternative education includes home schooling, private schools, and tutors. There are many personal and financial factors that impact a parent’s decision about a child’s education. The choice can raise tax issues that should be recognized.
Today there are an estimated 1.77 million students being home schooled nationwide, according to U.S. Department of Education (http://www2.ed.gov/about/offices/list/oii/nonpublic/statistics.html). Parents assume the responsibility for educating their children at home for a variety of reasons, including concerns about the environment of schools and dissatisfaction with academic instruction.
Deduction for home schooling costs. While educators could deduct $250 of out-of-pocket classroom costs as an adjustment to gross income, parents who home school their children are not treated as educators for this purpose (Code Sec. 62(a)(1)(D); 2014 IRS Publication 529, page 4). Note: This deduction expired at the end of 2014 but could be extended for 2015 and beyond.
Impact on alimony and child support. Child support is not taxable to the parent who receives it on behalf of a child; alimony is taxable (assuming it meets the tax law requirements) (Code Sec. 71). When a single payment is made to cover both child support and alimony and the amount of the payment changes, it is not always easy to determine whether there been a reduction in child support or alimony.
A reduction in child support results when there is a reduction in the designated amount or when there is a reduction that depends on the occurrence of a contingency related to the child (Code Sec. 71(c)(2)). Examples of contingencies include the child reaching a specified age or income level, the child leaving school, marrying, leaving the parent’s household, or beginning work. However, in a recent case the Tax Court concluded that ending home schooling is not a contingency related to the child (Wish, TC Summary Opinion 2015-25). In the case, the parent stopped home schooling so she could return to the workforce for financial reasons; the child then went to public school. Thus, the reduction in the monthly amount was not related to child support. As a result, the parent making the payment had a smaller tax deduction for the reduced alimony payment.
Almost 4.5 million students are in private schools, according to the U.S. Department of Education (http://www2.ed.gov/about/offices/list/oii/nonpublic/statistics.html). Again, a variety of factors come into play in deciding to send a child to a private school, including the opportunity for academic excellence, the need for unique training (e.g., help for special needs child), family scheduling, and other personal reasons.
Scholarships. Scholarships to pay for private primary or secondary education are tax-free (Code Sec. 117). However, this exclusion applies only to tuition and fees; it does not apply to room and board, books, travel, and other costs covered by the scholarships (Code Sec. 117(b)(2)).
Medical expense deduction. A child with a special physical, mental, or emotional condition may attend a private school able to treat the condition. The cost of attendance (tuition, room and board, special counseling, etc.) may be a medical expense that can be deducted as an itemized deduction (Code Sec. 213(d)). Examples of conditions for which educational costs become a deductible medical expense:
• Dyslexia (Letter Ruling 200521003)
• Epilepsy (Shidler, 30 TCM 529 (1971))
• Hearing impairment to learn lip reading or visual impairment to learn Braille (see IRS Publication 502)
• Hyperactivity (Newkirk, CA-6, 611 F.2d 373 (1979))
To qualify as a deductible medical expense, the school must have a professional staff competent to provide help for the child’s condition. Also, the principle reason for attendance is medical care (not ordinary education). Finally, the schooling must be recommended by a physician to address the child’s condition.
Using Coverdell ESAs. Coverdell Education Savings Accounts are savings programs that can be used for any level of education. Distributions from Coverdell ESAs are tax-free when used to pay qualified education costs for primary or secondary school (Code Sec. 530(d)(2)(A)). This is in contrast to other education breaks, such as the American opportunity credit and the above-the-line deduction for tuition and fees, that are restricted to higher education.
The exclusion for distributions from Coverdell ESAs can be used to pay tuition at private school, including a religious school and extended day programs. Other qualified expenses include books, tutoring supplies, special services for special needs beneficiaries, computers and peripheral equipment, Internet access, transportation, and uniforms (Code Sec. 530(b)(3)(A)).
Note: Up to $2,000 can be contributed annually to a beneficiary’s Coverdell ESA until the beneficiary reaches age 18; the contribution is not tax deductible. However, contributors cannot have modified adjusted gross income (MAGI) over a threshold amount. The MAGI limit for making a full contribution is $95,000 for a single taxpayer ($190,000 on a joint return) (Code Sec. 530(c)). The $2,000 annual contribution limit phases out for MAGI up to $110,000 for a single taxpayer ($220,000 on joint return); no contribution is allowed for a taxpayer with MAGI over this amount. The MAGI threshold is not indexed annually for inflation as are so many other MAGI thresholds.
Gifts from grandparents. Usually a gift is free from federal gift tax if it is below the annual gift tax exclusion amount (e.g., $14,000 in 2015). However, gifts in any amount can be made directly to an educational institution to cover the cost of tuition (Code Sec. 2503(e) (2)(A)). Utilizing the direct transfer gift option does not limit the ability to also make a gift to a child or grandchild up to the exclusion amount.
In one instance, grandparents prepaid the cost of private school for two grandchildren (for preschool through grade 12). The IRS said this transfer was tax-free for gift tax purposes (Technical Advice Memorandum 199941013). This conclusion was premised on the fact that the school would retain the prepayment if the children ceased attending the school for any reason.
A child may require academic tutoring or special educational assistance. Generally, there is no tax break for such cost; the parent must bear this out-of-pocket expense. However, distributions from a Coverdell ESA can be used for these expenses (IRS Publication 970). Note: There is no guidance on whether tax-free distributions from Coverdell ESAs can be taken to cover the cost of SAT preparation courses and other similar courses, but a good argument could be made that the cost would be a qualified educational expense.
Special savings accounts under state programs can be set up for a beneficiary who is blind or has a disability that occurred before age 26 and who is (1) receiving Social Security disability income or Supplemental Security Income (SSI) or (2) has a disability certification from the IRS (Code Sec. 529A(e)(1)). Created by Tax Increase Prevention Act of 2014 (P.L. 113-295) and modeled after 529 education savings plans, the Achieving a Better Life Experience (ABLE) accounts can be used to pay for qualified disability expenses, which include education (Code Sec. 529A(e)(5)).
The purpose of ABLE accounts is to allow for savings to cover the special lifetime needs of some individuals. The funds in the account are not taken into account for determining assistance under federal programs (e.g., Medicaid, SSI). However, once the account balance reaches $100,000, SSI can continue but distributions from the account are suspended.
Anyone can contribute to a beneficiary’s ABLE account up to the annual gift tax exclusion. However, unlike in the case of 529 plans, there is no special rule allowing ABLE contributors to contribution five times the annual exclusion in a single year.
States had until June 19, 2015, to submit plan designs for their programs to the Treasury. The IRS issued some guidance on ABLE accounts (Notice 2015-18, IRB 2015-12, 765) which makes it clear that at all times the beneficiary is the owner of the account. If someone else has signature authority over the account, such person may not acquire a beneficial interest in the account and must administer the account for the benefit of the designated beneficiary.
While a public school education is available to all children in the U.S., there may be reasons for parents to opt for alternative education solutions. Tax laws may come into play in handling the costs of nonpublic education.Write comment (0 Comments)
- Written by: Sidney Kess, CPA, J.D., LL.M.
There are numerous instances in which small businesses receive tax-favored treatment compared with their larger counterparts. For the most part, the definition of “small business” for each tax break varies; the definition can turn on the amount of gross receipts, the amount of assets, or the number of employees. Recent IRS pronouncements have created a number of new areas of relief specifically for small businesses.
What this simplified method means to small businesses is an opportunity to easily adopt various elections under the final regulations. However, use of the simplified method is not mandatory; these taxpayers can still choose to file Form 3115. The simplified method does not provide any audit protection while filing Form 3115 creates protection and a paper trail. Use of the simplified method is explained in IRS question and answers related to the final repair regulations (http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Tangible-Property-Final-Regulations).
Waiver of Affordable Care Act penalty
In light of rising health insurance premiums, some small employers dropped coverage and instead offered compensation to employees so they could purchase coverage on a government exchange. Others provide health reimbursement arrangements to supplement employee out-of-pocket medical costs. The government has taken a dim view of these actions, concluding that the arrangements are impermissible under the Affordable Care Act. As such, an employer can be subject to a $100 per day/per employee penalty (Notice 2013-54 and http://www.irs.gov/Affordable-Care-Act/Employer-Health-Care-Arrangements). However, the IRS has granted relief from this penalty (an excise tax under Code Sec. 4980D) to small employers for reimbursing or paying premiums from January 1, 2014, through June 30, 2015 (Notice 2015-17). A small employer for purposes of this relief is an employer with less than 50 full-time and full-time equivalent employees.
The penalty relief also applies to employers who pay or reimburse employees for Medicare Part B or D, or TRICARE-related expenses. And it applies to health reimbursements arrangements (HRAs) in which employers agree to reimburse out-of-pocket medical costs up to a set dollar limit each year. These plans fail to meet the definition of a health plan providing minimum essential coverage required by ACA.
Small employers are not subject to the employer mandate and are not subject to a penalty for failing to offer coverage. They are encouraged to do so by the incentive of the small employer health insurance credit (Code Sec. 45R). Starting in 2014, the credit is up to 50% of the premiums paid by the employer. Small employers who nonetheless decide to drop coverage and increase compensation for employees are not penalized as long as they do not require that it be used for medical insurance.
Treatment of health care for S corporation owners
According to the IRS’ interpretation of ACA, S corporations that pay premiums for more-than-2% shareholders would also be subject to the penalty described earlier. Again, the IRS has granted relief in this situation, waiving the penalty (Notice 2015-17).
Because of uncertainty about payments of premiums for these owners, the penalty relief applies until further IRS guidance is provided, but at least through 2015. Until then, S corporations can rely on prior IRS guidance with respect to medical coverage for these shareholders (Notice 2008-1). Under that guidance, S corporations must include medical coverage as taxable compensation to more-than-2% shareholders. These shareholders can then deduct 100% of the premiums as an adjustment to gross income on their personal tax returns; no itemizing is required.
Work opportunity credit certification
While businesses of any size can use the work opportunity credit (Code Sec. 51), many small businesses do so because every penny counts. When hiring new employees, employers who choose them from certain targeted groups specified in the tax law may enjoy a tax credit (the amount of the credit varies with the group to which the new employee belongs). To qualify for the credit, an employer must submit a pre-screening certification to the state workforce agency within 28 days of the first day of employment. The work opportunity credit had expired at the end of 2014 only to be extended retroactively in mid-December. Many employers failed to timely submit the certifications (IRS Form 8850 and DOL Form 9061 or 9062). Fortunately, the IRS has provided relief for Form 8850 (Notice 2015-13).
According to the Notice, employers have until April 30, 2015 (the IRS website says April 29, 2015), to submit the forms for employees hired in 2014. This will enable them to claim the work opportunity tax credit on 2014 returns. Before claiming the credit, employers must receive certification from the state workforce agency that a new hire is within a targeted group. (Employers may need to obtain an extension of time to file their 2014 returns.) If a particular employee is not certified, the employer can request a reconsideration of the certification.
Going forward, the work opportunity credit expired again at the end of 2014; its fate for 2015 is uncertain. However, employers who hire workers in 2015 and believe they may fall within a targeted group can submit the certification forms to the state workforce agency with the hope that the credit is again extended. The forms will not be processed until the credit is extended (http://www.doleta.gov/business/incentives/opptax/pdf/InterimInstructions_2014Reauthorization_2015Hiatus.pdf).
Simplified change of accounting method
Regulations for tangible property (T.D. 9636) (referred to as the “repair regulations”) and certain dispositions of property (T.D. 9689) that became final for tax years beginning on or after January 1, 2014, may require businesses to change their method of accounting. Usually this means filing Form 3115 (with a return for automatic relief or with the IRS to request relief in non-automatic situations). Fortunately, the IRS has provided relief to small businesses making changes in accounting methods under these regulations (Rev. Proc. 2015-20; IR-2015-29, 2/3/15). They do not have to file Form 3115 or any other formal election for a change in accounting under these final regulations. Instead, they simply implement them on their tax return.
This simplified procedure can be used only by a taxpayer with one or more separate and distinct businesses that has either (1) total assets of less than $10 million on the first day of the taxable year to which the change applies, or (2) average annual gross receipts of $10 million or less for the three prior years (or the years in business if less than three years). The total asset test applies for all of the taxpayer’s businesses; the gross receipts test applies to each separate and distinct business. The term “separate and distinct businesses” is not defined so it is a factual determination.
When a taxpayer makes a change in accounting method, usually this requires an income adjustment (positive or negative) as a result of Code Sec. 481. Under the simplified procedure, a change in accounting method under the repair regulations for 2014 can be made with zero adjustment.
Taxpayers who have not yet filed their 2014 returns can rely on the simplified method. Those who already filed their 2014 with a change of accounting on Form 3115 but want to rely on the simplified method can withdraw Form 3115 by filing an amended return. This must be done no later than the due date of the 2014 return, including extensions.
These various types of IRS relief are favorable to small businesses. However, relying on them may necessitate additional actions by small businesses (e.g., payroll adjustments related to ACA relief).
Sidney Kess, CPA-attorney, is of counsel at Kostelanetz & Fink, consulting editor to CCH, author and lecturer.
- Written by: Sidney Kess, CPA, J.D., LL.M.
Under the current tax system, most savings programs, such as IRAs, are incentivized by tax deductions for contributions. However, there are three important savings vehicles, one of which is new, that do not hinge on deductions for contributions; they rely on tax breaks for withdrawals and offer other benefits.
The average cost of a four-year education at a private college for someone enrolling in 2033, which is 18 years from now, is projected to be $323,900 (http://www.savingforcollege.com/tutorial101/the_real_cost_of_higher_education.php). To help students avoid or minimize the need for student loans and the resulting debt, parents, grandparents, and others can save for a child’s higher education in a tax-advantaged account called a 529 savings plan. (There are also 529 tuition plans, which are a form of savings; they are not discussed here.)
Every state offers a savings program. Each state sets its own cap on lifetime contributions. Once an account (contributions plus earnings) reaches the cap, no additional contributions are permitted; the cap can be adjusted annually. For example, the current cap in New York is $375,000; it is $418,000 in Florida and $452,210 in Pennsylvania. However, contributions made in one state usually are not taken into account by another state for purposes of the lifetime cap.
Each plan offers a range of investment options. Investments can be changed once a year.
Contributions are treated as completed gifts for federal gift tax purposes, even if the donor retains control over the account. Contributions qualify for the annual gift tax exclusion. What’s more, under a special rule, a donor can make up to five times the annual exclusion amount without any gift tax (e.g., in 2015 this is $70,000, or $140,000 if a spouse joins in the contribution).
Distributions are tax free if used for qualified education expenses. These include tuition, fees, books, supplies, and equipment required for enrollment. (In the past, computer equipment and technology were qualified expenses, but this is no longer so.) Distributions for nonqualified purposes are taxable under annuity rules discussed earlier; the taxable portion is subject to a 10% penalty. To the extent that expenses are taken into account in figuring the American opportunity credit or lifetime learning credit, they cannot also be treated as qualified distributions.
The federal financial aid application (FASFA) counts assets in a 529 plan as a parental asset, even if the account is owned by the student. This means that 5.64% of the assets are assessed in determining a student’s Expected Family Contribution (EFC). Also, tax-free distributions from a 529 plan are not part of the “base-year income” and, thus, do not reduce the next year’s financial aid eligibility.
Who knows how much a person needs to achieve a financially-secure retirement. Health care costs, what is needed and what this will cost, is the great unknown. Individuals with earned income from a job or self-employment can make contributions to a Roth IRA up to set limits (for 2015, the limits are $5,500, or $6,500 for those age 50 and older by year end, assuming earned income is at least this amount) (Code Sec. 408A). Again, contributions are not tax deductible, but earnings grow tax deferred and withdrawals are tax free if certain conditions are met. Earnings are excludable when a distribution occurs more than five years after the start of the year in which the initial contribution to the account was made as long as the contributor is over age 59-1/2 or becomes disabled or dies.
Contributions can be made regardless of participation in a qualified retirement account or the age of the contributor. However, income limits may limit or bar contributions. For 2015, a full Roth IRA contribution can be made only if modified adjusted gross income $183,000 for a married person filing jointly, or $116,000 for singles (including heads of households) (Notice 2014-70, IRB 2014-48, 905). A partial deduction is allowed for joint filers with MAGI between $183,000 and $193,000, and for singles with MAGI between $116,000 and $131,000.
There are no lifetime required minimum distributions for Roth IRAs. Thus, if the account owner does not need the funds, he or she can leave tax-free income to a beneficiary. A beneficiary who is a surviving spouse can rollover the funds to his/her own Roth IRA and continue tax-free growth. However, a non-spouse beneficiary must take required minimum distriutions (RMDs) over his/her life expectancy (according to an IRS table for this purpose) even though the distributions are not taxed.
Designated Roth accounts. A 401(k) plan can permit after-tax contributions that are segregated from regular 401(k) accounts; these are referred to as designated Roth accounts. As with other after-tax contribution plans, there is no upfront incentive for contributions (i.e., there is no salary reduction for contributions to designated Roth accounts). Earnings become tax free when a distribution occurs more than five years after the initial contribution to the account and when the contributor is over age 59-1/2 or becomes disabled or dies.
Unlike Roth IRAs, there is no income limit on eligibility to contribute to designated Roth accounts. However, also unlike Roth IRAs, designated Roth accounts are subject to required minimum distribution rules. Lifetime distributions can be avoided by rolling over the designated Roth account to a Roth IRA.
The cost of raising a disabled child to the age of 18 can reach $1 million (https://www.mint.com/blog/planning/the-cost-of-raising-a-special-needs-child-0713) and the needs of a disabled person do not end at the age of majority. Achieving a Better Life Experience (ABLE) Act (H.R. 647, which was part of Division B of H.R. 5771) was signed into law on December 19, 2014, as part of the Tax Increase Prevention Act of 2014 (the “extender bill”). It creates a new type of savings plan for disabled individuals without causing them to lose eligibility for Medicaid and other government assistance programs. Contributions to an ABLE account are not tax deductible, but earnings grow on a tax-deferred basis, and withdrawals for qualified expenses are tax-free (Code Sec. 529A).
An account may be set up for a designated beneficiary by such person, a parent, grandparent, or any other individual. A designated beneficiary is someone who is entitled to benefits based on blindness or disability under the Social Security Act where such disability occurred before the age of 26, or any person who has a disability certification on file with the IRS (details about certification are to be provided by the IRS).
States are authorized to set up programs for ABLE accounts. States can set the dollar limits on lifetime contributions on behalf of a designated beneficiary. Only residents of a state can participate in its program.
Contributions to ABLE accounts are treated as completed gifts and qualify for the annual gift tax exclusion (in 2015 it is $14,000, or $28,000 if a spouse joins in the contribution). However, the special gift tax rule applicable to contributions to 529 plans (discussed later) does not apply to contributions to ABLE accounts.
Qualified expenses for which tax-free withdrawals can be made include expenses for health, education, transportation, housing, assistive technology, legal fees, and burial expenses. In addition, the IRS is authorized to add to the list of statutory expenses that are treated as qualified for tax-free withdrawal purposes.
Withdrawals are permitted for nonqualified purposes, but are taxed according to the rules applied to commercial annuities (Code Sec. 72). Thus, the portion of the distribution related to after-tax contributions is tax-free while the portion reflecting earnings on those contributions is taxable. In addition, there is a 10% penalty on the taxable portion, regardless of the designated beneficiary’s age.
Rollovers can be made to change designated beneficiaries or savings programs. The same 60-day rollover period and the one-rollover-per-12-month period rules for IRAs apply to ABLE accounts. Investments are restricted, but changes can be made within the account twice a year.
Usually, having assets over $2,000 or income over $700 a month causes a disabled person to lose eligibility for Medicaid and other government programs. However, assets in an ABLE account are ignored for purposes of government programs. But eligibility for Supplemental Security Income (SSI) is lost when the ABLE account balance exceeds $100,000.
The law is effective after December 31, 2014. The IRS is expected to promulgate rules for ABLE accounts, including the certification rules, within six months.
While an upfront federal tax deduction is not available for these savings accounts, they still provide significant tax and other benefits. For example, there may be state income tax incentives (e.g., New York allows a deduction of up to $5,000 per taxpayer for contributions to its 529 savings plan so a married couple can deduct up to $10,000 annually). Look into these and other after-tax savings plans (e.g., Coverdell education savings accounts) to provide for future needs on a tax-advantaged basis.
Sidney Kess, CPA-attorney, is of counsel at Kostelanetz & Fink, consulting editor to CCH, author and lecturer.Write comment (0 Comments)
- Written by: Sidney Kess, CPA, J.D., LL.M.
Do you or your clients have household help? Does your client have a nanny or babysitter, cleaning person, domestic worker, caretaker, health aide or private nurse? Numerous times in the past, the subject of household help has made national headlines – most notably concerning political figures who faced violations that surfaced regarding proper hiring and tax withholding guidelines for domestic employees.
In a complex world, household employees can help simplify our lives. But, the payroll tax implications associated with a household employee can be complicated. To avoid the headaches of reporting all of the necessary data, many employers of household help often hire workers “off the books.” However, is it worth the risk?
The IRS continues to scrutinize the proper employment of household employees. There is no statute of limitations for failure to pay household employment taxes. Therefore, a household employee could file for social security and unemployment benefits many years down the road. In addition to owing back taxes if caught, employers could also face significant fines, penalties, and interest charges. In some instances, blatant employment violations could also compromise the professional licenses of some employers.
As a trusted advisor to your clients, it is best to share the reality of household employer responsibilities and the importance of this worker classification at the onset of the employment relationship, to help avoid financial risk in the future. Reporting household employee wages and paying employment taxes is the law. It is also the right thing to do for the household help to ensure they are receiving the appropriate benefits and protections as a worker. Therefore, it may simply not be worth the risk – it is best to pay household employees the proper way – “on the books.”
This material identifies federal requirements for household employees. For federal information, including information on determining if the person(s) hired is considered an employee for employment tax purposes, visit the IRS website (www.irs.gov) and see Publication 926, Household Employer’s Tax Guide. Additionally, more information on employee status can be found in the Fair Labor Standards Act, on www.dol.gov.
Determining Worker Status
Be sure to accurately identify the household worker’s status as either an employee or independent contractor under the applicable law(s).
Generally, a household worker who performs services that are subject to the will and control of the payer, as to both what must be done and how it must be done, will be considered an employee for employment tax purposes. With that “employee” status, comes effort and paperwork. More information on determining worker status can be found in IRS Publication 15-A, Employer’s Supplemental Tax Guide.
Household Employer Responsibilities
Below, please find the federal responsibilities for household employers if it is determined that a household worker is, in fact, an employee for employment tax purposes.
Federal Employer Identification Number and Registrations
- If you do not already have one, a household employer must get an employer identification number (EIN), using Form SS-4.
- Complete Form I-9, Employee Eligibility Verification Form to verify work authorization.
Federal Employment Taxes
Social Security and Medicare. Withhold and pay social security and Medicare taxes if cash wages of $1,900 or more in 2014 are paid to any one household employee. Do not count wages paid to your spouse, your child under the age of 21, your parent, or any employee under the age of 18 at any time in 2014. See IRS Publication 926 for more details on exclusions.
Federal Unemployment. Pay and report federal unemployment tax if cash wages of $1,000 or more in any calendar quarter of 2013 or 2014 are paid to all household employees combined. Do not count wages you pay to your spouse, your child under the age of 21, or your parent. See IRS Publication 926 for more details on exclusions.
Federal Income Tax. Withhold and pay federal income tax if requested by the household employee (Form W-4, Employee Withholding Allowance Certificate completed by employee). Federal income tax withholding is optional on the part of the household employer, unless the employee asks for it and you agree to it.
Federal Wage and Hour Law Requirements. Household employers must meet federal wage and hour requirements under the Fair Labor Standards Act including but not limited to minimum wage and overtime requirements, where applicable. The U.S. Department of Labor, Wage and Hour Division can provide additional information at www.dol.gov.
When filing your federal income tax return, use Schedule H (Form 1040), Household Employment Taxes, to calculate your total household employment taxes (Social Security, Medicare, FUTA, and withheld federal income taxes). Add these household employment taxes to your income tax. Attach Schedule H to Form 1040.
If you want to make estimated tax payments to cover household employment taxes, get Form 1040-ES, Estimated Tax for Individuals. If you did not pay enough income and household employment taxes during the year, you may be subject to the estimated tax underpayment penalty. See IRS Publication 505, Tax Withholding and Estimated Tax, for information about this penalty.
Prepare and provide your employee Copies B, C, and 2 of Form W-2, Wage and Tax Statement, if applicable. Send Copy A of Form W-2, with transmittal Form W-3, to the Social Security Administration, if applicable.
Form 941, Form 943, or Form 944
If you own a business as a sole proprietor or your home is on a farm operated for profit you can choose to pay the household employment taxes with the business or farm employment taxes, and include the applicable amounts on Form 941, 943, or 944 for your business.
File Form W-2 for the household employee with the Forms W-2 and W-3 for your business employees. Include the household FUTA tax on your Form 940. For more information, see IRS Publication 15.
States generally follow federal rules regarding domestic employees. There are exceptions, so please refer to your state’s laws.
State Income Tax. This tax is withheld if the employee requests withholding and the employer agrees. See your state regulations for details.
State Unemployment Insurance (SUI). Some states follow the federal rules for unemployment insurance reporting for domestic employees; however, some set their own. Check with your state for SUI reporting requirements.
Workers’ Compensation. Check your state laws regarding workers’ compensation insurance. Some homeowners’ policies may already provide coverage for domestic workers.
State Disability Insurance. In some states, individuals who hire domestic employees are required to contribute to a state disability insurance fund while some states require employers to withhold disability taxes from the employee’s pay.
State & Municipal Labor Law Standards. Some states and municipalities have additional requirements regarding minimum wage standards, overtime requirements, written wage notices (or employment agreements), detailed pay stubs, paid sick leave and paid vacation.
Managing household taxes and payroll responsibilities may be a complex process for busy families. This is why some people are inclined to pay household help “off the books.” But, as pointed out, this is not a wise decision. To avoid the headaches with paying a household employee, some people hire the employee directly from an employment agency. Or, as an alternative, you can use a payroll company.
Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He probably is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.Write comment (0 Comments)